Live blogging hedge fund hearing!

November 13, 2008

Today’s main event — the fifth in a series of hearings examining the market meltdown — is likely to be a lively hearing featuring five top hedge fund managers and a group of professors, among them former SEC Chairman David Ruder. The prepared testimony is available on the committee’s site.

Henry Waxman just opened the hearing, noting that each of the five hedge fund managers made over $1 billion a year and that current tax rules allow them to be taxed at just 15% — “a lower tax rate than school teachers, firefighters and even plumbers.”

Stay tuned for more….we’ll be live blogging today’s hearing.

2:02 pm: Waxman wraps it up by saying he believes there’s been a consensus that hedge funds cause systemic risk and that the current tax system isn’t fair. Also thanked the witnesses for their thoughts on TARP. Time for lunch!

1:56 pm: Rep. Issa asks a question about calculating leverage.

1:50 pm: Rep. Van Hollen asks a question about regulators and asks whether the SEC or some other group should be able to go in and fix things. Soros, Paulson and Falcone agree. Griffin says rules need to be clear so that he knows how to run his business. Adds that there needs to be a solution to meet all financial markets.

1:44 pm: Rep. Cooper jokingly describes this hearing as Paulson v. Paulson and asks about differences between hedge funds that hedge and other types of funds and suggests that some, such as pension funds, may not know exactly what they’re investing in.

1:38 pm: Rep. Yarmuth asks whether the hedge fund managers have a concern about corporate governance and excessive compensation at public companies. Soros says he hasn’t thought about this a lot. The rest talk about the need for profit-sharing. (Ed comment: Nice save! Imagine the headline “Uber-rich hedge fund managers say corporate executives make too much!).

1:26 pm: After thanking Soros for his funding of needles, Rep. Cummings mentions the $1 billion that each of these managers made last year and asks whether the 15% tax rate is fair and asks Paulson in particular whether it is fair since he reportedly made over $3 billion last year. Falcone says that hedge funds should not be treated any differently than any other investor. Says that 98% of his income was taxed as regular income last year. Cummings asks whether the managers would agree to a repeal of the carried interest portion. Soros and Simons agreee. Paulson says it’s “not a loophole”. Griffin makes a distinction between long-term gains and short-term gains.

1:20 pm: Rep. Shays is up again and asks whether income should be taxed as capital gains or earned income. Then he drills into Griffin about costs and asks whether funds that Griffin has his money in have done better than those that he doesn’t have his money in. Griffin quickly shoots him down. Shays seems pretty testy and quickly cuts the witnesses off.

1:13 pm: Griffin says “thousands of high-paying jobs” have been pushed overseas due to too much regulation.

1:06 pm: Rep. Souder scolds Soros for his support of certain drug policies, such as needle exchange programs. (And you thought this was a hearing about hedge funds).

12:44 pm: Rep. Davis asks if there a danger of too much transparency in the hedge fund industry. Griffin says disclosing to regulators is fine, but disclosing to the public would be akin to disclosing the secret formula of Coke to the public. The other managers essentially agree. Davis also asks for the fund managers’ opinions on TARP. Griffin says buying stakes is a good thing, but says where “do we draw the line” outside of the non-banking sector. Falcone says TARP “is a safety net” but that it shouldn’t be used for virtually anyone. Paulson says “list of recipients needs to be expanded to other types of financial firms” including auto finance firms, insurers and others. Says that any company that gets government money under TARP should eliminate cash dividends and that compensation and bonuses should be subject to restrictions. Simons says something has to be done with the assets. “It’s a problem and it’s a big problem.”

12:34 pm: The Q&A part starts and Waxman kicks it off by asking whether the collapse of large hedge funds poses systemic risk and whether that means there should be greater regulation. Soros, Simons and Falcone essentially say yes to both. Paulson says problem is due to too much leverage and that there needs to be more stringent leverage requirements on banks and financial institutions. Notes that not one dollar of the $700 billion in bailout money has “gone to support hedge funds” and cites money given to AIG and GE. Griffin says that private market solutions are the best way to fix crises. Adds that hedge funds are already heavily regulated.

12:29 pm: Ken Griffin of Citadel talks about Citadel’s size (enormous!). “In this crisis the concept of too interconnected to fail has replaced the concept of too-big-to-fail.” Talks about $55 trillion in CDS and says the number is “four times the GDP” of the nation. Suggests a central clearinghouse to correct this problem and says Citadel has begun to build one. “Our markets work best when they are competitive, fair and transparent.” Says Congress, regulators and industry needs to work together.

12:21 pm: Philip Falcone makes four points: Compensation in the hedge fund industry is performance based. Hedge funds use a variety of strategies. Short-selling is a valuable long-standing feature of our markets. And he supports greater transparency and better reporting in the industry. Gives some personal background to say he “wasn’t born on Fifth Avenue” and that good luck and hard work got him where he is today. Says hedge funds need to be looked at as part of the solution for the current turmoil.

12:15 pm: John Paulson of Paulson & Co. says that his fund is good for the economy — growing the number of high-paying jobs 10 times over the past 10 years. Says that in 2005 his fund became very concerned about economic climate and that he purchased CDS leading to substantial (a minor understatement) gains.

12:08 pm: Jim Simons of Renaissance Technologies says rating agencies are “the most culpable” because they allowed “sow’s ears to be sold as silk purses.” Says Renaissance models “tend to be contrarian” and that he stays away from the “alphabet soup” — CDS and CDOs — that Soros just mentioned. Simons goes on to answer the questions that were posed to him prior to the start of the hearing. Adds that he has no problem with changing the tax rules on carried interest, but that it should apply to all such partnerships, not just hedge funds. Says most important thing right now is to keep people in their homes. And he says that there needs to be a new rating agency — “a new non-profit rating agency” that rates derivatives.

Noon: After a brief break, George Soros is up and he’s sticking pretty closely to his prepared comments. “Financial markets are proven to produce bubbles.” Says that regulators have to accept responsibility for controlling bubbles and they also have to control credit. Talks about an “alphabet soup” of new products that are impossible to currently measure and says regulations need to be global in scope. “The entire regulatory framework needs to be reconsidered. But we have to be careful of going overboard. There’s a real danger that the pendulum will swing the other way.” Says regulators aren’t just human, but also bureaucratic and susceptible to political influences. Says amount of money under management will shrink by 50 to 75% and that ill-considered regulations will only worsen the impact.

11:50 am: Rep. Shays (who recently lost his re-election bid) and who notes that he probably represents the largest concentration of hedge fund managers probably in the country (Greenwich) asks whether there was evidence that an implosion was imminent. Also asks whether a centralized exchange would have prevented the problem.

11:44 am: Rep. Van Hollen asks about what additional powers be given the SEC. Ruder says information on risks and leverage should go to the Federal Reserve. Ruder responds saying, “I think it would be wrong for some government agency to tell investors what their leverage should be. Van Hollen also asks about disclosing short positions. Lo responds that he could see a 13-F filing for short positions, but not necessarily one that would be made public.

11:37 am: Rep. Sarbanes asks about exemption for so-called sophisticated investors and asks whether this concept needs to be reassessed.

11:32 am: Rep. Cooper asks whether speculative hedge funds should really be called speculative funds and says pension fund managers don’t really know what they’re getting.

11:15 am: Rep. Lynch asks whether there should be something like a National Safety Transportation Board for hedge fund blow-ups. Lo says that this is a sensible approach.

11:10 am: Rep. Souder says “some of this has to be blamed on incompetency of management and nobody is willing to take the blame. Nobody in the private sector and nobody in government.”

11:01 am: Rep. Tierney asks what happens to the hedge funds that “go under”. Lo says that’s the purpose of greater transparency to see whether this might be a significant market event. Tierney also asks how imploding hedge funds will impact “Main Street”.

10:56 am: Rep. Issa says doctors have the same opportunity as hedge fund managers to get preferential tax treatment due to capital gains. Now asking Ruder about regulations for hedge funds and wants to know what size would exclude them from potential additional SEC regulation.

10:50 am: Rep. Cummings asks about tax rates for hedge fund managers and asks Prof. Bankman to compare that 15% to some other occupations, including teachers, firefighters and plumbers and notes that these people are paying around 25%. Asks whether Joe the Plumber is being taxed at a higher rate than Joe the fund manager. Ah — the return of Joe the Plumber. It took a little over a week!

10:44 am: Rep. Tom Davis asks witnesses whether hedge funds are properly regulated. Rudin says no and that there’s a need for greater transparency. Lo agrees with him that there’s a need for more information. Shadab says that hedge funds tend to take care of their own messes and notes that new funds are being created today, which shows the vitality of the market.

10:33 am: Houman Shadab, a Senior Research Fellow at the Mercatus Center, George Mason University says that “Hedge funds did not cause the financial crisis. They have made markets more stable.” Says that changing how hedge funds are regulated could lead to more financial instability. “When hedge funds get companies to more properly manage their businesses it helps companies run more efficiently.” Lawmakers should make it easier for hedge funds to invest in banks. Suggests also making it easier for ordinary investors to invest in hedge funds.

10:30 am: Joseph Bankman of Stanford University’s Law School is addressing tax issues related to hedge funds and debunks arguments that the capital gains tax rates are fair due to the amount of risk that is being taken.

10:23 am: Andrew Lo of MIT’s Laboratory for Financial Engineering notes declining assets and leverage of hedge funds over the past year and says several thousand will be going out of business. Lo compares hedge funds to banks. “Hedge funds now provide many of the same services as banks, but unlike banks are outside the Federal Reserve System. When hedge funds were a cottage industry, this wasn’t a problem.” But over the past few years, locked in heated competition with one another seeking that extra bit of yield. Lo also notes that banks have also become more like hedge funds. “The economic free-for-all is one of the reasons for the magnitude of the current problem.”

10:20 am: David Ruder calls for some new regulations including reporting the “size and nature of hedge fund risk positions and the nature of their counter-parties” to the SEC, but that the information wouldn’t necessarily be made public. Ruder says to deal with this, the SEC’s budget would need to be expanded dramatically. He adds that this information should be shared with the Federal Reserve.

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