Bailout

How money flows to hedge funds

By Felix Salmon

Why do American hedge funds make so much money? Macroeconomic Resilience reckons that most of it comes, ultimately, from the government:

Just because hedge funds do not directly benefit from a state guarantee doesn?t mean that central bank policy towards the banking sector is irrelevant in determining their returns… the ?alpha? that Magnetar generated would likely not have existed if it were not for the skewed incentives faced by bankers which in turn were driven by the rents they could extract from the state guarantees provided to them.

The example of Magnetar merely illustrates a more general principle that is often ignored: the ultimate beneficiary of any economic rent may be far removed from its initial beneficiary.

Essentially, when the government backstops its banking system, rents will end up flowing to some part of the economy, and not necessarily to banks. In the UK, banks are the primary beneficiaries. In Germany, it’s big companies. And in the US, it’s often hedge funds.

If the Magnetar trade is too recondite for you, then consider the case of David Tepper:

In February and March 2009, when consensus had coalesced among market watchers that certain financial institutions were insolvent and would have to be nationalized, triggering a massive sell-off that drove shares of companies like Citigroup and Bank of America into the single digits, Tepper decided to tune out the chatter. After all, the Treasury Department had said it would hold up the banks?why wouldn?t they keep their promise?

That trade made Tepper something over $7.5 billion. In Europe, he would be excoriated as a profiteer: a billionaire using public policy to ratchet up his net worth to ever-more-stratospheric levels. In America, by contrast, he’s a hero, the living embodiment of everything CNBC viewers admire. His big bets are always on the long side: he makes his billions by seeing opportunity and placing huge bets on things turning out well.

It’s un-American to begrudge Tepper his wealth, even if largely because he has a pair of cartoonishly huge and grotesquely veiny brass testicles attached to a plaque in his hedge fund’s offices. Which makes me wonder what the White House economic team thinks of people like Tepper. My guess is that the more politically-minded among them are deeply appalled, even as the Summers and Geithner types reflexively look past the personality and consider him a pure economic actor who at the margin will help to fuel any recovery.

And I wonder, too, what Tepper thinks of them. Does he thank them for his billions? Or are they just another actor in a game he plays better than anybody else? And if he’s the winner of the game, does that make them losers?

Full post as published by Macroprudential on September 28, 2010 (boomark / email).