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Robert Reich

Feb 28

The awful truth about hedge funds


Bridgewater Associates is the world’s largest hedge fund, managing roughly $125 billion of other people’s money. The New York Times recently reported that its founder, Ray Dalio, agreed to relinquish control of the firm only if it gave him what could amount to billions of dollars in regular payouts over the coming years through a special class of stock.

Dalio already has an estimated net worth of $19 billion.

I first came across Dalio in 2019 when I read his 5,000-word treatise “Why and How Capitalism Needs to be Reformed.” I was intrigued. Here was a major financial figure arguing that capitalism “is not working well for the majority of Americans because it’s producing self-reinforcing spirals up for the haves and down for the have-nots.” That widening wealth gap, Dalio noted, is “bringing about damaging domestic and international conflicts and weakening America’s condition.”

Dalio foresaw one of two outcomes: Either we “re-engineer the system so that the pie is both divided and grown well” or else “we will have great conflict and some form of revolution that will hurt most everyone and will shrink the pie.”

All of that seemed right to me — even more so today. America has already started down the second path. Trump, DeSantis, and other demagogues have been exploiting working-class anger to pump up their power.

But Dalio had no proposal for “re-engineering” the system. To the best of my knowledge, he hasn’t supported a wealth tax or any tax increase on people like himself. He hasn’t proposed stopping giant hedge funds and private equity funds from forcing companies to squeeze out every ounce of profits, typically by suppressing wages and abandoning workers and communities. And he certainly hasn’t proposed capping executive pay.

Worldwide, there are now some 10,000 hedge funds, which together manage about $2 trillion — and they charge their clients a bundle. On top of a 2 percent management fee, they deduct 20 percent of any investment gains. This lets hedge fund managers classify much of their income as “capital gains,” taxed at a far lower rate than regular income. Their wealth has given them so much political clout that this absurd “carried interest” tax loophole remains, despite promises from the last four presidents to close it.

So while schoolteachers and cops face a marginal tax rate of 25 percent, hedge fund managers like Dalio have for years paid only 15 percent on their enormous incomes.

Yet most of the funds Dalio manages come from schoolteachers and cops and other average working Americans. Fully a third come from public pension funds such as the Pennsylvania Public School Employees’ Retirement System. Another third from corporate pension funds that are supposed to guard the retirement savings of their workers, such as those at Kodak and General Motors.

Meanwhile, CEOs and star traders now routinely demand eight-figure compensation packages to keep up with their counterparts at hedge funds.

It’s a giant zero-sum game, as Dalio himself recognizes. “In order to earn more than the market return, you have to take money from somebody else,” he says.

It’s worse than a zero-sum game because hedge funds, like private equity funds, pressure corporations to lay off workers, reduce the (inflation-adjusted) pay of average workers, bust unions, and move production abroad or to anti-labor states.  

They also use their wealth to distort and corrupt American politics, as I’ve already noted.

And they use piles of borrowed money — thereby blowing gigantic, dangerous speculative bubbles. When Wall Street firms got into trouble in 2008, Bridgewater was one of the funds that pulled money out of Lehman Brothers, leaving the American public holding the bag.

There is little justification for hedge funds. If pension funds want to balance out any risks they may take in the stock and bond markets, they can accomplish this far more cheaply through standard leveraging tactics.

Note to pension fund managers: Get the hell out of hedge funds. You’re wasting the retirement money of the workers you’re supposed to represent.

Meanwhile, there’s no justification for the giant compensation packages of hedge fund partners.

Note to pension fund managers: If you absolutely must be in hedge funds, make your voices heard on taming executive pay.

And there’s no justification whatever for maintaining the “carried interest” loophole in the tax code.

Note to President Biden and Congress: Get rid of it.

As Ray Dalio wrote, the system is not working well for the majority of Americans because it’s producing self-reinforcing spirals up for the haves and down for the have-nots. Dalio and his compatriots are part of that self-reinforcing spiral. The rest of us are all the worse for it.

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