America's New Math: 1 Wall Street Hour = 21 Years of Hard Work For the Rest of Us
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We also are told that these guys (and yes, they are all guys) make big bucks because they're terrific gamblers, the very best poker players in the financial world. But that's a misleading analogy. Evidence suggest that many are more like card sharks. They don't really want to gamble. Instead they always seeking to bet on a sure thing. Better yet, they would prefer to create a rigged bet. Sounds far fetched? I'd wager that the financial maneuvers I'm about to list understate the severity of hedge fund cheating. (For more detailed information please see my workshop on C-Span Book TV.)
1. Insider trading. Many hedge funds (and we don't know how many) make their money through illegal insider tips. If you know something big is about to happen to a company that no other outsider is supposed to know, you're betting on a sure thing. So far U.S. Attorney Preet Bharara has nailed about 70 hedge fund honchos for obtaining illegal tips. The billionaire Raj Rajaratnam tried, found guilty and put away for nine years. And the third richest hedge fund earner in 2012, billionaire Steven Cohn, is watching as several of his high-level employees succumb to federal indictments. He could be next.
How endemic are these crimes? We can only speculate, but this much is clear. It's very hard to nail someone for insider trading. So the odds of ever getting caught are slim given that there are 9,000 hedge funds. But perhaps we should listen to the man closest to the prosecutions:
"Given the scope of the allegations to date, we are not talking simply about the occasional corrupt individual. We are talking about something verging on a corrupt business model." -- U.S. Attorney Preet Bharara, NYT, May 27, 2011
2. Design financial products to fail so you can collect the insurance. This was the game of choice before and during the housing bubble. We know for certain that hedge funds colluded with big banks to create mortgage-related securities that were designed to crash and burn, so hedge fund investors could bet against them. In fact, the hedge fund bettors designed the bets by assembling the worst mortgages they could find to place into the securities.
Sounds strange? It is. In fact, nowhere else in capitalism is something this shoddy permitted. It's precisely like designing and building a home to fall down in six months so that you, the seller, can collect the insurance. Goldman Sachs, JPMorgan Chase and Citigroup have paid over a $1 billion in SEC fines for misleading investors about these shoddy deals. But their hedge fund partners made billions on the insurance and didn't have to cough up a dime in penalties.
Not only did these deals defraud investors, but overall they puffed up the housing boom and then accelerated the crash. Without any exaggeration, these scams had no positive redeeming value for the economy. We're talking pure rip-off.
3. Manipulating the media -- rumor mongering. If you're really clever you can slip phony tips to gullible reporters; information that is designed to assist your betting strategies. For example, you can set off rumors about a particular bank's solvency while you're betting against that bank. If you can help set off a bank run, so much the better, because then you can really win big. However, rumor mongering violates the law...if you're caught.
What evidence do we have that this really goes on? Ask Jim Cramer, the frenetic star of "Mad Money." Over a decade ago he ran a very successful hedge fund. Years later he admitted during an online interview (transcript here) that he fed false rumors to his comrades at CNBC so Cramer's hedge fund could cash in on them. (The statue of limitations had already run when he confessed his sins.) Furthermore, he said point blank if you're not willing to violate the rules, "maybe you shouldn't be in this game."