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Just What Do Hedge Fund Honchos Do For a Million Bucks an Hour?

Les Leopold's new book reveals that hedge funds make their super-profits by doing what the rest of us would call cheating.

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In fact, hedge fund apologists take it one step further. They claim hedge funds dissipate risk throughout the economy; that hedge fund managers are the brave, bold entrepreneurs who are the only ones willing to take risky investments off the timid shoulders of those who don't want them. This not only helps cautious investors protect their portfolios, we are told, but it makes the entire economy safer.

Sounds great, doesn't it? Except it's not true. Just go back to the housing bubble. Rather than dissipating risk, hedge funds helped to increase and concentrate it. Rather than making the system more stable, they helped it explode. As I show in the book, step by painful step, hedge funds did all they could to build up, and then crash, the housing bubble so that they could do one thing, and one thing only -- extract enormous profits.

Josh, I really didn't expect to find what I ultimately discovered -- that hedge fund super-profits actually come from what the rest of America would call cheating. I think readers will be as amazed as I am to learn about the various ways hedge funds rig the game. (I've even got a confession from Jim Cramer of Mad Money .)

JH: Les, I want to get your reaction to a fit of pique from John Paulson, who heads the Paulson & Co. hedge fund. When Occupy Wall Street was in the public eye, he issued a press release. Let me quote it:

The top 1% of New Yorkers pay over 40% of all income taxes, providing huge benefits to everyone in our city and state. Paulson & Co. and its employees have paid hundreds of millions of dollars in New York City and New York State taxes in recent years and have created over 100 high-paying jobs in New York City since its formation.

New York currently has the highest income taxes of any state in the country and thousands of businesses have fled New York to states with no income taxes such as Florida, Texas and Nevada, or moved offshore.

Instead of vilifying our most successful businesses, we should be supporting them and encouraging them to remain in New York City and continue to grow.

Your reaction?

LL: Josh, are you trying to raise my blood pressure? I could write another book about how out-to-lunch Paulson's comments really are. First off, Paulson himself is not suffering. He took in $4.9 billion in 2010 -- that comes out to about $2.4 million an hour. And with all that profit he created only 100 jobs? That's a disgrace.

Second, hedge funds like his take advantage of an incredible income tax loophole called "carried interest." At the time of his rant, Paulson was probably using a federal tax provision that limited most of his income to a 15 percent tax rather than the top rate of 35 percent. His overall tax rate was probably less than his chauffeur's. And note how he neglects to mention payroll and sales taxes that the average New Yorker pays in a higher proportion than he does. And, he fails to note that whatever he pays in New York state and local taxes is deducted from his federal taxes.

As for businesses fleeing, Paulson seems to be blissfully unaware that study after study shows how marginal tax rates have little or no impact on where businesses and individuals locate. And he'll need to explain why Wall Street's casinos haven't already fled the higher taxes in New York for low-tax Las Vegas. Maybe it's because the casinos in Nevada are more regulated than those on Wall Street?

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