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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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Hmm. You think maybe the big hedge funds and banks helped to shape the bailouts?

JH: Another issue that comes up when you think about the financial sector is how much it's grown relative to the rest of the economy over the past decade or so. And critics have pointed out that Wall Street's influence on corporate America -- on non-financial companies -- isn't always positive. There is that short-term thinking that comes with companies trying to meet or exceed quarterly earnings projections, and sometimes they sacrifice long-term growth strategies in the process.

What's your take on the interplay between these hedge funds and the larger economy?

LL: I believe there are multiple influences and most are pernicious. You already mentioned the focus on short-term profits and with it comes a reduction in research and development, disinvestment in employees, outsourcing to low-wage areas, and totally unnecessary plant shutdowns and relocations.

But this book forced me to focus on another main impact -- the dramatic rise in CEO pay compared to average worker pay. In 1970, for every dollar the average worker earned, the top 100 CEOs paid themselves, on average, $40. That's a $40 to $1 ratio. By 2007 the ratio jumped to a whopping $1726 to $1. Nothing in free-market literature can explain that colossal increase -- not increases in skills, experience, new technologies, or new products.

Instead, I believe a large part of it has to do with hedge fund envy -- my new entry into Freudian financial literature. Imagine a CEO in a firm with 50,000 employees watching some 35-year-old hedge fund manager with 50 employees waltz off with $100 to $200 million a year in booty. Imagine how pissed off you'd be making only seven digits. (Yes, it is hard to imagine ever whining about making all that money because we're not animated by greed.)

I believe the enormous gap between financial sector pay and compensation in the rest of the economy motivated CEOs to press their boards for higher pay packages that were more in line with what they saw going to Wall Street's new elites. They all wanted in on the feast...ultimately at our expense.

JH: According to the Wall Street Journal, in 2009 hedge funds controlled about $140 billion in high-frequency trading accounts. This seems like a rip-off for other investors -- a classic case of rent-seeking. What's your take?

LL: Josh, this was one of those out-of-body experiences you sometimes get when chasing a story. I got a chance to interview some New Jersey guys who try to protect their clients from high-speed traders. It was like walking into the Twilight Zone. They took me through the spooky ways in which high-frequency traders extract hidden fees from just about anyone who makes a trade on the stock market.

Catch this: If you're making a trade for your 401k for example, using something like E-Trade, there's a high-speed trader using automatic computer programs waiting out there for you. By the time you hit the "buy" button on your computer, that trader has bought the stock ahead of you and sold it back to you for a profit of a few pennies, which you will hardly notice. They picked your pocket. They do this again and again -- millions of times a minute. Overall, they are extracting from $5 to $20 billion a year from the rest of us -- from our pension funds, mutual funds and other retirement accounts. And in return they produce nothing of value at all.

In fact, from 50 to 80 percent of all trading on the stock market is the result of high-speed trading. Thanks to my sources, I think I do a pretty good job of walking the reader through this murky world. Actually, it's sickening that our regulators allow this industry to exist at all.

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