How Hedge Fund Vampires Use Insider Info to Extract Their Dishonest Fortunes
Ever wonder how hedge funds can make 20 percent returns during the worst economic crisis since the Great Depression, while your savings account grows smaller? Ever wonder how it’s possible for the top hedge fund manager in 2011 to make $1,442,308 an hour , while it takes the average American family over 29 years to earn that much?
Well, a slew of financial writers are quick to tell you that the answer is simple: hedge fund managers are simply much smarter than you are, so get used to it. But that's nonsense.
Hedge funds make enormous sums of money because they have an edge – one that pushes them out to the ethical limit...and beyond. Their edge often depends on obtaining privileged information that is inaccessible to the rest of us. Sometimes they get information illegally through well-paid sources inside corporate boardrooms, as Raj Rajaratnam did before he was sentenced to 11 years in the hoosegow. In other cases, hedge funds can buy it from congressional “sources.” And they even can get it for free when one of their own is appointed to the highest councils of government.
This sets up a vicious cycle – hedge fund money buys more information which leads to more hedge fund money which buys more information. It doesn’t take long for hedge funds to turn Washington into a wholly owned subsidiary.
But, surely this is a gross exaggeration, isn’t it? If only.
Why is privileged information so important?
If you know something that will move markets and the rest of the investment community doesn’t know it, you will make money. If it’s good news for an industry – like news that a regulation will be removed or new money will be coming from Washington– you can jump in and then ride the market up and out. If it’s bad news, you can short the stock and do the reverse. You will always make money as long as you’re ahead of the information curve.
Hedge funds get the scoop on healthcare reform
For example, as the national healthcare bill was nearing completion late in 2009, “Hedge-fund managers at Viking Global Investors and Karsch Capital Management were among investors who met privately…in a nondescript Capitol basement with senators whose support was crucial to passage,” reported the Wall Street Journal . At the meeting, these senators revealed to the hedge funds -- but not as yet to the public -- that there would be no public option in the bill, which, in turn, would be great news to health insurance companies. Lo and behold these hedge funds quickly bought into several large health insurers and made a handsome return in a matter of days...and all of it perfectly legal.
Hedge funds get the scoop on the takeover of Fannie and Freddie
Perhaps the most obscene way to get an edge is when a top official lies to the public and then in private tells hedge funds the truth. In the summer of 2008, when Fannie Mae and Freddie Mac were near collapse, Hank Paulson, Bush’s Treasury secretary, told lawmakers and the press that the government would not take over the two troubled mortgage giants. Instead the Treasury Department, in a confidence-building move, would review their books, while also asking for takeover authority, just in case. Why the takeover authority? As Paulson put it to Congress, “If you have a bazooka, and people know you have it, you’re not likely to take it out.”
This was good news for investors as the stock prices of Fannie and Freddie improved. But if the bazooka was fired and the government took over the two giants, its shares would plummet in value with some preferred classes being liquidated entirely. So if you knew that a government takeover would happen soon, you could short their stocks and make a killing.