WASHINGTON — Billionaires testifying before Congress on Thursday gave guarded support for proposals that would bring greater regulation of hedge funds, the investment funds for the ultra-wealthy being blamed in part for today's global financial turmoil.
Five powerful icons of investment told the House Committee on Oversight and Government Reform that hedge funds should be subject to greater oversight. But they stopped short of supporting public reporting of hedge fund data.
It was just what Democrats in control of Congress wanted to hear. Lawmakers from both parties agree that greater financial regulation is needed amid a steep slump in global financial markets whose likes has not been seen since the Great Depression. But there has not been consensus on what kind of regulation should follow.
"Good regulation is good for every market participant," said Kenneth Griffin, chief executive of the Citadel Investment Group, a Chicago-based financial firm whose varied businesses include a top hedge fund.
Hedge funds invest large pools of capital on behalf of the very rich or big institutions such as charitable endowments, state and local pension plans and university endowments. They had almost $1.9 trillion in assets under management at the end of last year, compared to just $367 billion a decade earlier.
These funds for the mega-rich are at the center of controversy now because so little reporting is required of them. They are big players in the trading of contracts for future delivery of oil, they borrow heavily to bet for or against stocks, and they use their vast amounts of cash to capitalize on small movements in direction on a number of different financial markets.
The lack of reporting makes it difficult to determine with certainty whether they are a cause of today's financial turmoil, or have prevented it from becoming worse since they act as shock absorbers. They take the biggest losses when markets turn south — and enjoy the biggest gains during good times.
Hedge fund chiefs told lawmakers Thursday that they do not believe they are the source of today's financial turmoil.
"Not one dollar yet has been used (from Wall Street rescue programs) to support a hedge fund," said John Paulson, president of Paulson & Co. Inc., a big hedge fund that in January appointed former Federal Reserve Chairman Alan Greenspan to its advisory board. "The problems have been with investment banks and other financial institutions."
Paulson, no relation to Treasury Secretary Henry Paulson, said Congress should adopt limits on how much Wall Street firms can borrow to invest. This sort of speculative borrowing bankrupted investment bank Lehman Brothers in September, triggering a cardiac arrest in the global financial system.
"The authorities have been involved since then in resuscitating the system, but it has been a tremendous shock, the impact of which has not been fully felt," testified George Soros, the billionaire hedge fund pioneer.
Former Defense Department code-breaker James Simons, president of Renaissance Technologies, said more regulation of hedge funds would provide greater transparency and comfort to other market participants. Renaissance is one of the oldest hedge funds, and uses complex mathematical models that trigger large, automated trades.
"Certainly the possibility exists that an individual hedge fund or hedge funds as an aggregate (or group) could be the cause of systemic risk," Simons said, adding that "regulation in the form of reporting up to the SEC (Securities and Exchange Commission) in a more detailed manner than is presently done, with that information aggregated and passed to the Federal Reserve or some such (agency) would be a good approach."
By providing confidential information that can be compiled and analyzed, a federal regulator could learn whether too much risk was building up and whether a company's investments were so large that they could pose a risk to the broader financial system.
The fund managers on average each earned $1 billion through their funds, which compensated them through performance. They cautioned against making public the positions of individual hedge funds, since it would compromise their strategy, and other proprietary information.
Hedge fund managers are controversial because they earn a management fee that is a percentage of earnings. This compensation is taxed as a capital gain, currently at 15 percent, instead of ordinary income, which would put them in the highest tax bracket. This leads to the perverse scenario where a secretary at a hedge fund pays a higher percentage of her income in taxes than does a billionaire fund manager.
The compensation issue got little attention on Thursday. A measure to subject hedge fund managers to ordinary income tax rates passed the House of Representatives in the current congress but failed to advance in the Senate.
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All prepared remarks from hearing
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