Hedge Fund Compensation
Earlier this week, I asked, "What's Wrong With Billionaire Fund Managers?"
We noted the very top % of this profession carried enormous compensation for those Alpha creators who earned tremendous returns for their partners. Most of the top earners are also have very significant holdings in their own funds. They not only get paid for taking risks with OPM, but with their own money at risk as well.
At the same time, if you really want to be upset at enormous paydays, the collection of thieving former CEOs who helped destroy shareholder value then parachuted out with 100s of millions of dollars were better targets for your ire.
All About Alpha looked at manager compensation from a different perspective, and asked Is high hedge fund compensation really that new?
Their approach was from a different angle, based on both earnings size and source
1. Appreciation vs. Compensation
2. Paper vs. Cash
3. Income vs. Options
4. “Creating” vs. “Speculating”
Here is the quadrant they put together:
In today's NYT, Harvard prof Greg Mankiw also looks at wealth disparities, using Lloyd C. Blankfein, chief executive of Goldman Sachs and Bill & Hillary Clinton as examples (The Wealth Trajectory: Rewards for the Few).
Note to Professor Mankiw: From a statistical perspective, perhaps another example from a pool of candidates greater than three (living former US Presidents) or one (the most recently retired President) might be more suitable, informative and tad a less political. That choice tainted an otherwise fine article...
Courtesy of NYT
>
Previously:
What's Wrong With Billionaire Fund Managers? http://bigpicture.typepad.com/comments/2008/04/whats-wrong-wit.html
Source:
Is high hedge fund compensation really that new?
All About Alpha, 17 April 2008
http://allaboutalpha.com/blog/2008/04/17/is-high-hedge-fund-compensation-really-that-new/
The Wealth Trajectory: Rewards for the Few
N. GREGORY MANKIW
NYT, April 20, 2008
http://www.nytimes.com/2008/04/20/business/20view.html
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You kept telling us how they put there money at risk. Look if the game is fixed, is their money at risk? Take a basketball analogy. You bet on your team to win. You put your money at risk. Is the risk more or less if you know the players in the game. You know one player and he is going to to toss the game for extra reward. Certainly your money is at some risk depending on how much this guy will be able to control the game. Certainly not as much as if you didn't know anything.
CEO's didn't create a false market to get rich. They didn't fall back on taxpayers to bailout their poor choices.
If you honestly think that hedgies are not using taxpayer money now to play in oil futures, your blind. That is going to affect everybody that posts here. I don't think you can say that about any golden parachutists.
Posted by: Ken H. | Apr 20, 2008 8:40:07 AM
What kind of crystal ball do you have that you know that "money earned" by hedge funds isn't just a mirage, like the banking profits?
Hedge funds lack transparency and without it to suggest that they've earned tremendous returns is speculation. You can't possibly know if it is real or just an illusion like the illusion the banks had until it faded.
~~~
BR: Because they get mark to market daily, weekly quarterly. The compensation is based on the net gains in the account.
Short of fraud, the money is either there or not. Its not merely an accounting entry -- its real cash.
Posted by: Deborah | Apr 20, 2008 8:52:12 AM
I vaguely recall some data out in later 2006 or 2007 which showed the failure rates of hedge funds approaching that of a typical US small business (within five years 70% failure... something like that.)
If that's the case, more power to the ones that succeed. But as in investor in them, realize you're basically investing in a business that's a bit more successful than a liquor store (the most failures in five years) and worse than a dry cleaner (one of the best.)
Posted by: VennData | Apr 20, 2008 9:12:45 AM
yawn....
I don't hear an outcry over the "excessive pay" of Britney Spears or the Olsen twins.
I don't hear the parents of thousands of top tier college students complaining about hedge-fund-return-subsidized scholarships.
Money managers get paid "exorbitant" amounts cuz their skills are massively scalable, just like entertainment celebrities.
Backlash against fund managers is just the 21st continuation of the media's/intelligentsia's/populist's disdain of "the East Coast Banker" just as in John Ford's film *Stagecoach* or Capra's *It's a Wonderful Life*.
Sincerely,
Leftie, pinko, progressive who believes that capitialism is the worst economic theory except for all the others that have been tried.
Posted by: i try to avoid reading comments but still can't help myself | Apr 20, 2008 9:24:20 AM
MANKIW is a no talent hack, a sycophant to the Bush administration, that's the reason why Clinton is mentioned multiple times.
I think the uneasiness of the Hedge fund compensation, is because we've heard the exact same justifications all before when CEO pay started to go to obscene levels.
And in the past nobody cared about excessive income inequality, because everybody was doing well. Corporate performance used to be tied to employment growth, increased pay, better benefits, but there's a growing disconnect between what's good for the boardroom is good for Main Street.
Americans have had a more favorable attitude towards Corporations because they did many of the things government didn't do. Health care, pensions, sick time, quality of life. And in return, Americans had the least restrictive rules than all other western nations.
Over the last 25 years, the corporations have been abandoning their caretaker role, but at the same time they want the freedom to act as they always had (low taxes, low regulation). And what you are seeing is the American people slowly realizing they can't have it both ways.
As American companies move further away from their society and worker caretaker role, the American people will move towards more socialist policies.
Posted by: Dervin | Apr 20, 2008 9:27:46 AM
All of this debate on income inequality is very interesting. I believe Mankiw is wrong in his conclusions but at least he brings up a topic many don't want to discuss. For Mankiw to identify the problems, he would need to unlearn many of the biases that define him and define the general consensus of group think by current economists. The answer is right in front of him yet he is blinded to what it is.
One can't assume just because a hedge fund manager made a lot of money that they were doing wrong or that they did so because the game is fixed or rigged or because they took undue risk. Although undue risk, lack of transparency and unsustainable profits do play a role in general financial industry profits.
Bill Gates made billions but people look at that differently because it was 'business' and not Wall Street. But his game was, to use wording from another poster, rigged as well. Microsoft did not abide by free market principals. They are a monopoly and as such their business practices entailed unsavory deeds that destroyed capital and competitors just as has happened with many hedge funds. That is capitalism. And it provides everyone who posts on here with a job. It isn't always pretty. And, it doesn't always entail free markets. And, neither hedge funds nor Microsoft represent free markets.
That said, who gets to decide what is moral and what is not? What business should be able to earn money and which should give it all back? To assign morality to business is a false notion. Business does not have a conscience. People do. Society does. Business does not have a mandate to meet some extraneous morality that has a different definition depending on the person asked. It has an obligation to operate within the framework of rules. Those rules are defined by the referee or the government. Those being laws and regulation. The problem is with the rules and by conclusion the rule makers not with those playing the game. Although indirectly those playing the game have impacted the rules in ways they should not be able to. That too is a problem. If society doesn't like the rules, change them. Or get a new referee. Or both.
Posted by: bdg123 | Apr 20, 2008 9:31:21 AM
Barry,
The compensation of hedge fund managers is indeed getting out of control, but to almost defer the blame to just CEOs that plunder shareholder wealth doesn't even begin to explain it.
Entertainers (athletes, actors, musicians, etc), CEOs (and other executives), and those that manage money (ibankers, money managers, etc) - all have had their pay scales rise exponentially in comparison to the average worker.
As far as I'm concerned, the U.S. is now divided into 4 social classes, and 3 of them can't keep up:
- lower class
- middle class
- slightly better than middle class
- the ultra rich
We live in a world that's all about the bonus. If your job doesn't have some ridiculous bonus type compensation attached to it, you're most likely getting screwed (hello teachers, doctors, nurses, etc).
Barry,
Just a question (and this is coming from one of your most loyal readers), but: what's your breaking point in all this to when you come out and say there needs to be more regulation for 'exponential pay'?
Dave
Posted by: TraderMD | Apr 20, 2008 9:35:39 AM
I'm with you, Ken H.
If this isn't a rigged game, it certainly has all the appearances of one.
Just look at the top dog in the former post--"What's Wrong With Billionaire Fund Managers?"
John Paulson's an intimate of the very guy who was key in creating this mess. And at the same time Greenspan was assuring us common dopes that everything was OK, Paulson was busy maneuvering behind the scene to make billions off the very fiasco his buddy was overseeing. Now Greenspan works for Paulson!
But if their insider information and priveleged foreknowledge isn't enough and they still crap out? Why then they're the first ones bellied up to the public trough, claiming they are "too big" to fail and their failure would cause "systematic failure." And almost without fail, they get what they ask for, often by fiat of autocratic entities like the Fed who answer to no one. For it is big business and big finance--not labor, not consumers, not small investors--who have their armies of paid lobbyists and insider contacts and who hold the initiative in framing the codes and policy decisions.
You cannot defend this heap of stinking dung. As Frederick Lewis Allen said of Wall Streeters back in the 1930's, "they inevitably lost prestige among the less fortunate. For the rich and powerful could maintain their prestige only by giving the general public what it wanted. It wanted prosperity, economic expansion. It had always been ready to forgive all manner of deficiencies in the Henry Fords who actually produced the goods, whether or not they made millions in the process. But it was not disposed to sympathize unduly with people who failed to produce the goods..."
Posted by: DownSouth | Apr 20, 2008 9:47:56 AM
Honestly, who cares..
Inflation adjust compensation for a hundred years ago (divide by .02) and billionaire is just the old millionaire.
After 3 generations or so, the deck gets re-shuffled. Except in history books or endowments, what happened to the Morgans, Pullmans, Kellogs, Rockefellers, Sloans, Posts, Hursts and other 'old' money fortunes?
Posted by: Ross | Apr 20, 2008 9:53:11 AM
The inequality of compensation has been institutionalized over the last 30 years. We went from wage inflation to asset inflation with the help of the Federal Reserve and our government. Exactly how much money has been given to business outside of the finance rabbit hole? ZERO!
There is a mean when it comes to compensation, and like all things it swings wildly but always returns to the mean. This issue will be no different once it sinks into the consciousness of our society. $3.7 Billion because you were better at gearing money that was borrowed in a Vegas style casino makes you a lucky gambler. Don't believe me? Just ask The Hedge Fund of the Year that was toasted at a ceremony in Jan. - Feb. before it was toasted in the market. Red or Black?
Posted by: SPECTRE of Deflation | Apr 20, 2008 10:15:11 AM
We know that equity is granted as a form of compensation. If earlier-year "pay" is presented as later-year "equity" I'm not going to be that impressed.
In fact, I'm going to go with my guy and say that little, if any, of this "personal investment" came in the door with them, as their old money.
(I say this even, as someone who did make a fair chunk on options granted for my services as an employee.)
I think you're running a fast one on us.
Posted by: odograph | Apr 20, 2008 10:20:18 AM
re Britney ... her misbehavior did not cause the Fed to drop rates, reduce my income, and increase the level of inflation I face.
Ye Gods! To call "communism!" in the face of Wall Street's socialization of losses!!!
(Britney also did ever pretend fiduciary responsibility.)
Posted by: odograph | Apr 20, 2008 10:23:58 AM
Geez, this is turning into another sour grapes/socialism thread.
Nobody is preventing any of you from
"speculating" like the hedge funds and making
millions. Just go ahead and do it.
Mortgage your house, your job, and just do it
instead of complaining of people that did not
break any laws.
I'm all for socialism / grass roots movement for the avg joe out there, with more healthcare, higher minimum wages, better pensions, more holidays.
But complaining about someone else's success at investing/speculatin is pointless.
Fine, we can raise the capital gains taxes for these guys... and let Bush spend it on the war in Iraq.
Posted by: rickrude | Apr 20, 2008 10:24:49 AM
heh s/guy/gut/
the gut may be growing in middle age but is not yet another person
Posted by: odograph | Apr 20, 2008 10:25:52 AM
An expert always comes from somewhere else. People who are likable also are sincere. Friendly experts who manage money in a far off place are godlike beings. Give them your money. They deserve it. You will be better off for having trusted their omniscience. Especially if their funds are highly leveraged and their pay is guaranteed.
Remember, high profits are just around the corner and the hedge funds always have the correct answer waiting for you. They have charts to prove it.
Derivatives are your friend. You can makes bundles of money with only a tiny down payment. Don't stop with the hedge funds. Manage your own investments and watch the money machine roll in the dollars. Make your friends jealous and win!
If you only know the right people, markets only go up. All you have to do is believe!
Posted by: cinefoz | Apr 20, 2008 10:26:43 AM
Someone calculated that the interest rate cuts have reduced income of Americans with CDs by an aggregate of 90 billion dollars.
Socialization of losses, anyone?
Posted by: odograph | Apr 20, 2008 10:29:14 AM
The inequality of compensation has been institutionalized over the last 30 years by the Federal Reserve and our Government. Wage inflation was stomped down while asset inflation was encouraged at every step. How much has been given to business outside of the finance rabbit hole? ZERO!
$3.7 Billion Dollars because you used gearing on borrowed money is insane, and it shows the Vegas style casino we call the market is badly out of whack. Just ask the Hedge Fund of The Year which was toasted in London in January of this year before they were toasted by said market months later. Red or Black Barry!
Posted by: SPECTRE of Deflation | Apr 20, 2008 10:30:15 AM
“Xavier Gabaix, a finance professor at New York University, said it is not clear whether such gaping inequality is necessarily bad. “Because hedge fund managers make their money by charging fees on investments from rich people, these fees represent the redistribution of wealth from the rich to the very rich, he said.
“By contrast, the income inequality plaguing many developing countries represents rich people profiting at the expense of the poor, he said.”
…Make their money charging fees on investments for rich/ “accredited guardians” of capitalism – but by doing what?
Posted by: Nihilism | Apr 20, 2008 10:35:30 AM
If you honestly think that hedgies are not using taxpayer money now to play in oil futures, your blind. That is going to affect everybody that posts here. I don't think you can say that about any golden parachutists.
Posted by: Ken H. | Apr 20, 2008 8:40:07 AM
????????????????????????????????
Duh ?? Hedge funds are using Tax payer money ??
Source please !!!
Posted by: rickrude | Apr 20, 2008 10:38:15 AM
Are you people delusional? Of course this is a rigged game.
And not, Darvin, this not like Microsoft-in fact, it is the exact opposite. There can be no monopoly but government-run and government-sponsored monopolies. Free-market capitalism means a company can act as it pleases, as long as it doesn't aggress against other people and their property. The should be able to compete fiercely, collaborate fully, and charge whatever amount that they think the market can sustain. If they charge "excessively" then that is a profit signal for new, often disruptive competitors. Look what hapenned to IBMs "monopoly", Xerox's "monopoly", now Microsoft's "monopoly", and someday Google's "monopoly".
Now, the banking system and Wall Street is unique because they ARE a government sponsored monopoly. Why? Because they are "systemically important" to the economy. Commercial banks are the first to receive newly printed money, the only business allowed to produce multiple claims on the same assets (frax reserve), and the only industry to have a guardian-angel "of last resort" to fall back to when things get tough.
And now these privileges are being afforded to the "shadow financial system" as well, who in the mean-time had the leeway (rightfully so IMO)to conduct its business with almost zero regulation. Let them spin derivatives, domicile offshore, and short the market, as long as YOU LET THEM PAY when those margin calls come in.
The moral hazard that is currently built into the system will have catastrophic consequences when (not if) the very clever passing game of moral hazard-->undue risk-taking-->socialization of losses-->monetary inflation-->ballooning foreign debt, eventually stops.
How? Quite simply, the dollar cannot go on being the global reserve currency when other more sensible alternatives appear on the horizon...(euro maybe?) Once China and the PetroStates find an alternative to the sucker game they've been forced in for so many years, they'll stop buying into US debt. And then and there, the whole system comes apart.
ALL of this is because the US has been trying to finance an empire. Through this scheme, it has succeeded to use OPM to do it, but it can't go on forever, and there are many signs to suggest that we are at the beginning of the end.
All gloom and doom you say? The US is leading the charge in transitioning to a market-state from a nation-state. The problem is that unlike the theoretically "ideal" outcome, the transition period is fraught with corruption and rigged games, and THAT is the hardest to leave behind.
Why should JP Morgan root for a truly free-market when it can have all the benefits, with zero risk (government sponsoring).
We went from governments running the show, and are trying to go to a place where private enterprise runs the show.
Trouble is, the transition means that the current reps of "private enterprise" have ever larger powers, but are still protected by government's mantle.
This cozy relationship is far too tempting to leave for a "purer" one. To move past it means that government will not be free to use this system of conduits (that's what they are to them) to inflate the money supply, and use that money for what THEY think must be done (wars, intelligence, plus the inevitable lining of pockets for the "conduits" to keep the system going).
And for private enterprise to move past it means to give up the "special" status they enjoy every time the fed runs the printing presses, or give up the no-fee insurance policy the government runs on their behalf.
And when options get fewer? Shit, there's always someone out there to invade!
THIS is where I think the road to the market -state will first stick, and its only undoing will be a collapse of trust in the US government and the greenback.
The question is, will the backlash be toward true free markets, or back to more authoritative, socialist systems of governance?
Unfortunately, I don't see any true free-market economy rising to compete with the US and show the way. Up-and-coming socialist models of "capitalism" however...(monetarism)...well I could point to a few.
God help us if we move down that road again.
Posted by: Whitespiral | Apr 20, 2008 10:43:37 AM
Sorry-meant dbg123 not Darvin above.
Posted by: Whitespiral | Apr 20, 2008 10:45:15 AM
Although indirectly those playing the game have impacted the rules in ways they should not be able to. That too is a problem. If society doesn't like the rules, change them. Or get a new referee. Or both.
Posted by: bdg123 | Apr 20, 2008 9:31:21 AM
______
What's the easiest way to rob a bank? Own the bank.
What's the easiest way to avoid going to jail for robbing a bank? Own the police, the prosecutors, and the judges.
Therein lies the fixing of the game (impacting the game by failure to enforce existing rules and/or by changing the rules to favor certain players).
Interestingly, the second part of your conclusion - that society can change the rules - points out a larger and more alarming situation: "Society" already had/has rules in place to prevent the merger of corporate and political powers (and the attendant looting of national wealth) such as we are currently witnessing.
Although this transformation of our basic government structure appears legitimate (seemingly having sprung fully formed from the ether by magic, and having merged seamlessly and effortlessly with the pre-existing infrastructure), this apparent legitimacy is only because the system has abrogated its responsibility to enforce the laws governing such a merger of political/economic power.
The electorate has defaulted - not by choice, but by failing to recognize the subtle but fundamental political changes in our regulatory and enforcement systems. In doing so, it has remained ignorant of both the magnitude and the inherent danger of those changes.
I think we've witnessed the first bloodless coup of the 21st century. We are now non-voting shareholders in our own government (sure you get a vote, but it's non-binding on management). In a stunning display of the power of mass marketing, we have been persuaded to focus on the flag (our corporate logo) instead of our Constitution (our corporate bylaws). This is clearly the path to serfdom (the end-game of unregulated capitalism).
Meet the new boss. NOT the same as the old boss.
Posted by: Marcus Aurelius | Apr 20, 2008 10:58:41 AM
Harvard prof Greg Mankiw writes "A top education is no guarantee of great riches, but it often helps."
Society can't be full of chiefs, it must have its share of indians.
The indians drive the majority of markets, you all know that.
Posted by: Greg0658 | Apr 20, 2008 11:04:48 AM
Hey Barry,
Why are you obsessing with hedge fund managers and CEO compensation, but at the same time ignoring “draconian” compensation paid to Hollywood freaks, baseball players, and people like Oprah (she is a billionaire)?
Posted by: Bear Requiem | Apr 20, 2008 11:05:29 AM
Marcus Aurelius,
Well said.
Posted by: DownSouth | Apr 20, 2008 11:16:59 AM
