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Defending the “Hedge Fund Guys” from Donald Trump
Donald Trump has made financial elites one of his latest targets, recently declaring on Face the Nation that, “I have hedge fund guys that are making a lot of money that aren’t paying anything [in taxes]. They’re paying nothing and it’s ridiculous. I want to save the middle class. The hedge fund guys didn’t build this country. These are guys that shift paper around and they get lucky.” As I note in my new column for Defining Ideas, that considerably misstates the case:
The reality is the opposite of what Trump claims. When these hedge fund guys trade, they are not just haphazardly shifting paper around. They are shifting paper as a means to transfer wealth and reallocate risk. Nor do they do it in a self-contained universe. They have paying clients who need accurate information and reliable execution to enter into transactions essential to their business survival.
In countless ways, the financial system—and the bankers and hedge funders that are participating in it—supports the so-called real economy. Start with the simple notion of liquidity. People need to have access to cash and cash equivalents all the time to pay bills and to make investments and gifts. It is those hedge funders who organize complex payment systems—credit, debit, electronic funds transfers, and more—that allow for literally billions of small and large financial transactions to take place every second of every day.
Perhaps these bankers did not build this country by laying down the bricks and mortar for various roads. But even an ignoramus like Trump should know that the scarce commodity in setting up these systems is the architecture and design that allows for individual transactions to go effortlessly forward. The fact that no one pays these transactions any mind is a tribute to how well that task is being done.
Many businesses also operate in international markets. When a manufacturer hedges a currency risk, for example, it eases its long-term planning ability, knowing that a fixed sum has allowed it to remove or control the serious risk of currency fluctuation. This risk could increase their production costs, reduce their output, and result in the layoff of middle class workers on the assembly lines—but it is controlled and hedged because of the modern financial system.
These risk-management systems are not self-funding. Someone has to make financial investments that stoke the engines. Millions of people have savings and pension funds and stock and bond portfolios that do not magically organize themselves free of human intelligence and coordination. Acting as isolated individuals, these small fund owners have no idea which investments to make, how long to hold them, and when to sell them. It is the “hedge fund guys” that take up this challenge.
Trump thinks he knows how the individuals who work in this highly risky, highly stressful, highly visible, and highly regulated space should be compensated. But he should think twice before second guessing how independent businesses led by trained professionals should best compensate their key employees. Humility is the first sign of wisdom in examining these far-flung markets. It is a commodity in short supply for Trump and the many other populists who want to manage other people’s money.
You can read the full piece — which also includes a thorough discussion of the debate over the taxation of carried interest — here.
Published in Economics, General
The Hedge Fund class has solidly supported Obama, Hillary, Schumer, and every other left-wing Democrat. Screw them.
A flat sales tax would eliminate the issue.
Mr. Epstein you must be hanging out with a much different group of money managers than I am and I am one.
Where Donald Trump is too hard on them, you are too easy.
I disagree with your rose-colored assessment of the hedge fund industry’s contribution to society. The world and the financial system worked just fine, arguably better, before the year 2000 when hedge fund assets were a lot smaller than now. If hedge funds provide liquidity, it is mainly to… other hedge funds that trade manically via human traders or super-manically via high-frequency algorithms.
Trump’s higher tax will not really change much. What is needed is more regulation, transparency and accountability.
Donald Trump doesn’t understand a complex issue? I am shocked. SHOCKED!
So what does this have to do with whether or not they are taxed equitably?
Great article, Prof. Epstein. Most people don’t understand how the financial system works, or how it is a critical underpinning to our economic success. They see people getting rich, who appear to be doing little or nothing, and they object. Come to think of it, we lawyers face the same problem of public perception.
This is not to say that all of the finance guys and gals are heroic white knights. Many of them are money-grubbing opportunists. What people don’t understand is what Adam Smith taught more than two centuries ago — that the “invisible hand” of the market harnesses their self-interest to advance the well-being of the public at large.
Most people also don’t understand that in this area, as in so many others, governmental intrusions into the free market often do more harm than good, even if undertaken with the best of intentions.
I do not quibble with what the ‘hedge fund guys’ do nor with how they are compensated. Neither is Trump.
But…
If they want a capital gain they should pony up their own money and invest in the fund. As fund managers they earn a fee which is taxed as ordinary income and their skice of the fund profits which gets taxed as capital gains. THAT is hokum. Its a bonus. Plain and simple. I don’t care HOW it is calculated. It is a garden variety bonus. And THAT’S ordinary income. Just how the fix was put in to classify this particular bonus as a capital gain, I don’t know. But it is pretty outrageous.
Trump is right on this one.
A note of clarification. Incentive fees earned by the general partners in a traditional hedge fund GP/LP structure are treated as ordinary income. Same as fees earned by CTA’s and other advisors using the LPA model.
The carried interest treated as capital gains is unique to private equity funds, not generally considered hedge funds in the financial industry.
I acknowledge that somewhere someone can find an exception, but believe those are extremely rare.
Except that the funds he is describing don’t generally have a carried interest provision.
If there is nocarried interest – no harm, no foul. But carried interest for investment managers with no money in the fund is just a example of why we need a flat tax.
Both finance and law could be perceived as ‘extractive industries’, to use the lingo from Why Nations Fail. They don’t produce anything but are necessary to enable others to produce. The tipping point is when the tail wags the dog. To avoid that, heed Churchill’s words: “I would rather see finance less proud and industry more content.”
In accord with Guru here.
The post pretends that Trump wants to demean or even eliminate Hedge Fund Guys and it assumes that he doesn’t know how they function in a (semi) free economy.
But he’s just talking about raising their taxes by eliminating a loophole, nothing more.
I know it’s very, uh, Republican to be against raising taxes on anyone, but I can’t really argue that if I have to pay a huge percentage of my income in taxes and Hedge Fund Guys are having no problem feeding their families and vacay-ing in the Hamptons. Giving millions in political donations to both parties with their couch-change doesn’t help their case. They are buying all the other candidates into silence on this issue. The model is skewed and we all know it. But even free-market capitalist in me can’t see how this is a bad idea in any way.
In no way does Epstein explain how this tax reform will put Hedge Fund Guys out of work or otherwise affect their economic function.
In the above post I mixed up the issue with what Trump said.
But the issue is at the root of this anyway.
Trump is still right in a sense. They are basically traffic cops of money flow and they charge fees on activity like toll collectors. It’s not the same as starting a small business or creating Fed Ex or Apple. It’s not making a major motion picture or producing a Broadway play, or a guy with resort properties and towers.
He’s not trying to convince Richard Epstein of anything. He’s talking to people who see all this with their own eyes.
I have met and talked to some of these guys in social situations. They are, for the most part, very lucky smart go-getters who are money-driven. They have amazing stories and are sharp operators. They aren’t otherwise impressive in any way. They play golf. They have nice houses. They suffer daily at work, commuting, a horrendously stressful workday. It’s American Hustle cubed. But they make insane money and that’s why they do it. But they’d still do it for slightly less insane money.