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What social functions do hedge funds provide, indeed? Renaissance Technologies avoided $6bn in taxes by using derivatives to pretend their ultra-high frequency

• m52go 12y ago
  You're conflating 'social' with 'moral'. Everything you mentioned is morally questionable, not socially harmful.
  • atmosx 12y ago
    Geez we all enjoy the benefits of the 2008 financial crisis. Society was never happier.
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    • spindritf 12y ago
      The 2008 financial crisis was not brought on by people avoiding taxes. I don't think any crisis can be caused this way because the US government can easily borrow money when it needs and clamp down on tax avoidance or raise taxes later.
    • m52go 12y ago
      That was almost entirely caused by an institution known as the BANK. Banks and hedge funds are totally different things. Likening one to the other is like saying Google and Square are both evil just because they're technology companies. You seem to lack a fundamental understanding of the financial system.
      • atmosx 12y ago
        Oh really? So in your dictionary AIG is a bank, like say BoA. You seem like having a deep understanding of the financial system. Don't forget to edit the wikipedia page, these guys got it all wrong[2] oh yes the WSJ[1] too! [1] http://online.wsj.com/articles/SB123734123180365061 http://online.wsj.com/articles/SB123734123180365061 [2] http://en.wikipedia.org/wiki/American_International_Group#Liquidity_crisis_and_government_bailout http://en.wikipedia.org/wiki/American_International_Group#Li...
        • m52go 12y ago
          There were many types of institutions involved in the 2008 crash, from traditional banks to investment banks to ratings agencies to insurance firms to mortgage brokers to governmental bodies and more. The root cause of the crash was unquestionably the banks. It was the banks that lowered their standards, made bad loans, and packaged them up into MBSs and CLOs to ship them off to other institutions to trade and insure so they could make more bad loans. If the banks didn't make these loans, AIG would have had nothing to insure. Goldman would have nothing to trade. S&P would have nothing to rate. Et cetera. Don't misconstrue what I'm saying as vindicating everyone else. They all royally messed up too. It's just that the banks started and perpetuated it all.
  • bksenior 12y ago
    No, you are conflating 'social' with 'legal.'
    • m52go 12y ago
      I should have said moral AND legal. Those companies' actions are morally wrong and legally wrong. Social good is totally different. Are you assuming money paid in taxes is socially good?
  • simonster 12y ago
    Most moral wrongs are also social wrongs. Laws and regulations exist for the good of society, and flouting those laws is bad for the public good. If you pay less in taxes than you ought to, that means that the average citizen either pays more in taxes or doesn't get the social services those taxes would have paid for. Insider trading means that the insiders profit at the expense of the outsiders, who are typically far more numerous.
    • m52go 12y ago
      > If you pay less in taxes than you ought to, that means that the average citizen either pays more in taxes or doesn't get the social services those taxes would have paid for. No, it means SOMEONE is paying more. That someone could be a rich person, another company, or a smorgasbord of other taxpayers. You can't assume it's Joe the Plumber who's paying more taxes (on average, because proportionally, corporations and rich people pay most taxes). Also, don't assume those taxes would have paid for social services. They could have also been used to kill innocent women and children in unspeakably nasty ways (on average, most of the budget does NOT actually go to social services). The vast majority of trading is done by institutions, so here again, your assumption that Joe the Plumber gets hurt by the big bad hedge funds doing insider trading is faulty. Yes, 401(k)s might get hit, but it's not your average E*TRADE daytrader who's losing out (again, on average, based on trading volume). Anyway, in the name of morality, it's irrelevant to speculate WHO pays for your wrongdoing and for WHAT your taxes would have been used. The action is immoral and illegal. To say it's socially wrong is a big stretch. There are way too many unknowns to make a definitive statement.
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• danwyd 12y ago
  The comparison has to be with banks... Does Citi diligently pay every penny in taxes it owes? Does J.P. Morgan perfectly free of corruption and accusations of insider trading? Does Goldman always deliver high returns to its clients and charge very reasonable fees always?
• damoncali 12y ago
  You might want to rethink your position on stock buybacks - they're more or less equivalent to dividends, and perfectly harmless.
  • yummyfajitas 12y ago
    The claim is that corporations will borrow money and use it to buy back shares. That's actually a nice hack - interest income is favorably treated relative to capital gains, so it's a way to turn a higher tax piece of capital (stock) into a lower tax piece of capital (bonds).
    • damoncali 12y ago
      If it's advantageous to have more debt, then this is what you do. It's done by pretty much every company in the world, not just hedge funds. It's literally finance 101.
      • pjc50 12y ago
        Advantageous for whom, though? http://www.theguardian.com/money/2014/sep/22/phones-4u-closure-job-cuts-announce http://www.theguardian.com/money/2014/sep/22/phones-4u-closu... My understanding is that phones4u was paying out dividends while increasing its debt; effectively an equity-for-debt swap. The difference is that this transfers risk from the owners to the creditors, allowing the business to collapse after it's been looted. I think there's a case to be made for a rule "always pay your creditors before your equity investors" to avoid this kind of thing.
        • damoncali 12y ago
          That's how it's supposed to work. A company makes money and gives it to the shareholders. When lenders lend money to the company, they are getting a return for their risk. Companies adjust their capitalization all the time - it's a normal part of running a business. You can do it with dividends or share repurchases, and if it makes sense, you can fund either with debt. There is nothing nefarious about doing that. Further, if you always pay your creditors first, there is no point in capitalizing with debt - you give up significant value by doing so. It is normal and healthy for some companies to finance themselves perpetually with debt. Edit: Ok, so there are still some non-believers. Think of it this way. You own a profitable company with no debt. Your accountant tells you that you'll increase the company's value if you are 50% debt and 50% equity. This is a consequence of our tax code. Sounds like a good plan. Now what? The company already pays dividends and has as much cash as it needs for operations. You borrow money (which banks are happy to give you because you can more than afford the debt service), and pay out the proceeds as dividends. You are now have all that money in your pocket, and your company is basically worth the same amount (value = equity, which is now 1/2 what it was + debt) - a little more, actually, because of the tax consequences of the debt. This is totally normal. Sometimes the optimal debt level is zero. Sometimes it's 90%. If companies are pulling huge amounts of cash out as a result of debt financing, it's only because they had a sub-optimal capitalization to begin with. Again - nothing nefarious here. It's all just a way of adjusting risk and optimizing returns to the shareholders.
• onetimeusename 12y ago
  There was no dishonest or misleading tactic that Renaissance tech used. They held on to options and used that legal tax structure. Options for a basket of stocks and the basket of stocks themselves are completely different things and have different risks and payouts. That they are using derivatives to avoid taxes is just drama that politicians are inventing.
  • frandroid 12y ago
    So what is the social function of Renaissance not paying $6B in taxes? How does this benefit society?
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      • georgemcbay 12y ago
        wat.
    • onetimeusename 12y ago
      Renaissance did not avoid $6b in taxes. They never owned the stock in the baskets that the politicians claimed they did. The payout to risk ratio of the options is most likely why they were invested. There can't be a social function to not paying because there was nothing to pay.
      • hsitz 12y ago
        I don't know specifically about Renaissance's case, but they may well have avoided $6B in taxes if a lot of their fees were categorized as "carried interest". (I don't think the particular fact that they invest in derivatives has anything to do with it.) For hedge funds any fees they accrue for "performance" are carried interest and not subject to regular income tax, though they will eventually be taxed at the capital gains rate. E.g., if a hedge fund charges 2% of assets annually, plus 20% of annual increases in asset value over 8%, the 2% fee would be taxed as regular income and the performance part (20% of increases > 8%) would accrue to them as carried interest, treated as capital gains. You can read more about this at Wikipedia: http://en.wikipedia.org/wiki/Carried_interest http://en.wikipedia.org/wiki/Carried_interest My not-so-informed belief is that while there may originally have been a decent rationale for treating hedge fund performance fees as carried interest, in many (most?) modern hedge fund scenarios that categorization is misapplied. In any case, the treatment as carried interest is legal, at least for now.
• lmm 12y ago
  > Plenty of socially questionable legal strategies in HF land. Big one is stock buybacks - rational responses to Federal Reserve interest policies. If debt is priced too cheaply, HF will push companies to lever up to buyback stock. This is a socially useless form of activity, which increases business risk based on capital structure theory. Short term payoff, the debt will never go away. If it's useless then why does it make them money? Capitalism is a bit like a genetic algorithm - it will find a badly specified reward function faster than it will find the solution you were looking for - but if our tax policies encourage businesses to take on dangerous levels of debt, maybe we should, like, change our tax policies? > So - to deliver middling average returns, the hedge fund industry will charge 4x to 20x the cost of an index fund. Shouldn't we be happy about that? They take a load of rich people's money, provide liquidity to the market and do other price discovery things, and give those rich people a middling average return. What's not to like? > Much of the money for the funds comes from public pension funds. Maybe those pension funds should stop investing in hedge funds, like calpers just did.
  • Daishiman 12y ago
    > If it's useless then why does it make them money? Is that really a line of reasoning? I can make money by drug and arms trafficking, helping other skirt the law, take advantage of legal loopholes, using violence where competitors cannot to strongarm others into submission, exploiting labor, etc. If a hedge fund makes its money just by being faster in transactions in a way that gives no real benefit to actual creators of value, then it is of no use to society. Thus far, the argument for liquidity seems shoddy, at best.
    • m52go 12y ago
      Hedge funds are opportunistic pools of capital. Like venture capital firms, they exist primarily to make a buck, only hedge funds play primarily in the financial markets. Real estate firms exist to make money using real estate. Banks exist to make money using loans. Finance exists to make money. By design, it doesn't care about real value.
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• prostoalex 12y ago
  > If debt is priced too cheaply, HF will push companies to lever up to buyback stock. This is a socially useless form of activity, which increases business risk based on capital structure theory. Short term payoff, the debt will never go away. Aren't stock repurchases generally a more tax-efficient vehicle for providing return to shareholders than dividends? Also, why would the debt never go away? Companies usually raise debt by selling bonds with maturity dates.
• inthewoods 12y ago
  The social function of hedge funds is to provide the expected returns for their given investor (examples: uncorrelated returns to the S&P500, downside protection, returns generated by non-stock/bond investments, et al) - the same as any investment vehicle. Those returns should then be accrued to the investors in a given fund, thereby enabling things like pensions as well as non-retirement gains. Now, I don't believe this is what they provide, but I'm trying to answer your question.