Over at EconoSpeak, I try to tie Stein's belief in the magic money machine to the Social Security debate.

Typo ... 8% of $20t is $1.6t, not $1.6b.

Daddy, where do bubbles come from?

Ben Stein: Mr Cohen and his lodge brothers bid up the cost of everything through leveraged financial paper, honey.

Daddy, will the bubble ever burst?

Ben Stein: No, honey, Mr. Cohen and his lodge brothers have been assured by the good Dr Bernanke that more money than you ever dreamed of will be available to borrow in case some other lodge tries to manipulate Mr Cohen's manipulated market.

Daddy, is Mr Cohen helping or hurting the US economy?

Ben Stein: Yes, honey, Mr Cohen has relieved everyone else of their poorly invested money by increasing the price so that their automatic 401K investments can buy higher priced stock. The companies help Mr Cohen by borrowing money to buy up their own stock too. The nice Mr Cohen helps the stock exchange and government regulators because they are blind, deaf, and mute.

Daddy, how can we help the nice Mr Cohen.

Ben Stein: We can give Mr Cohen even more money to bid up the price of everything. It's called a "wall of money".

Now go back to sleep, America.

Dean,

I have not read the Stein column and it does sound ludicrous. But your conclusion

"Hedge funds make their returns at the expense of other investors. The more money taken by the hedge fund boys and girls, the less for everyone else. Understand grasshopper?" is very misleading at best perhaps even dishonest.

When you say "the money taken by the hedge fund boys and girls" are you referring to their fees or the money they make for the investors who buy shares in their funds? Let's assume that you mean the money they make on their investment strategies. When a hedge fund profits from a trade it generates money for the investor in the fund. There is currently maybe one trillion USD invested in hedge funds by pension funds, university endowments and insurance companies. So are you saying that when the Texas Teachers Retirement Fund earns money on its hedge fund investments then Dean Baker loses money in his investments? Should we be worrying about that?

Now let's assume your beef is with the fees earned by the hedge fund boys and girls. Well, are our baseball players costing us all money because they are paid so much? Is our problem that people who manage money should not earn fees for it?

Ok maybe your beef is with the notion that hedge funds are "speculators" and you feel that speculation costs the markets money. But you are a trained economist and you couldn't possibly believe that nonsense. If speculation has a cost it is moe than offset by benefits of the liquidity and rapid price discovery that it generates for all investors. And of course, the decision to invest in anything is speculation no matter how long you intend to hold it and no matter who does it.

Oh and by the way, the tax loophole for carried interest on private equity fund managers should be eliminated ASAP and hedge funds should be more tightly regulated in general. But what is the beef with hedge funds making money for their investors?

changed the "billion" to "trillion," thanks Bruce.

pgl at econospeak addresses the real motives of those who propose these absurb scenarios for eliminating debt or SS shortfalls.

But another thing which the proponents fail to address is the enormous market distortions which would ensue if the government gets into the speculative financial markets in a big way - current projections of profits, etc. are just not reliable in such cases.

Max wrote, But what is the beef with hedge funds making money for their investors?

My impression is that Dean doesn't have a beef with that, so much as he has a beef with the common claim that hedge funds are contributing to economic growth by making capital markets more efficient.

I'm with Dean on this one; IMHO most (if not all) of the actual improvements in efficiency are rounding errors.

Meant to say the size of rounding errors.

I am very skeptical that anyone could consistently earn 40% just by outguessing the market on both up and down sides, particularly if leverage is not used (which is assumed in the Stein scenario - where would you borrow money to leverage $10 trillion?).

Do we really know that this is how hedge funds make their money? Over time, I have seen several different accounts of what they do. Maybe Stein's (satirical) point is that closer examination of hedge funds is required.

Skepto - thanks for the EconoSpeak plug. And I tend to agree with your 2nd comment. There may be a very small efficiency benefit from hedge funds but it is nowhere close to the returns Stein mention. So yes - it does turn out the they are picking off more from the rest of us than they are creating wealth. That was Dean's simple point and he's taking heat for this? But let me stick my neck out further and query whether some of their excess returns come from exploiting inside information.

Dean,

You have said in the past:

"In short, the stock market is often about redistribution. When it falls sharply this is a redistribtution from the wealthy to the less wealthy. That is not upsetting for everyone, even though the media may not report it that way."

Why is it that sometimes losses for stockholders are "not upsetting for everyone" and only affect "the wealthy", but other times, those losses are not transfers amongst the wealthy, but losses for "us" and on "our holdings"?

PGL is on the money. I would also willing to bet that many of the hedge fund folks occasionally benefit from inside info. We know it happens (stocks have a widely noticed tendency to rise in price just before the announcement of positive news, like buyout proposals), so it is reasonable to believe that the hedge fund crew is occasionally the insider.

AO, I'm lost as to what the mystery is. Stockholders are on average richer than people who don't own stock. Among stockholders you have some people with modest accounts and some with multi-billion fortunes. When the big money crew enjoy extraordinary returns, it is at the expense of stock holders with more modest stakes. I'm not sure what is mysterious about this.

Dean,

When you want people to celebrate the fall in stock prices it's "the wealthy" who hold stock, who we should not pity when they lose money. But when you want people to look at hedge funds as robber barrons, then stock owners are "us", with "our" "modest stakes".

Do you have empirical evidence to support your claim that the investors in hedge funds are richer than the average stockholder?

AO,

the hedge funds don't disclose info (that's what distinguishes them from mutual funds), but you need a minimum stake of more than a million to buy in. That's the law, so unless we have reason to believe that there is massive evasion, I'll substitute that for empirical evidence.

Dean,

Like the millions of dollars that pension funds have?

AO,

Yes, but how much per investor? What's the median holding?

Liberal wrote

"My impression is that Dean doesn't have a beef with that, so much as he has a beef with the common claim that hedge funds are contributing to economic growth by making capital markets more efficient."

I have been working in the financial markets for 20 years. I have never heard anyone claim that hedge funds are contributing to economic growth. I have heard countless times that financial speculation make capital markets more efficient. But John Doe sitting at home day trading on his Schawb acct. is a speculator too. Microsoft deciding to invest $2 billion of its cash holdings into corporate bonds is speculation too. Is it Dean's position that hedge funds are some sort of special "evil" speculator? If Dean wanted to tell people he thought that hedge funds do not contribute to economic growth as commonly perceieved, I suppose he would have said that. He didn't. He said that hedge funds make money at the expense of other investors...Then he finishes by saying "understand grasshopper" as if this is some deep wisdom that only a guru can impart. But the fact that an investor who buys a stock going up is taking money away from the guy who sold the stock is obvious. No? So let's ask Dean. What did you mean by singling out hedge funds as taking money away from other investors?

Max,

I was doing my best to try to get something beyond utter nonsense out of Ben Stein's column. Maybe everyone already knew that above normal returns to hedge funds come at the expense of other shareholders. I personally didn't find this to be a great insight, but what else can you make out of Stein's column?

Dean,

I enjoy your writings very much. You are spot on when it comes to social security/ health care/budget issues...we differ in degrees only on free trade but when it comes to financial markets you seem to have this chip on your shoulder for hedge funds.
Shouldn't your above response read..."maybe everyone already knew that above normal returns to any shareholder will come at the expense of some other shareholder? What has it got to do with hedge funds? Ken Lay got above average returns on his Enron stock by selling with inside info? Ken Lay was not a hedge fund. Ken lay was a crook. I find when you write about hedge funds you are subtling implying they are all crooks. That doesn't provide any insight. We know some hedge funds are crooks but they are not the bogey man for all the world's troubles.

pgl:

I didn't mean to criticise Dean - I agree wholeheartedly with the idea that hedge fund profits come from other investors. The question is whether they are not doing something more destructive than simply playing the stock market. Hedge funds seem to epitomize unregulated financial manipulation, which has led to several debacles in the past. If hedge fund managers are not technically crooks by the letter of the law that does not mean, as implied by Max, that what they are doing is beneficial to anyone but themselves and their wealthy investors (and in the long run, investors in seemingly high-paying operations often find themselves victimized).

Like Dean, I am puzzled to find the intent of Stein's column, but I think anything that causes attention to be paid to this subject is probably good.

csning,

yes, thats exactly my point, those are questions that Dean needs answer before he can call hedge funds "them" and non-hedge fund investors "us", and decide one group is "big money investors" and the other has "modest holdings".

Of course, investing pension funds in Hedge Funds would lend more credibilty to their continued existence. That's exactly why the unknowing average first-world-country Joe Bloggs gets duped into having his invested in one of these.

And of course hedge fund investors are the rich, if by the rich you mean anyone of the minority first-world middle class and up. So who cares about the majority of POOR people in the WORLD who do not invest in Hedge Funds!?

So, finally, of course hedge funds don't benefit the world economy as a whole. Everybody knows (or should know) that massive pro-cyclical capital flows don't lend stabilty to world markets. And then you get these f***ers who want to accelerate and increase these flows all over the the place to get a bigger return on their investment. Pure and unrestrained selfishness has never benefitted anyone else directly/indirectly in a sustained and consistent manner. Intellectual drabble and I'll have nought of it.

Actually, the dollar is immediately borrowed by the Government and put to use in all the things they do. In a way the Trust Fund is a type of forced savings. The payee eventually gets back the principal with interest when he retires or is disabled. Any kind of retirement savings does the same thing, though private retirement funds obviously invest much more in the private sector.

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