The signature moment of today’s long House committee hearing on hedge funds came deep in the Q&A. Massachusetts Democrat John Tierney looked at hedge fund manager John Paulson, who earlier had offered some pointed suggestions on how Treasury Secretary Hank Paulson ought to be using the $700 billion Troubled Asset Relief Program, and said, “I’m thinking we’ve probably got the wrong Paulson handing out the TARP money here.”
So much for the Waxman Witch Trial, as Dealbreaker had billed it. This was more like a love-in. Some members of the House Committee on Oversight and Government Reform did razz the five multi-billionaire hedge fund managers assembled before them about the taxation of carried interest (performance fees that are taxed at capital gains rates). But two of the five–George Soros and Renaissance Technologies’ Jim Simons–agreed that carried interest should be taxed as ordinary income. Paulson didn’t, Philip Falcone of Harbinger Capital and Ken Griffin of Citadel were opposed with some caveats. But that discussion remained civil.
The most heated moment of the whole hours-long hearing came when Indiana Republican Mark Souder gave Soros hell for about 20 seconds for supporting marijuana legalization. But then he switched to a question about whether hedge funds helped bring markets toward equilibrium, and all was friendly again.
If the hedge fund industry is worried about becoming the scapegoat for the current financial crisis, there was no sign of that happening in the Rayburn House Office Building today. Committee Chairman Henry Waxman, citing the testimony of an earlier panel of professors, said he worried about the systemic risks posed by hedge funds. But most of the committee members, both Republicans and Democrats, seemed to buy the hedgies’ argument that those systemic risks paled beside the ones posed by banks, investment banks, insurance companies and other more traditional financial firms. They mainly wanted to ask the hedge fund guys for advice.
What kind of advice did they get? Well, Soros wants tighter regulation of new financial products, and regulatory efforts to control asset bubbles by tightening margin requirements and raising bank capital standards when markets are booming.
Simons thinks Calpers, PIMCO, TIAA-CREF and other big investors should get together and start a new non-profit rating agency focused on derivative securities.
All the hedgies said they were okay with disclosing more about their positions to regulators, as long as the information stays with the regulators. “It shouldn’t be reported in The New York Times,” Simons said. They also all seemed to be for more transparency and standardization in derivatives markets.
And then there was Paulson, who went from little-known to legendary last year by pocketing a reported $3.7 billion betting against the subprime mortgage market. He seemed to expect a tough audience: His opening statement (all the statements are available here) was a somewhat defensive explanation of what he did for a living. But as soon as he realized that committee members weren’t going to rake him over the coals for profiting from the pain of American homeowners, he loosened up.
He waxed ominous about the dangers of leverage (his fund uses very little), saying that maybe what was needed were higher margin requirements on lots of different asset classes. He said Treasury should demand higher interest rates and bigger equity stakes when it injected capital into banks, and should also require that banks that get its money stop paying cash dividends and cap cash compensation for executives (they could pay all they want in common stock).
Paulson did get chided repeatedly for failing to turn on his microphone when he started answering a question, but he was clearly the star of the day. After Tierney’s comment, Tennessee Democrat Jim Cooper quipped, “The headline of this hearing is definitely Paulson vs. Paulson.”
That was actually too much for John Paulson. “I in no way want to be critical of Secretary Paulson,” he said. “He’s done a great deal for this country. He’s willing to change his positions when the circumstances change.”
Update: Sean DeCoursey forgot his password–who has his own blog now–wonders in the comments if the Curious Capitalist has taken a stand on carried interest taxation. Yup, it did again and again back in those innocent summer days of 2007. Carried interest should be taxed as ordinary income.