They Bet Your Life

Seeking to understand my fate, in 2011 I reviewed 10 books on the financial crisis. Needless to say, this endeavor straightened out our misshapen economy not a whit. But it did improve my comprehension, and made me feel better the way spiritual disciplines supposedly do. Problem is, all such consolations come with an expiration date, hurried along in this case by my nervous habit of scanning the financial pages. So soon I was feeling the need to know more.

My prospective areas of specialization were different in kind. First, I wanted to learn about hedge funds. Hedge funds didn’t cause the 2008 crisis — the big banks were the chief culprits. But often it was hedge funds within the banks that speculated most recklessly, and it was hedge funds where the kinds of headlong economic behavior that typified the crisis were rampant. Ever since I was amused to encounter the gerund “hedging” in a plan-your-retirement paperback thirty years ago, I’d been trying to get a better grip on what it was, and this was my chance. But in addition I craved human interest — some kind of bead on the hedgers. Who were the bettors in Wall Street’s grand casino? Did they have politics? Scruples? Fun? Did they love their wives (pardon me, spouses) and children (if any)? Or were they all the de facto sociopaths I suspected? Three 2013 titles indicate that the amateur speculators who run the book business think there might be money in these questions: Barbara T. Dreyfuss’s Hedge Hogs, Turney Duff’s The Buy Side, and Anita Raghavan’s The Billionaire’s Apprentice.

The first hedge fund was A. W. Jones & Co., begun in 1949 by liberal sociologist-turned-journalist Jones with the aim of protecting his investors, most also his friends, by leveraging their money to buy a maximum of promising stocks while also hedging that money — that is, reducing investment risk — by shorting overvalued ones. Among his early imitators was humanitarian left-liberal George Soros, probably the most successful trader ever. But profit maximization has its own logic, and it’s telling that Jones soon had another bright idea — insider trading, which was not then illegal. Soros too sometimes exploited inside dope in those days, although his specialty was currency fluctuation — when the pound was devalued in 1992, partly due to pressure he applied, he made a billion bucks while 50 million Britons sunk into a recession. That’s the way the money business is.

But it would soon get a lot worse as hedge funds, emboldened by cabals of quants devising ever more arcane variations on “value at risk,” leveraged more and hedged less. Hence the 2008 crash presaged by the 1998 failure of Long Term Capital Management, whose founder had another hedge fund up 15 months after LTCM almost wrecked the world economy by misreading the ruble. Why not? The (first?) tech bubble was up and floating, with two new pieces of deregulation tempting anyone with a few million to spare to put skin in the game.

This fast-moving system was ripe for exploitation by headstrong criminals brainy enough to play all the angles at once and invent a few more. The biggest of these that we’re sure about is billionaire Sri Lankan–American insider trader Raj Rajaratnam, in whose legal downfall Raghavan discerns an even bigger story: a meaty chronicle of “the rise of the Indian-American elite,” with starring roles for Rajaratnam informant-turned-informer Anil Kumar and, especially, tragic hero Rajat Gupta, the highly respectable financial consultant now appealing his 2012 conviction for a single documented tipoff that many regard as the tip of the iceberg. Raghavan, a Malaysian-born ethnic Indian who worked 18 years for The Wall Street Journal, goes long on some half dozen South Asians, including U.S. Attorney Preet Bharara and the SEC’s Sanjay Wadhwa, and provides detail on the meritocratic educational network India maintains for its ruling class. But there’s also plenty about the evolution of American finance, particularly the McKinsey Group, the enormous but staid consulting firm Gupta broke down racial barriers to head for nine years. Modernizing McKinsey to compete with the likes of Bain Capital, Gupta supported Kumar’s seemingly mad notion of outsourcing American paralegal and research work to English-speaking Indians. He courted tech companies. His penchant for philanthropy brought McKinsey into contact with healthcare and pharma magnates. But avarice ruined him anyway.

Because Gupta rather than Rajaratnam is her protagonist, however, Raghavan doesn’t say much about hedge funds per se. She just assumes readers understand that scenes like the book’s legal linchpin — in which Gupta steps out of a Goldman Sachs board meeting at 3:54 p.m. to tell Rajaratnam that Goldman has brought Warren Buffett aboard and Rajaratnam’s Galleon Fund somehow buys $25 million in Goldman stock in the four minutes before closing — are how hedge funds do business. Duff and Dreyfuss provide more detail.

Duff worked at Galleon before moving on to a smaller fund where he was a bigger shot. While at Galleon, he enthusiastically pursued the company policy of two dinners a week on the expense accounts of bank traders whose sales commissions depended on “buy siders” like him, picking up tidbits of info as he parties. But Rajaratnam himself was the master suborner, which is why he’s now doing 12 years in stir. Although Duff glimpsed some shady dealings — like the private “admiral’s account” where lucrative transactions were booked so they profited only Galleon employees — he was privy to nothing blatantly criminal. Instead, his tell-all goes for human interest. No math whiz, Duff compares his edge as a trader to a poker player’s. He’s an affable character who reads people and situations well and is blessed with a courageous calm he attributes to the low-grade depression that probably fed the same cocaine habit that turns the last third of his book into a tedious dysfunction memoir.

Burning no bridges, Duff concludes by praising his “amazing, intelligent, honest, and friendly” co-workers. But although he majored in writing and is facile enough at it, the only amazing figures I noticed — including the beautiful and sensible wife who dumped him, and who he plainly hopes to woo or placate here-are bad guys like the appalling Rajaratnam, who claims as his motto, it is my sad duty as a rock critic to report: “Remember never grow up-and nothing is so serious as the pursuit of fun!!!” Few successful bankers are unintelligent, and many seem to cherish their families as respites from the alpha-male math and schmoozing competitions of their daily lives. But even the friendliness of Duff’s friends seems provisional, and in the banking business honesty only goes so far. Torn and contradictory, Rajat Gupta is something special. Due in part to Duff’s own affability, affable is as much as can be said for the overpaid drones and party people who populate his tale.

The principals of Hedge Hogs are even bigger shots with more vivid profiles, especially Brian Hunter and John Arnold, the energy traders whose high-stakes 2006 battle to corner the natural gas market destroyed Amaranth Advisors, the firm Hunter came to dominate. The same competition imperiled the pension fund of the San Diego Employees Retirement Association as well as grossly inflating energy and heating costs for countless businesses and municipalities that do more concrete good than Centaurus Advisors, which Enron vet Arnold closed holding $2.8 billion in 2012.

Forced to choose between these two believers in extreme “value at risk,” most would take Arnold. Based in his hometown of Calgary, Alberta, Hunter seems pure cowboy, with paltry philanthropic impulses; Arnold is at least an early Obama supporter whose wife is a trustee of the Houston Fine Arts Museum, and unlike Hunter he’s never been fined $30 million for market manipulation. On the contrary, he signed Bill Gates and Warren Buffett’s Giving Pledge, and his John and Laura Arnold Foundation put up money for Head Start programs threatened by the 2013 shutdown. But note, as Dreyfuss for some reason does not, that his chief “philanthropic” endeavor is “reform” of public employees’ pensions — that is, promoting legal means, such as a California initiative, to slash them, for fiscal reasons worthy of more debate than the wealthy are inclined to countenance.

Two points, then. First is that, at the very least, the financial markets attract natural gamblers. There are exceptions, and some gamblers are more mindful of risk management than others. But there are always going to be addicts and high rollers, just as there are always going to be crooks, and it’s in the public interest to constrain both. Second is that philanthropy will always involve, at the very least, unnecessarily rich men (and a few women) riding their hobbyhorses. Wealthy speculators may indeed underwrite causes that save some real ordinary lives and improve many others. But their careers as championship number pushers limit their insight into — and sympathy for — the duller struggles of their fellow citizens.

Nor does their main economic rationalization hold much water. As Jeff Madrick argues in 2011′s The Age of Greed, the hedge fund chapter of which is the best writing I’ve found on the subject, the liquidity these funds inject into the economy is an unresearched talking point whose benefits are unlikely to justify the multiple millions winning bettors gain moving money around. Note, however, that in a banking business where verbal language obfuscates more often than it clarifies, “hedging” per se isn’t the problem. “Hedging” requires the kind of caution that would have prevented the 2008 crisis if traders and their bosses hadn’t dismissed their risk managers as wet blankets, which is why risk-reading hedge funds like John Paulson’s made billions betting against mortgage derivatives. And as Dreyfuss explains, “hedging” on a smaller scale is an essential budgeting strategy for any enterprise dependent on commodities whose prices will fluctuate due to unforeseeable market or environmental variations. But while the anti-regulation claque isn’t just blowing smoke when it claims that demand and scarcity factors also inflate those prices, I buy Dreyfuss’s argument that the major reason natural gas costs so much more than it used to is that there’s so much money to be made messing with its economics.

Yet having struggled to gain these unremarkable insights, I began to feel I was working from a skewed sample. Book speculators invested in Hedge Hogs and The Billionaire’s Apprentice because they aren’t so much finance stories as crime stories, and moreover, the insider trading Rhagavan so disdains shocks Wall Street more than other fiduciary malfeasances because it involves bankers robbing each other rather than us. So for balance I went to Maneet Ahuja’s The Alpha Masters, which aims to turn a profit flattering the industry for insiders rather than exposing it to outsiders. Ahuja is a comely 29-year-old hedge fund specialist for CNBC who tweets as @WallStManeet. Her nine interview profiles, including a long one with Pershing Capital’s activist William Ackman, were all vetted by their subjects. But it was an accomplishment to get them to speak for the record at all — although a few hedge fund magnates are given to going public like Ackman, often with the hope of lowering a target’s stock price, most prefer to “express their views,” as the poets of banking put it, by simple short-selling.

So in Ahuja’s business plan, Galleon and Amaranth are off the books and John Paulson is her best friend. Her subjects are all guys who bet right. But all of them are also guys who deploy careful research and analysis rather than — or as well as — what Ahuja describes as “the massive, veiny, brass testicles” Appaloosa Management’s David Tepper has hanging on a plaque in his office. Indeed, many of their approaches have discernible social utility. Like Konikos’s James Chanos with Enron, they ferret out inflated values before they spin further out of control. They take on risks others can’t, financing small companies and saving troubled and bankrupt ones, at what cost to their employees Ahuja never thinks to ponder. At their best — which in this crew means Bridgewater’s 75-year-old Ray Dalio, also treated to a 2011 profile by The New Yorker‘s John Cassidy — they provide low-risk “alpha” returns for institutional investors, including pension funds like the one Amaranth bilked. I didn’t like all of these people; I didn’t like most of them. But I wouldn’t call them sociopaths without doing more research.

No fan of Wall Street, Cassidy nonetheless admires Dalio, a guru type unbrushed by scandal who lives modestly for a billionaire-times-ten. I kind of admire him too. Yet in the end Cassidy returns to the usual unremarkable points. Especially in an environment where lesser greedheads play follow-the-leader, hedge funds encourage disastrous speculative bubbles. They normalize income inequality by setting an extravagant standard of executive compensation. They attract “some of the very brightest science and mathematics graduates” to what Dalio unapologetically identifies as a zero-sum game — that is, a game whose social utility is limited by definition. And then Cassidy transitions to a sentence that leaves us ordinaries pretty much where we started.

“Rather then confronting these issues, Dalio, like all successful predators, is concentrating on the business at hand.”