an autodidact meets a dilettante…

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hedge funds, the stock market, and other unknowns

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A GameStop shop in Florida – it’s a US thing, but with retailers in Australia

So there’s a big story in the USA to do with hedge funds, stocks and the little guys upsetting the big guys, finance-wise, or something like that. Time for a closer look, comme on dit (I know far more about French than finance).

Having been poor (in first-world terms) all my life – and work-shy, because I’m constitutionally anti-authoritarian, and when you’re a nobody and a know-nothing, you have to work for bosses – I’ve tried to salve my guilt for living mostly off the public purse by being a more or less prolific writer and reader. Of course I’ve had brief jobs – in factories, offices, restaurants, schools, a hospital and a farm – and I did eventually manage to get to university, again off the public purse, incurring a debt I’ll never be able to repay. So during this misfit life I’ve learned a lot, in a general way, about history, politics and the various sciences, but virtually nothing about finance, the province of the wealthy.

Some preliminary remarks. Most wealthy people, surely, come from wealth. They have wealthy parents, wealthy friends and associates. They get advice from those around them about increasing their wealth, minimising losses, investment, property and so forth. I’ve heard this kind of talk at restaurant tables and in wealthy homes where I did occasional gardening work. It was like listening to people speaking a foreign language, and as psychologists tell us, we feel anxious, and sometimes hostile, when we listen to a language we don’t understand. They even have a fancy name for it – xenoglossophobia. 

The best way to overcome phobias, so I’m told, is to expose yourself, little, by little, to the fear-inducing thing. It’s never too late, so here goes. 

What is a hedge fund? The ABC (Australia) business reporter David Chau tries to explain:

Essentially, it’s a fancy word for an “alternative” investment partnership that has the freedom to invest aggressively in a broad range of financial products. They’re actively managed, and more expensive to invest in, compared to other funds. Many of them use a “2 and 20” compensation structure. It means hedge fund managers are paid a 2 per cent commission (of the assets they’re managing), and 20 per cent of profits (above a certain benchmark) each year. Even if the fund manager does nothing (or worse, loses money on your investments), they’ll still get paid their 2 per cent. Their goal is to maximise investor returns, but only “sophisticated investors” can join. To qualify, you typically need to own about $2.5 million worth of net assets, or earn $250,000 per year in gross income (for the past two financial years). So a hedge fund’s clients tend to be rich people, or big institutional investors (like an insurance company or superannuation fund).

The idea, clearly, is to invest in a company that you think will do well in the future. Or one that you want to do well, because you think what it’s doing/manufacturing etc is positive for the community, or the world. I presume, for example, that Elon Musk’s fantastical personal wealth, which he derives from his companies, is a result of people investing in those companies because they believe in what he’s doing – though that may be a naïve view. 

In any case, clearly, hedge funds are for the rich who hope to get richer. It’s like placing a bet (though presumably you can do this without joining a hedge fund), putting money into shares, calculating that you can make a profit by selling them later. This makes things a bit weird, though. You buy shares in a company because you believe it will do well, so then why would you want to sell those shares later? Presumably because you’ve lost faith in that company? Or is it just to make a profit, knowing that the shares you’re selling will be snapped up by others? But why not keep them, if the price is going up? But surely you have to sell at some time, to make a profit? To liquidate your assets? 

Okay, more questions than answers. Short selling, or shorting, as David Chau and others explain it, involves somehow borrowing shares from the market and then selling them, believing or knowing that their value will tank. After it has tanked they buy the shares again and give them back to the market at their current reduced value, and pocket the difference. Which sounds like a very dodgy practice to me, an easy or lazy way of making money – looking for businesses that are failing, which given our rapidly changing economic and technological environment, wouldn’t be difficult to find, and cashing in on the misery of those businesses. So how is this allowed, and how can you get away with selling borrowed stock? How can it be your stock to sell? I’ve watched Sal Khan, who of course I hugely admire, talking about this, but his explanations about the possible benefits of shorting seem vague to me. 

All of this attempt at understanding comes, of course, due to the ‘GameStop’ bubble which is bound to burst in the USA. Hedge funds and their rich customers have been shorting the stock of this gaming franchise called GameStop, as well as other brick-and-mortar companies that have been losing business, either due to the pandemic or to changing consumer practices. People on Reddit, a social website I’ve never used, have been doing the opposite, buying shares and doing everything to inflate the share price of these companies, and everyone’s awaiting the fallout, or the train-wreck as one pundit described it. These Reddit investors have been able to do this using an app called RobinHood, a name with obvious connotations. This has of course led to an outcry from the rich-getting-richer crowd, and the RobinHood CEO stepped in, banning the buying of these declining stocks, but not the selling. Which led to an outcry from the Reddit ‘rookie investor’ crowd, which led to RobinHood modifying its position and allowing some stock purchases. A number of financial pundits I’ve listened to, who seem largely sympathetic to the anti-hedge fund investors, are shaking their heads and predicting it will all end in tears, and not so much for the hedge fund zillionaires. Ain’t it always the way. 

Meanwhile the the wealthy professional hedge fund types are decrying the behaviour on the Reddit subgroup WallStreetBets as ‘unsophisticated’, though it’s clearly because the newbies are, quite deliberately, upsetting the applecart of making a profit from business misery. Having said that, they’re clearly trying to cash in as well. So I really don’t know quite what to make of it all. Like just about everyone else. 

Stop press (sort of): I’m not much of a gamer, so I didn’t have any idea whether GameStop had a presence here in Australia. Apparently, EB Games, which I’ve seen around, is our principal retailer for GameStop. This Crikey article, which clearly takes a much more negative line on hedge funds than Sal Kahn does, points out that EB games employs, or did before the pandemic, between 2000 and 4000 workers, and that they, like so many others, are impacted by hedge fund shorting. Here’s what the Crikey journalist, Christopher Warren, has to say:

Rather than leave matters to the actual marketplace of buyers and sellers, the masters of the universe in the financial markets decided to hurry on the collapse of retail by using “shorts”, borrowing shares to sell now, buy back (cheaper) later. The play has been hollowing out capitalism for 30-odd years in a five-step death spiral: manufactured share price collapse through shorting, which allows a cheap private equity buyout, who gut through sackings and closures, then relaunch or rebrand, before quietly closing. In journalism, movies and TV, the hedge funds are proudly the misunderstood anti-hero. Take the fictional Bobby Axelrod in Stan’s anchor program Billions: “We’re white blood cells scrubbing out bad companies, earning for our investors, preventing bubbles. A hedge fund like mine is a market regulator.” The reality is that hedge funds create no value. They’re money-sloshing machines that make money on turnover, not results. This means they’re incentivised to “do something” to maximise turnover, whether that’s moving the market through shorts, falsifying results (hello Bernie Madoff!) or offering, umm, alternative services like the late Jeffrey Epstein.

I’m inclined to take this line myself, but I’m not informed enough to be sure. And there are so many more interesting things to learn about than financial markets.

References

https://www.abc.net.au/news/2021-01-30/hedge-funds-the-gamestop-bubble-and-wall-street/13104846

Mehdi Hasan Gets a Personal Khan Academy Lesson on the GameStop Stock Squeeze | The Mehdi Hasan Show (video)

GameStop Surge Shows Power Shift On Wall Street | Stephanie Ruhle | MSNBC (video)

https://www.news.com.au/finance/money/investing/gamestop-stock-surges-again-after-trading-app-robinhood-lifts-restrictions-for-rookie-investors/news-story/76c47084a2a995e155512eec58d62d0c

 

Written by stewart henderson

February 1, 2021 at 2:59 pm

getting roolly rich in the USA 1: Jeffrey Epstein

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Epstein’s two islands in the Caribbean – Little St James is immediately below the Great one

The Jeffrey Epstein case, in terms of women, girls and exploitation, is something I’m far too squeamish to explore, and of course it’s very very sad and disgusting, but my interest was also piqued by the news that he was/is a hedge fund manager (but maybe not), with mansions and an island and oodles of moolah to invest in all sorts of science projects. This raised many questions. Was he obnoxiously rich to begin with, like little Donny Trump? And what is a hedge fund, and can you legitimately make millions from one?

I’ve never been rich and I’ve never invested in anything, unless you call giving money to Oxfam or UNHCR an investment, so I’m really starting from scratch here. The first definition I’ve found is that a hedge fund is ‘an offshore investment fund, typically formed as a private limited partnership, that engages in speculation using credit or borrowed capital’. So, if this is true, why invest ‘offshore’, and how are you able to do this with money you don’t really have or haven’t earned? I suspect I won’t find easy answers to these questions. The website Investopedia (which sounds immediately suss!) starts with another definition: ‘Hedge funds are alternative investments (?!) using pooled funds that employ different strategies to earn active return, or alpha, for their investors’. Alpha! What a lovely musical note that hits for investors (especially combined with ‘male’). But the mention of pooled funds (e.g. mutual funds and pension funds, as well as hedge funds) might explain how you can make money even if you have little personally to invest. Investopedia also tells us that hedge funds ‘are generally only accessible to accredited investors’, because they’re less regulated than other funds. And we all know that the wealthy are very very keen to have less regulation and oversight than what the Yanks call ‘regular folks’

However, it does seem that, to be an ‘accredited investor’, it helps to be already rich. The term applies to financial institutions such as ‘investment banks’ and corporations as well as individuals. Needless to say, this is a world of which I know absolutely nothing. All I’ve really heard about it is negative – high rollers, corruption, anti-government arrogance and the like – which says much about where I get my information from. Even so, the most objective analysis raises questions – for example, the Australian Corporations Act of 2001 ‘defines “sophisticated investor” [basically synonymous with ‘accredited investor’] so as to exclude them from certain disclosure requirements.’ That rings alarm bells for me – you’d think that these heavy investors would be the last people to be excluded from disclosure. The Act also says that such investors require an accountant’s certificate to the effect that they have a minimum of $2.5 million in net assets or a gross income of $250,000 over each of the previous two years. Presumably they’re not asked about how they acquired such income/assets. And the financial bar is considerably lower in the USA.

Hedge funds have grown in popularity, and as a proportion of the asset management field, over the years. After the GFC of 2007-8 there was an attempt (probably feeble) to rein in the sector. The essential hedge fund strategy (think ‘hedging your bets’) is to receive a positive return regardless of bear or bull markets, by spreading the risk in some clever non-risky way. If you get to be a hedge fund manager (which some reports have claimed Epstein to be, though Wikipedia doesn’t mention this in a fairly comprehensive bio) you get to keep a certain percentage of invested funds for yourself – generally a management fee (maybe 2% of assets) and a performance fee (a substantial percentage of any annual increase in net asset value). You can see how disclosure is essential in payment of such fees, and why the temptation to cook the books would be high.

Epstein seems to have ‘risen’ from humble beginnings. His mother was a ‘homemaker’ and one-time school aide, and his father was a groundsman and gardener, yet Epstein is described, at various periods in his career from the early eighties, as an options trader, a financial consultant, a limited partner (at the dodgy investment bank Bear Stearns), a finance manager and other such vagueries – all despite a patchy scholastic record (but as an autodidact and dilettante I certainly don’t hold that against him). However, one very interesting item stands out….

Back in the eighties, Epstein became an associate of one Steven Hoffenberg, who hired him as a consultant for his company, Tower Financial Corporation (TFC). Epstein was paid $25,000 a month, which to me is an absurdly huge amount for anyone to be paid, though in this world it’s probably peanuts. Even before joining TFC (a collection agency that bought up other people’s debts – and if you think that’s dodgy, read on), Epstein had been bruiting it about among the crooked rich that he was a ‘high-level bounty hunter’, sometimes working for governments or the super-rich to recover embezzled funds, sometimes working for clients to secure embezzled funds. He and Hoffenberg became very close, flying around the world to do their dodgy deals, done not so dirt cheap, but in 1993 TFC collapsed and was exposed as one of the biggest Ponzi schemes in US history, with some $475 million of investor funds vanishing. Epstein, though, had already left the company and managed to escape without charge. Hoffenberg was sentenced to 20 years’ jail, and has always claimed that Epstein was intimately involved in the scheme. In fact, Wikipedia’s brief entry on Hoffenberg ends with this fascinating line:

In July 2019, he claimed that the American financier Jeffrey Epstein was his co-conspirator in the Ponzi scheme.

That’s right now, folks. Presumably he has the evidence for that – so why wasn’t Epstein prosecuted way back then?

Anyway, it appears, surprise surprise, that Epstein’s criminality isn’t restricted to his treatment of the opposite sex, which makes you wonder how many super-rich types who don’t draw attention to themselves vis-a-vis sexual exploitation can be shown to be criminals. And how is it possible to buy what is presumably an American island to use as a tax haven?

Tax havens are always described as ‘offshore’. That’s to say, not a part of the country in which you want to avoid paying taxes. The US site Investopedia underlines its dodginess by providing plenty of info on tax havens (hey man, we’re just tellin’ stuff, not selling’ stuff, I mean, peace off man), as well as providing a list which includes the British (but not the US) Virgin Islands. Epstein owns two of the US Virgin Islands, Great Saint James and Little Saint James, where he has one of his mansions. Great Saint James cost him $18 million in 2016, pretty cheap for an island I would’ve thought, and I can’t find the price he paid for Little Saint James back in 1998. This tiny island was his principal centre of sexploitation, aka Orgy Island by the cognoscenti.

The USA has an international reputation as a bad actor in respect of tax disclosure. With monumental hypocrisy, it implemented the Foreign Account Tax Compliance Act in 2010, requiring or ‘forcing’ (dog knows how) financial firms everywhere in the world to report accounts held by US citizens to their IRS, while at the same time refusing to comply with the OECD’s Common Reporting Standard – the only major nation to do so. To be clear about this the USA demands that other countries share information about US citizens’ offshore dealings, but refuses to share the same information with those countries about foreign investment in the USA. As a result, the USA is arguably now the world’s biggest tax haven. How this works exactly for US citizens like Epstein I’m not sure at this point, but the USA has become, especially over the last decade, one of the easiest places in the world for successful tax evasion, especially through the use of LLCs or shell companies. We’re finding this out through examination of Trump’s criminal activities, but of course I’m far from understanding the detailed nature of LLCs, offshore trusts and the like. I need to lern more.

I’ll end this piece – almost – with a quote from an organisation and site that’s the polar opposite of Investopedia, the Tax Justice Network:

The United States, which has for decades hosted vast stocks of financial and other wealth under conditions of considerable secrecy, has moved up from sixth to third place in our index. It is more of a cause for concern than any other individual country – because of both the size of its offshore sector, and also its rather recalcitrant attitude to international co-operation and reform. Though the U.S. has been a pioneer in defending itself from foreign secrecy jurisdictions, aggressively taking on the Swiss banking establishment and setting up its technically quite strong Foreign Account Tax Compliance Act (FATCA) – it provides little information in return to other countries, making it a formidable, harmful and irresponsible secrecy jurisdiction at both the Federal and state levels.

Of course, none of this clearly explains how Epstein ill-got the wealth to be tax-liable in the first place. Certainly the Ponzi scheme he seems to have gotten away with was one, possibly the main, source, but he seems even before this to have ingratiated himself into the world of dodgy financial entities and personae, presumably through schmoozing and force of personality. Certainly his relationship with Ghislaine Maxwell, daughter of that supremo of repugnant dodginess, Robert Maxwell, is an indication of the world Epstein had become familiar with, a world in which everyone is advising everyone else on how to make money out of nothing and how to retain as much of that money as possible, regardless of anything so inconvenient as the law.

References

https://en.wikipedia.org/wiki/Jeffrey_Epstein

https://en.wikipedia.org/wiki/Hedge_fund

https://www.investopedia.com/terms/h/hedgefund.asp

https://www.investopedia.com/terms/p/ponzischeme.asp

https://en.wikipedia.org/wiki/United_States_as_a_tax_haven

https://www.investopedia.com/terms/t/taxhaven.asp

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https://en.wikipedia.org/wiki/Robert_Maxwell

Written by stewart henderson

July 21, 2019 at 2:14 pm