Hedge Fund Nation

The Wall Street bailout is alive again. In an effort to make the $700 billion bailout palatable, the architects of the law have larded it up with all sorts of goodies, such as increasing the levels of deposit insurance, sparing some taxpayers the ravages of the Alternative Minimum Tax, and extending tax breaks for alternative energy. Henry Paulson's three-page sprig has sprouted into a 451-page Christmas tree. (The current version of the bill, in all its lengthy glory, can be seen here).

What's most interesting about the Emergency Economic Stabilization Act of 2008 is just how much it reads like a prospectus for a hedge fund. In the past, hedge funds—secretive pools of capital—were open only to qualified (read: rich) investors. But with the stroke of a pen, President Bush will soon make all American citizens investors in the world's biggest fund—and a democratic one, at that. Taxpayers won't just be the investors. We'll own the management company too. Best of all? For at least a few months, we'll have the former CEO of Goldman, Sachs run our investment for a very small fee. Call it the "Universal Hedge Fund."

Hedge funds use leverage: that is, they borrow money to amplify their returns. The Universal Hedge Fund will use massive leverage, borrowing up to $750 billion, which it will use to buy up distressed assets. The Universal Fund might best be described as a multi-multi-strategy fund. Its stated goals are to maximize returns to its investors, while promoting general market stability and bolstering the crippled housing market.

The Fund's bylaws give the manager (the Treasury Secretary) significant discretion. He can buy troubled mortgage-related instruments from finance companies (Section 3(9)(A), page 5). But he can also invest in "any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, determines the purchase of which is necessary to promote financial market stability" (Section 3(9)(B), page 6). The manager then has the authority to manage the assets as he sees fit (Section 106(b) page 22), collecting revenue streams, holding bonds to maturity or flipping them for a quick profit. (Section 106(c), page 22). Like many of today's sharpest hedge funds, the Universal Fund will also have the ability to drive a harder bargain by demanding equity stakes, or new debt securities, from the institutions it is helping (Section 113(d), page 35). It can also do what many of the big hedge funds, and so-called "funds of funds": do: bring in outside managers to run the investment. (101(c)(3), page 8)

There are some important differences between the Universal Fund and its private-sector peers. Hedge funds thrive on secrecy. The Universal Fund will operate with maximum transparency, disclosing all new sales and purchases on the Web within two business days. (Sec 114(a), page 39) Rather than send in all our money upfront, we hedge-fund investors will give the manager $250 billion to start with (Sec 115(a)(1), p. 40). And the proceeds won't be distributed via dividends or end-of-year partnership distributions. Rather, revenues and profits "shall be paid into the general fund of the Treasury for reduction of the public debt." (106(d), page 22)

The Bush administration's desire to turn all Americans into participants in the capital markets through the privatization of Social Security never got off the ground. But in the last months of its second term, it has managed to pull off something of a coup. Soon enough, we'll all collectively own various securities issued by lots of big companies. Too bad the Ownership Society is happening only because we became a Bad Debt Society.