Barbara Dreyfuss spent 20 years on Wall Street before leaving the financial industry behind to become an investigative reporter. In Hedge Hogs: The Cowboy Traders Behind Wall Street’s Largest Hedge Fund Disaster, Dreyfuss uses her investigative and analytic skills to give readers an insider look at the high-stakes, high-ego industry she knows so well.
The book tells the story of Brian Hunter, a 32-year-old trader whose outrageous attitude and high-risk bets led to the collapse of Amaranth Advisors, one of the largest hedge funds of the time, and the loss of hundreds of millions of dollars. Dreyfuss not only explains what happened, but also the deregulation of Wall Street and lapses in oversight that led to the fiasco.
POGO: What are some of the most significant loopholes and watered-down regulations that have weakened the government's oversight of our financial system over the years?
Dreyfuss: Beginning in the late 1990s Congress, along with officials, first in the Clinton and then the Bush administration, dismantled the New Deal safeguards designed to prevent another great depression.
One of the most detrimental acts was the elimination of the Glass-Steagall Act, which kept commercial banks focused on lending consumer deposits to businesses, sparking economic growth. Suddenly commercial banks were allowed to play in the wild world of Wall Street investments. Bank gambling with house money took off.
At the same time new laws and rules allowed banks and the burgeoning hedge fund industry to freely trade a range of emerging financial derivatives with no regulatory scrutiny. The over-the-counter swaps market was officially given the okay to operate behind closed doors. Commodity trading on new electronic exchanges was deemed beyond regulatory jurisdiction. Banks were given the go ahead to both own massive amounts of a physical commodity and trade its futures contracts too. Regulatory agencies were pressured to pull back on tough implementation of existing rules.
Hedge funds were already operating with no oversight because Congress considered their rich clients sophisticated enough to evaluate their own investments. But when the tech industry bubble burst in 2000, pensions started pouring millions of dollars of retiree money into hedge funds. Suddenly the money of ordinary Americans was at risk. But even efforts to just require hedge funds to register with the Securities and Exchange Commission were quickly shot down in the past.
POGO: What additional reforms are needed to crack down on price manipulation and excessive speculation in these markets?
Dreyfuss: Some important regulatory changes have occurred with the Dodd-Frank bill. But Wall Street sent a lobbying army to ensure they had lots of wiggle room in the regulations implementing it. So, for example, while hedge funds must register with the SEC, only the few funds managing over $50 billion will get tougher SEC scrutiny. It will take an enormous commitment by regulators, Congress, the courts, the White House, just to enforce what’s on the books and keep it from getting watered down further.
But a more fundamental debate needs to take place about what exactly “excessive speculation” is. Do we need $400 trillion in swaps, where traders bet with one another on the prices of stocks, bonds, commodities, and derivatives? The industry argues this speculation provides liquidity, but as we saw in 2008, massive gambling can cripple the economy.
As I detailed in my book Hedge Hogs, people who use natural gas in their factories, homes and schools believe that when speculators started trading swaps and futures in a big way around the year 2000, prices started to skyrocket and fluctuated wildly. It was hard to run businesses that used gas and to heat homes and schools at fair prices. Before this huge wave of speculators, the natural gas market worked fine, representatives of large corporate gas users told Congress.
Massive speculation distorts the price discovery role of the marketplace. It diverts money that could go into economically productive investment. Separating commercial banks from Wall Street activities, reinstating the Glass-Steagall law that worked so well for so many decades, would be important. But we also need a strong public debate on the role of Wall Street and the impact of speculation on the real productive economy.
POGO: How, if at all, are technological, budgetary and staffing shortages affecting the government's oversight capabilities today?
Dreyfuss: The Dodd-Frank law has finally put the over-the-counter derivatives market under regulatory scrutiny but opponents of tough regulation have been trying to starve the regulatory agencies to keep oversight at bay. The Commodity Futures Trading Commission, which is responsible for much of the new oversight, has only a few dozen more staffers than it did twenty years ago. But now it must also closely monitor a $400 trillion swaps market along with the futures market it previously oversaw. And the agency has been fighting congressional opponents just to maintain its budget, let alone dramatically increase it as the White House has proposed.
POGO: Your book delves into the "shadowy world of hedge funds," and exposes some pretty outlandish behavior, as someone who worked in the industry, were you surprised with what you uncovered?
Dreyfuss: It was pretty shocking that within six months of losing $6 billion, putting a $10 billion hedge fund, Amaranth, out of business, Brian Hunter, the firm’s lead natural gas trader largely responsible for the fiasco, was setting up his own hedge fund. Perhaps even more surprising though was the fact that he had people lined up ready to invest $800 million as soon as his new firm was operational.
The cavalier attitude of traders who are managing the savings and retirement funds of other people was unexpected and troubling to see. After Amaranth’s traders lost billions of dollars, while they were getting out of their remaining holdings, they tossed around a football, made jokes to one another and offered no apologies. Why pension funds continue to pour money into hedge funds, which charge enormous fees, have not beaten the performance of the S&P 500 index for years and which take enormous risks with clients money, is hard to understand.
POGO: You left your job as a securities analyst to become an investigative reporter. Is there anything you miss about working in the financial industry? What skills from your previous career have most helped you in your new one?
Dreyfuss: Being an analyst was very similar to being an investigative reporter, or at least it was in the days before high-speed computers took control of most investment decision-making. Investors needed the broad policy information I provided in order to decide such things as which companies were developing the best products and were best able to handle changing payment policies. My reports to the investment community focused on such issues as congressional plans to cut payment rates for hospitals or HMOs, FDA concerns and Medicare coverage initiatives, much as the Washington Post did.
Companies were always telling investors rosy stories about how quickly new products would come on the market, how great their manufacturing facilities were. It was important to ignore all the spin from them and write about what was actually happening. One drug company, which claimed the FDA was going to speed approval of its weight loss pill because it worked so well, put in some nasty calls to my boss and colleagues when I reported that in fact it was FDA policy to review more carefully any new drugs that might have broad use if they were not for life-threatening diseases.
Companies move quickly when they know Wall Street is aware of problems. At one point I learned that the FDA had shut down a major company’s dialyzer production, due to concerns about manufacturing. It was causing a crisis for dialysis patients but the firm had not told Wall Street about it. I relayed the news to the analyst covering the company at our firm, who coincidentally was meeting with executives of the firm that day. When she asked them about the problems at the plant they immediately set up a conference call for all Wall Street analysts from her office to discuss the issue. Perhaps given the importance of the product to the company they were already trying to get the problems fixed as quickly as possible but clearly scrutiny by Wall Street gets the attention of corporate executives.