July 5, 2022

Deal Professor: Federal Reserve as a Hedge Fund: Higher Profits, Lower Pay

Harry Campbell

The year 2011 is over, and soon we’ll be hearing again about billion-dollar paydays for select hedge fund wizards.

If it makes you feel any better, not everyone is sharing in these riches. The people who operate the most successful hedge fund around are receiving a relative pittance.

That hedge fund is the Federal Reserve. Last year, the central bank turned over $76.9 billion in profit to the federal government, slightly down from $79.3 billion it provided in 2010.

The Fed made this money in interest on a nearly $3 trillion portfolio of securities. This enormous holding was built up largely in the wake of the financial crisis as the Fed bought these securities through two rounds of quantitative easing.

Deal Professor
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I call the Fed a hedge fund because it is operating like one, leveraging its balance sheet to earn huge profits. The main difference between a hedge fund and the Fed is that the Fed effectively creates its own money, so it doesn’t have any borrowing costs, meaning yet more profits. Remarkably, the Fed’s profits are also an afterthought. The Fed is trying to stabilize and increase the United States economy in the wake of the financial crisis, and its profits are a nice byproduct.

Still, these earnings blow away any other hedge fund profits.

The Fed employees who manage this operation receive a federal salary for their efforts. The money is well above the pay of the average American but still relatively modest compared with those in the financial industry. The top salary class at the Federal Reserve has a maximum of $205,570 a year. Ben S. Bernanke, the chairman of the Federal Reserve, earns $199,700 a year, while the other members of the Federal Reserve board earn $179,700.

Officers of the branch banks of the Federal Reserve system earn more. The president of the Federal Reserve Bank of New York, Treasury Secretary Timothy F. Geithner’s old position, receives $410,780. By my calculation, the 17,015 employees of the Federal Reserve received an average compensation of $87,579 in 2010.

Figures for 2011 hedge fund compensation are yet to be known, but compare the Fed’s salaries with the highest paid hedge fund managers in 2010. According to AR: Absolute Return + Alpha magazine’s annual list, the top 25 hedge fund managers made $22 billion, or an average of $880 million. The highest paid hedge fund manager in 2010 was John Paulson, who made $4.9 billion running a hedge fund that had about $33 billion in assets. (He is likely to make much less in 2011, with his funds falling as much as 52.5 percent last year.)

Hedge fund managers make their money from the “2 and 20.” Hedge funds generally charge a fee of roughly 1 to 2 percent on all assets under administration and take 20 percent of the profits. The idea is that this large cut will incentivize the hedge fund manager to earn outsize profits.

But federal employees who were paid astoundingly less made fantastically higher profits than any single hedge fund manager. The entire Fed payroll for 2010 was still less than Mr. Paulson’s 2010 salary. One man made four times more than the Fed’s 17,000 plus employees combined, and earned much less money.

The point is not that the federal government should go into the hedge fund business or that making money is relatively easy for the Fed. Rather, it is that these government employees did this service without demanding to be paid billions in compensation.

They are not alone. Treasury Department employees take on the similarly complicated, hedge fund-type task of supervising the economy for even lower pay than the Fed’s employees.

Even outside the federal government, there are those who are not paid enormous sums to perform the most complicated financial tasks.

David F. Swensen, the chief of the Yale endowment, for example, is one of the most successful asset managers in recent history, consistently earning outsize returns and often beating the best hedge fund performers. His salary too is much less than that of the hedge fund barons. In the last few years, his salary has ranged from $3 million to $5 million a year for managing Yale’s endowment, which is valued at about $20 billion.

Even so, people in private industry argue that you have to pay top dollar to get the best people and that the market demands it.

We even see this argument being made by the federal government. The regulator who oversees Fannie Mae and Freddie Mac, Edward J. DeMarco, has asserted that he had to pay the top six executives at Fannie and Freddie more than $35 million in combined pay over 2009 and 2010. He said that to do otherwise would be “irresponsible” because it would fail to retain and attract the appropriate people. Yet, the Fannie and Freddie executives are arguably doing even less sophisticated work than the Federal Reserve employees do.

Why these executives should be paid more than Mr. Bernanke and his colleagues defies reason. This is government work now.

These disparities show that compensation, like people, is a complicated issue. People are willing to forgo earnings for prestige and other benefits like job security. And perhaps top dollar simply does not need to be as high as those in the finance industry would want you to believe.

Perhaps more interesting, the Fed pay structure may show that the work that these hedge fund barons and other titans of finance and industry perform doesn’t require multimillion-dollar salaries — even when some claim that the market demands them. Perhaps they would be willing to accept lower amounts when push comes to shove.

This will happen only when the pension funds and other institutional investors recognize that a 20 percent cut of the profits paid to hedge fund managers is too much, and they push hard to lower these fees. In the private equity realm, the Institutional Limited Partners Association is leading a similar crusade, but no such movement has yet penetrated the hedge fund universe.

The Fed has unwillingly made billions, to the benefit of the United States taxpayer. The Fed and its employees have done it in a way that would make even the most ardent opponent of the Fed proud — at a low cost.


Steven M. Davidoff, writing as The Deal Professor, is a commentator for DealBook on the world of mergers and acquisitions.

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The Media Equation: At Gannett, Furloughs but Nice Paydays for Brass

After explaining that revenues at the newspaper giant continued to be soft and the outlook was uncertain, Robert J. Dickey, Gannett’s president of U.S. Community Publishing, said, “I know furloughs are very hard on you and your families and I thank each of you for the continued commitment and great work.”

Mr. Dickey made it clear that not only did the company’s executives feel their pain, they would share the sacrifice, noting that he too would take a furlough and that Craig A. Dubow, the chief executive, and Gracia C. Martore, the president and chief operating officer, “each will be taking a reduction of salary that is equivalent to a week’s furlough.”

But as it turns out, the buck stopped just short of Mr. Dubow and other executives. Mr. Dubow had agreed to lower his salary by 17 percent through 2011, but then again, last month he received a cash bonus of $1.75 million for 2010 and Ms. Martore received $1.25 million. For 2010, they were also awarded stock, options and deferred compensation that would bring their combined packages to $17.6 million if the company and its stock hits certain targets.

A company spokeswoman pointed out that 70 percent of their compensation was noncash and dependent on future performance. In fact, the top six executives at the embattled publishing company would receive 2010 compensation packages of more than $28 million if the company does very well, which seems unlikely, but the symbolism remains.

The savings from two years of mandatory furloughs for the rest of Gannett employees: $33 million. Well, that didn’t go very far, did it?

This is not a story about incompetents feeding at the trough, although a lot of Gannett employees would say that is precisely what the story is about. Yes, revenues have declined at the company four years in a row and the stock price is down more than 70 percent, but even divine intervention could probably not fix all that is wrong with Gannett and publishing in general. The company has 23 television stations, but with 82 newspapers, many of them dailies in small and medium-size cities, the company was bound to be clobbered by a recession on the one hand and a systemic flight from advertising in newspapers.

Gannett’s flagship, USA Today, is a once-robust national newspaper but has lost 20 percent of its circulation in the last three years. About a week ago, I was at the Marriott in Detroit, and as I stepped over the newspaper at my door as I usually do, I then wondered why. It occurred to me that everything in that artifact that would be useful for me — scores from the teams I follow, a brief on big news and a splash of entertainment coverage — I had already learned on my smartphone and tablet before leaving the room. Gannett is aware of the challenge and has moved aggressively into mobile, with six million downloads of its apps, but those marginal revenues will not fill the hole created by challenges to its core business.

In terms of financial engineering, Mr. Dubow and his crew have done a good job with a bad hand. Last year, revenue was down only marginally, and according to the company operating cash flow was $1.3 billion, up 19 percent from 2009, while debt was reduced by $710 million, to $2.35 billion.

That’s a testament to what the Street would call “aggressive cost management.” But out in the rest of the world, we know that generally means dumping bodies overboard, and Gannett is a high achiever when it comes to downsizing. In the five years that Mr. Dubow has run the company, its work force has gone from 52,000 employees to just over 32,000.

Most of its employees are nonunion, so the leadership is free to manage as it sees fit, including telling some people their careers are over and telling the people that remain not to come to work.

“It has been incredibly galling to watch them lining up for these big compensation packages while they have squandered every opportunity to make the kind of changes necessary for the company to survive,” said an employee of USA Today. (She and others I spoke to said that there would be retaliation if they spoke for attribution.) “Meanwhile, we have had furloughs three years in a row, so you can’t help but feel exploited and angry.”

E-mail: carr@nytimes.com;
Twitter.com/carr2n

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Even Funds That Lagged Paid Richly

Last year, it took only one.

John Paulson, who rose to fame in 2007 with a prescient bet against subprime mortgages, earned a record $4.9 billion in 2010 as a result of a big wager that his fund, Paulson Company, made on gold. The metal soared last year, lifting the values of some hedge funds by more than 30 percent.

Last year was very lucrative for some of the biggest and best-performing hedge funds’ chiefs. Wealth was so concentrated that a mere 25 people pocketed a total of $22.07 billion, according to this year’s annual ranking by AR Magazine, which tracks the hedge fund industry. At $50,000 a year, it would take the salaries of 441,400 Americans to match that sum.

Hedge fund managers can still have huge paydays even in years when their funds do not perform well. That is because of the millions they earn in fees from charging state pension funds, college endowments and wealthy individuals to manage money. These fees are typically collected regardless of whether the firm has a profit or a loss.

“So many of these guys are killing it on the management fees,” said Bradley H. Alford, chief investment officer of Alpha Capital Management, which invests in hedge funds. “You can’t feel good giving 30 percent of your returns to some guy who was up single digits. That has to give you indigestion.”

In fact, the hedge fund industry as a whole did not do better than the stock market last year. The HedgeFund Intelligence Global Composite Index, which tracks nearly 4,000 hedge funds around the world, had a median gain of 8 percent in 2010, trailing the 11.7 percent rise in the MSCI World Index of stocks and the 12.7 percent rise in the Standard Poor’s 500-stock index.

And this year’s list of top hedge fund earners includes a number of managers who pocketed hundreds of millions of dollars in fees but produced only single-digit returns for their investors. AR Magazine arrives at the pay figures by estimating a money manager’s portion of fees along with the increase in value of personal stakes in the funds.

For instance, David Shaw of D. E. Shaw, a firm that uses complex algorithms to determine its investments, made the list with income of $275 million, even though his biggest fund returned a paltry 2.45 percent and over all the firm lost 40 percent of its assets, the magazine said.

AR Magazine said Mr. Shaw, who gave up day-to-day oversight of the funds in 2002, made the list because the firm charged a 3 percent management fee and took 30 percent of the investment gains. Mr. Shaw also has much of his own personal wealth tied up in the firm.

Other managers who collected big paychecks while their funds had mediocre returns included George Soros, who is retired but has most of his money in the $28 billion Quantum Endowment fund. The Quantum fund rose 2.63 percent last year, its worst performance since 2002.

Likewise, funds at Moore Capital Management had mostly single-digit returns, but the manager, Louis Bacon, pocketed $230 million based on the increase in value of his holdings in the funds as well as a portion of the firm’s 3 percent management fee and 25 percent performance fees, the magazine said.

To be sure, there were some managers from the 2009 list who did not make this year’s ranking because of subpar performance or even losses at their funds.

For the first time since opening Centaurus Advisors in 2002, the former Enron energy trader John Arnold had a losing year, ending down 3.27 percent. Under Alan Howard, Brevan Howard Asset Management struggled throughout 2010 and wound up with gains of 0.9 percent to 1 percent, the magazine said.

And Philip Falcone of Harbinger Capital Partners, who made $825 million in 2009 and has worried some investors with a huge bet on wireless broadband technology, did not make the list after his flagship fund tumbled 12 percent last year.

Still, there were plenty of bright spots for this year’s top earners.

Big gains late in the year helped Third Point Advisors’ Daniel Loeb make returns of 33.7 percent to 41.5 percent in his funds, giving him a payday of $210 million.

Likewise, David Tepper of Appaloosa Management, who topped the hedge fund rich list in 2009 with a payday of $4 billion, earned another $2.2 billion last year after his funds posted returns of 22 percent to nearly 28 percent, the magazine said.

And a return of 20 percent in his fund last year landed Leon Cooperman of Omega Advisors on the list for the first time since 2004.

Many of the managers on the list declined to comment or did not respond to calls seeking comment. But Mr. Cooperman was willing to discuss his history and his returns.

The son of a plumber, he attended New York City public schools in the Bronx. Mr. Cooperman earned an undergraduate degree at Hunter College at a time when it cost $24 a semester to attend, he recalled in a telephone interview.

When told he made the list with a payday of $240 million, Mr. Cooperman laughed.

“I have no idea how much I made last year. I don’t know until it’s tax time. Besides, I’m giving it all away anyway,” he said, noting that he has taken the Giving Pledge, an effort by Bill and Melinda Gates and Warren E. Buffett to prompt wealthy individuals to give away the majority of their wealth during their lifetimes or upon their deaths.

Mr. Cooperman, 67, explained that he had been giving money to several hospitals and charities, as well as Columbia, where he earned his business degree and immediately joined the ranks of Goldman Sachs after graduation.

“I’m very, very philanthropic toward Columbia, which opened the door to Wall Street for me,” said Mr. Cooperman. “I’m trying to give money away to the kinds of things that touched me during my lifetime.”

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