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April 19, 2007

Rent Extraction

Don Boudreaux

I like very much this letter that my friend Andy Morriss sent today to the Wall Street Journal:

Sirs,

Your story “Hedge Funds Coming of Age Politically” (April 19) reports that hedge funds are beginning to form PACs and engage in political activity to protect themselves from threatened regulation. It is no coincidence that this is happening at the same time that politicians are considering regulatory measures that could prove costly for hedge funds.  Northwestern Univ. Law Prof. Fred McChesney’s “money for nothing” theory of regulation explains exactly this behavior.  Politicians target an unorganized but wealthy industry by holding hearings, calling for regulatory action, proposing legislation, and so forth. Alarmed, the industry organizes interest groups and begins making contributions to the politicians. Miraculously, most of the threatened regulations then vanish from the agenda, leaving the politicians richer and the industry poorer but wiser. Whenever a new round of contributions is needed, another round of hearings on the latest issue can be scheduled.

Andrew P. Morriss

Posted by Don Boudreaux in Politics | Permalink

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Comments

When Vanderbilt bought the NY legislature for similarly defensive reasons, he was the one vilified as the "corrupting" influence. This has been happening for so long that you'd think there was a name for the phenomenon that would be familiar to the press.

Posted by: M. Hodak | Apr 19, 2007 9:06:57 PM

This has been happening for so long that you'd think there was a name for the phenomenon that would be familiar to the press.

Extortion?

Posted by: Christopher Rasch | Apr 19, 2007 10:27:48 PM

This behavior exists somewhere between extortion and graft. The problem is that those forms of corruption are illegal when the public official directly benefits. But the behaviors we are seeing, such as threatening legislation, are perfectly legal. They're as legal as providing preferential access or consideration to anyone paying into a politician's preferred coffers, as long as the cash doesn't end up in his or her freezer.

The obverse behavior is also apparently legal, i.e., threatening to undermine a company's ability to fairly participate in government programs supposedly to the benefit of all citizens. Here is a brazen example:

http://www.hodakvalue.com/blog/2007/04/hillary_clinton_800_lb_gorilla.html

What the press and everyone else ignorant of public choice fail to see is how politicians will always find a way to monetize their power. I don't think there is a cure--it's an inherent aspect of democracy--unless we strip away the power of the legislature down to those of little economic consequence (my preferred alternative).

Posted by: M. Hodak | Apr 19, 2007 11:39:58 PM

One only need to remember what happened to Microsoft in the 1990s. It sat quietly in Washington State for two decades with just one or two lobbyists flying its banner in Washington, D.C., a fact it was always quite proud of.

Posted by: Brad Hutchings | Apr 20, 2007 12:57:09 PM

When one asks for handouts from the devil, the cost is always high.

Posted by: Reuben Sherwood | Apr 21, 2007 10:09:19 PM

This is definitely the case and hedge funds made the right bet in overwhelmingly throwing their political contributions at Democrats prior to Nov of last year. It is not just regulation that are concerned about. The big horror for hedge funds is a change in the tax treatment of their compensation. Right now, all performance fees, which are the meat of hedge fund compensation, are treated as an allocation of income earned by the investment vehicle, usually an LP. That allocation is divided up between the various components of income (dividends, cap gains, etc.). So a hedgie can earn $1 MM, some of which is dividends taxed at 15%, some of which is ST cap gain, taxed at ordinary income and some of which is untaxed unrealized gain. Congress is threatening to treat the whole $1 MM as ordinary income, which would drastically change the incentives of how we (I'm one of these hedge fund guys) manage money, very likely to the detriment of our clients. Plus it is baldly unfair. We'd pay tax on unrealized gains simply because we manage these pools of capital, but other individuals wouldn't?

Posted by: Don | Apr 23, 2007 12:48:39 PM

Don,

"Congress is threatening to treat the whole $1 MM as ordinary income, which would drastically change the incentives of how we (I'm one of these hedge fund guys) manage money, very likely to the detriment of our clients."

Don't worry. Congress will then become equally outraged at the detrimental treatment of our clients - which, of course, it will take no responsibility for - and enact more costly and useless legislation to "remedy" the problem. All, for our own good, you understand. This will cause more hedge funds to get around the new barriers and, in turn, cause more congressional outrage and regulation. My personal prediction is that my eyes will be the part of my body which will continue to get the most exercise from constant, unstoppable rolling!!!

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Posted by: Jim Crow | Jul 22, 2007 4:32:24 PM

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