George Soros

Five of America's leading hedge fund billionaires, testified before a congressional committee on Thursday and all of them - - Philip Falcone, Kenneth Griffin, John Paulson, James Simons and George Soros - - said they would support new rules that would force the sector, controlling nearly $2 trillion, to disclose more of its secrets.

The top 25 managers earned, on average, $877 million in 2007, up from $532 million in 2006 and John Paulson headed the list at $3.7 billion, by betting correctly that the subprime house of cards would come tumbling down. Hungarian-born George Soros (78), who earned $2.9 billion in 2007, may just break even this year.

When the inaugural Alpha Magazine list was published in 2002, Soros led the way with $700 million, a showing that in 2007 would have put him at No. 9. Back then it took $30 million to crack the top 25; in 2007, $360 million. The grand total earned by the top 25 in the 2003 ranking, almost $2.8 billion, was less than what any of the top three managers made in 2007 and less than one fifth of what the top ten made altogether ($16.1 billion).

The House Committee on Oversight and Government Reform panel questioned why most of the earnings of the billionaires are subject only to a 15% tax rate because their earnings are treated as capital gains.

"A schoolteacher or a plumber or a policeman makes on the average of $40,000 or $50,000 a year. Yet they had to pay 25% tax,"said Rep. Elijah Cummings, a Maryland Democrat.

Almost all the hedge fund managers agreed that they should be subject to higher taxes, except for Kenneth Griffin who defended the current model.

Managers typically take 20% of the gain on an investment and they charge an annual fee of at least 2%.

Griffin said that the bulk of his earnings are taxed at ordinary income rates as high as 35% because they are based on short-term gains. However, he defended the current tax treatment of carried interest, saying that hedge fund managers should be taxed the same way as restaurant owners.

"What we should seek to have is consistency in how we treat long-term capital gains,"he said.

Rep. Henry Waxman, a California Democrat who heads the Committee, had called the hearing at a time when hedge funds have been criticised for accelerating the worst financial crisis since the Depression.

"Currently, hedge funds are virtually unregulated," Waxman said. "They are not required to report information on their holdings, their leverage, or their strategies. Regulators aren't even certain how many hedge funds exist or how much money they control."

The hedge fund managers emphasised that they were not culpable in the financial meltdown. Soros blamed on the “financial system itself”, while James Simons, president of Renaissance Technologies, criticised credit ratings agencies, which he said had facilitated the sale of “sows' ears … as silk purses” through “fanciful” ratings of mortgage-backed securities.

Kenneth Griffin, who has run Citadel Investment Group for 18 years, was generally opposed to new regulations. "We do not need greater regulation of hedge funds. We've not seen hedge funds as a focal point of the carnage," he said.

Griffin conceded that some regulation may be necessary but regulators should not make it public, he said.

Soros said that the financial system in general should be regulated to prevent asset bubbles like the housing-market buildup that led to the current credit crisis. But he warned that overregulation of hedge funds would hurt the economy by putting even more funds out of business than the number already disappearing.

"Hedge funds were also an integral part of the bubble," said the chairman of Soros Fund Management LLC who famously made £1 billion from the crash of the British pound in 1992.

"But the bubble has now burst and hedge funds will be decimated,"he added in prepared testimony. "I would guess that the amount of money they manage will shrink by between 50% and 75%."

Soros proposed bringing back variable margin requirements and minimum capital requirements that were used in the 1950's and 1960's to control the amount of leverage, or borrowed money, market participants can use.

"Sophisticated financial engineering,"such as collateralized debt obligations and credit-default swaps, can make it almost impossible to gauge appropriate margin and capital requirements, he said.

That means financial engineering must also be regulated and new products should be registered and approved by regulators before they can be used, Soros added.

The US Federal Reserve and other regulators "abdicated" their responsibility to regulate because they thought that financial markets could correct their own excesses, Soros continued.

"The severity and amplitude of the crisis provides convincing evidence that there is something fundamentally wrong with this prevailing theory and with the approach to market regulation that has gone with it," he concluded.

Two weeks ago, former Federal Reserve Chairman Alan Greenspan told the same House Committee, that that he “made a mistake” in believing banks and others would protect their shareholders and own firms' equity.

He was “shocked” to learn of the breakdown in lending standards and risk management at the firms that lead to the current credit crunch. Greenspan admitted that he “found a flaw” in his ideology and “that's precisely the reason I was shocked.”

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