Congress should open the ‘black box’ of hedge funds, private equity firms

If you asked any given person on the street in our district what a hedge fund is or how a private equity fund operates, chances are that person would not be able to tell you. Alarmingly, the same confusion exists within the halls of Congress and at the Securities and Exchange Commission (SEC). Little is known about their potential impact on our overall economy since they go almost completely unregulated. Their mammoth profits earned through corporate takeovers are gaining some attention on the pages of The Wall Street Journal. Their impact is felt in our districts. They take their toll on our constituents and our neighbors. Recently, the private equity firm Cerberus bought Chrysler, whose Jeeps are made in Toledo, Ohio, and the Carlyle Group bought Manor Care, a Toledo-based assisted living company. These distant owners will have a huge impact on our way of life. Yet we do not really know them.

It appears these funds do not operate with the goal of strengthening our communities and contributing to the growth of the American economy. Their takeovers and investment strategies seem motivated solely by profit. Top firm managers reap billions as their tax rates are half that of ordinary incomes. Because private equity firms, and especially hedge funds, are involved in short-term investments, there is little incentive for growing roots in our communities. If the market goes sour, or their investment portfolios hollow out, their impact on our communities could be substantial. How do we protect against abandonment?

As former SEC Chairman William H. Donaldson pointed out, some of these deals involve managers who “are involved in takeovers themselves to their benefit and not for the benefit of the company.” A former manager, Andy Kessler, told The Wall Street Journal that the managers desperate to retain or raise cash were likely to “[c]ut spending, workers, offices, factories and advertising.”

Blackstone’s initial public offering last month combined with the $1.6 billion bailout of Bear Stearns may be signaling tough times ahead for these investors. In the words of Mr. Donaldson, hedge funds are “a ticking time bomb that is going to blow up at some point.” If these funds are already hurting workers with their profit-driven practices, does a sudden downfall foretell a fatal blow to our economy? These funds operate in a cloaked world, dealing directly with their investors and ignoring the public interest.

America appears to have thrust our political and economic security into a “black box.” Don’t the American people deserve to see where this money is, what it is doing, and who is controlling it? Hedge funds and private equity funds are completely opaque to not only the government, but to their own investors. These funds create huge profits for managers with small gains for outside investors and potentially huge losses for the American economy as a whole. While the fund managers rake in billions, analysis of what data are available show only small gains for outside investors like endowments and pension funds, especially given the huge risk involved for these parties. Furthermore, these funds create a back door for foreign investors to slink into American businesses, government and educational institutions.

Without question, hedge fund managers exert phenomenal political power. In 2004, for example, Cerberus founder Stephen Feinberg gave $25,000 to the National Republican Congressional Committee and donated over $100,000 to defeat House Democrats. James Cayne, CEO of Bear Stearns, sent the National Republican Senatorial Committee $10,000. The most prominent presidential candidates rely on contributions from these firms, whether it is Hillary Clinton’s ties to “the Street,” Barrack Obama and his ties to Citadel or John Edwards linked to Fortress Investments. In fact, Mitt Romney made his fortune with Bain Capital, the private equity firm he co-founded. But no matter to which party the fund managers give, the money comes at the expense of working Americans and at the risk of compromising our national security.

Without even discussing regulation of hedge funds and private equity firms, Congress needs to address the issue of transparency. If and when these funds falter, there is the potential for widespread economic damage. The players recognize this fear, as we have seen with the bailouts of Long-Term Capital Management fund in 1998 and with Bear Stearns’s two hedge funds just last month. But Congress and the SEC do not even have a grasp of how many funds exist, how much money is at stake, or who the investors are. One estimate assumes $1.2 trillion is at play in hedge funds, with private equity firms raising over $1 trillion since 1996. Mr. Donaldson noted that “[i]t seems rather inconsistent to me that we have that sort of economic force operating in a marketplace without having any jurisdiction over them.”

Why do these funds protect their secret investors and practices so fiercely? The very fact that the managers are afraid of disclosure reinforces the need to monitor hedge fund and private equity activity. Congress must pass legislation to increase transparency for hedge funds and private equity firms. We cannot stand by while workers at home fall victim to a cloaked force that is responsible to no one but itself.

Kaptur is a member of the House Appropriations and Budget committees.

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