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J.E. Fishman Headshot

Hedgzilla vs. Finothra

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Billionaire hedge fund manager Steven A. Cohen has been in the news lately, and not for the right reasons. The Feds seem to be after his firm for insider trading -- one of those "victimless" crimes that in fact affects the whole market and, therefore, all of us.

This guy is big. Remember Godzilla? Of course you do. He's the creature who emerges from the ocean after nuclear tests and goes on to crush Tokyo underfoot. It's not that he has anything against Tokyo. He has bigger fish to fry: Mothra, Ebirah, Megalon, and so on. Tokyo just gets in his way sometimes.

The same could be said for the titans of the financial world, I think. They're not bad guys -- at least, not all of them. They're just in a mad rush for the money. If a few million lives get destroyed in the process, well, the thinking goes, "I guess when people get mad I'll have to use a small portion of my newfound riches to build a taller fence around the old castle."

For example, I lived in the Hudson River Valley during a period of the last decade when hedge fund managers began springing up like mushrooms. You'd see these guys at the tennis club, overhear them at the next table when you went out for dinner, run into them at cocktail parties.

Not many of them rode the train like the rest of us. On the Metro North platform you might see bond traders or plain vanilla money managers or investment bankers, but the hedge fund guys made themselves scarce in the concrete canyons of New York. They saw themselves riding the technology boom, not the Harlem Line, and they took pride in their ability to outwit markets from any location. Why sweat it out with the commuters when you could mint money at your computer in the leafy suburbs?

As a result, for many years it felt like you couldn't swing a Blackberry on the sidewalks of nearby Greenwich, Connecticut, without hitting a hedge fund manager in the nose. Statistically most of these guys would prove to be merely average or worse, but that didn't seem to change their lifestyles much. There was so much money rushing by that anyone with a Wall Street resume had a shot at selling some institutional investor on their two and twenty scheme.

Ah, the two and twenty -- that always amazed me. Having worked in various aspects of non-financial business, I didn't understand how you could ask a client to take all the capital risk and then part him from a fifth of every dollar on the upside. Especially when you'd already been paid two percent a year on the initial investment for your efforts.

But that was the deal and they got it. Some of them still do, though nowadays most keep a lower profile.

Whether it's hedge funds or something else, the sums involved are staggering, and for the most part they have nothing to do with the genius of the players involved. Imagine that you walk across the kitchen with a spoon in your hand, turn on the faucet at a trickle, and stick the spoon under the water. What happens? The spoon gets wet, that's what. Maybe a little bit dribbles onto your thumbnail.

Now imagine you take the same actions, with the only difference being that you turn on the faucet full blast. What happens this time? Not only does the spoon get wet, but you get wet, too. All of you. That's the formula. Same effort + larger volume = soaked.

But when too many hit the spigot at once, the water pressure drops and it's time to move on. Collateralized debt obligations? A lot of money there...yesterday. Day trading? Bloom's off that rose, too. Leveraged buyouts? Fuhgeddaboudit. Oh, they're all still around, but the hot money's always looking for the next big thing. And, as with those nuclear tests in the ocean, another monster of unintended consequences will likely emerge eventually.

My new novel, The Dark Pool, addresses one such phenomenon. The characters in the novel are all made up, but the mechanism at its center is factual. Here's how it works in real life.

As the public markets and other financial activity become increasingly regulated, more trading action has been migrating to means of exchange known as "dark pools of liquidity." Say you're a brokerage firm with two big clients. One of them wants to buy $50 million of General Electric shares and the other one wants to sell. But they don't desire for their transaction to be seen on the public market. Maybe they're afraid their activity will move the price too much, or maybe they just don't wish for the outside world to know what they're doing. Since you, the well-connected broker, have the wherewithal to arrange the transaction between both parties, this private sale of stock in public companies gets consummated away from public scrutiny.

Wait a minute. Didn't we fight this battle back in the days of FDR? Is this just another crazy novelist's dystopian fantasy? Nope. Up to a third of all trades today occur in this lightly regulated -- and largely obscure -- way. That is to say, a huge volume of trading happens away from the public exchanges for stocks that are otherwise publicly listed.

It turns out that some managers in Cohen's firm, SAC Capital, have used this method of trading to conceal their intentions or, as Bloomberg put it, "to keep the trades quiet." That's not illegal in and of itself, but let's face it: people behave differently when they don't think anyone's watching.

Much has been made of Wall Street greed in recent years, but people everywhere are greedy. Most of us don't sit in a position to get away with this kind of conniving, however. If you chose the wrong business out of college, maybe that money faucet in your industry never gets past a trickle. Maybe you're greedy enough in theory to be soaked in riches, but in reality the spigot in your industry only goes drip, drip, drip.

Which brings me back to the hedge fund managers I used to rub shoulders with. They didn't set out with intent to harm the economy. No one at the top echelons of the financial food chain sets out to do so. All they want is to stuff their pockets as full of cash as possible, and if the dough comes from the hide of a guy at the other end of Putnam Avenue in Greenwich, well, that's how the game gets played, right? And if it comes out of everyone's pocket, that's okay, too.

These people are like Godzilla and Mothra, battling it out above our heads for stakes normal human beings can only dream about. Let's call the financial monsters Hedgzilla and Finothra. Sometimes they're allied and sometimes they're looking to lay a lick on their opposite number. Either way, damn the consequences.

But who's that down on the sidewalk getting squooshed under Hedgzilla's monstrous clawed feet? Why it's just those pesky little people, blithely rushing about while titans clash above.

Destroying civilization as we know it never figured into Hedgzilla and Finothra's plans. It's just that, you know, stuff happens. Did I really destroy your house with my giant tail? Golly. How about -- I know! -- a visit to the house in East Hampton for my larger-than-life friends.

Godzilla, you'll recall, surfaced from the watery depths. Will the rise of today's dark pools create another species of financial monster? If so, how many more of us will get crushed underfoot before the battle subsides?