The Super-Rich: The REAL Explanation
By Shlomo Maital
Want to know the real story behind the super-rich – those who pull enormous inflated salaries? The Dean of Univ. of Toronto’s Rotman School of Management, Roger Martin, a former McKinsey principal, tells us the story in the latest issue of Harvard Business Review:
The rich are getting richer in the United States, surely, but the real problem, says this former business school dean, is who exactly is getting mega-rich and how. It’s not the capitalists (that is, the shareholders and investors). It’s the speculators (the people who manage their money). The top 25 hedge fund managers in 2010 raked in four times the earnings of all the CEOs of the Fortune 500 combined. How come?
Here is the explanation.
Through a once-obscure mechanism called the “2&20 formula.” Derived from a 2,000-year-old practice whereby Phoenician ship captains took 20% of the value of a cargo successfully delivered, it’s the formula that governs how hedge fund managers are compensated — a 20% cut of the profits generated (taxed at the 15% capital gains rate) on top of a 2% asset management fee. And what are those 25 people doing? They’re borrowing stock, holding it for sometimes less than five minutes, and creating and profiting from the resulting volatility.
And – the solution? Pretty simple, according to Roger Martin:
This problem can be fixed with tax laws that penalize high-frequency trading and require the profits to be taxed as income, and concerted efforts among pension and endowment funds to stop lending the overpriced hedge fund managers the stock they’re playing with.
What are the chances the U.S. Congress will fix the problem? With obstructionist Republicans calling the tune, and with November elections upcoming, with the Democrats in danger of losing control of the Senate – less than zero.