Barbara T. Dreyfuss

Selected Articles

I wrote Hedge Hogs because I was troubled by the changes on Wall Street I witnessed over the twenty years I worked there as an analyst. It was an accidental career. I started out as a social worker, migrated to jobs at several hospitals, and when I moved to Washington, D.C. wrote a newsletter on health policy. After several years one of my newsletter subscribers, who had opened a Washington research office for a large brokerage firm, hired me. Starting work at Prudential-Bache -- later Prudential Financial -- I analyzed government policy on health issues for the firm's Wall Street institutional clients.

At the time these were primarily the burgeoning mutual fund companies, as well as pension plans, money managers, insurance companies and banks. Brokerage firms, such as the one I worked at, and banks handled the financial trades of these clients for a commission and provided them with research on companies and industries to guide their investment decisions. That is where I came in. My job was to look beyond the hype of corporate CEOs and public relations professionals and determine what legislation or regulation was in the works that might impact insurers, drug companies, hospital firms, and medical device manufacturers. Wall Street seemed a bit formal back in 1984, with clients always dressed in monogrammed white shirts with gold cufflinks, fancy suspenders and suits. Their offices sported conference rooms with lots of mahogany and paintings.

These portfolio managers were long-term investors, maintaining the same holdings for weeks, months, even years. Each mutual fund and money management company had rules for determining which stocks or bonds to buy or sell, along with parameters for how much to invest in each. They analyzed industries carefully and dug deep into the financials of companies before investing in stocks and bonds. Most mutual funds profited when their investments went up in price, as rules created in the wake of the Depression limited the ability of mutual funds to short stock, i.e., to make bets that a stock's price will drop. It was a good time to be bullish about the market. During most of the 1980s and 1990s, despite a few blips along the way, the market soared.

Over time , however, another type of investor, hedge funds, came to my attention. When I started out there were only a few dozen hedge funds, mostly large firms created and dominated by dynamic, highly skilled traders including Julian Robertson, George Soros and Paul Tudor Jones. Most of them did extensive research on companies, industries, and economic trends, and they keenly observed market psychology. They searched for unique opportunities -- and found them, too, not just because they were smart but also because there were so few hedge funds. They'd bet big, taking huge risks and making enormous fortunes. Unlike mutual funds, there were no limits on how hedge funds could trade. Many hedge funds shorted stocks, expecting prices to fall, and they traded rapidly in and out of holdings. They leveraged their bets, borrowing heavily so they could invest much more than they had on hand. By 1995 there were an estimated 2,000 hedge funds.

The stock market crash that followed the bursting of the tech bubble in 2000 caused a seismic shift on Wall Street. Mutual funds lost heavily and so did the pensions and endowments that invested in them. As a result, many investors started looking for a place to put their money that provided the sort of returns they'd gotten used to in the 1990s, regardless of how the overall market faired.

And thatís when hedge funds, which had done better as a whole in the market crash than mutual funds, made their move.

They urged potential investors to ignore their reputation as risk takers. Because of that risk, hedge funds had been mostly a playground for the super-wealthy who could afford to gamble and lose big in search of a payout. 'Invest with us and we will always make you money,' they promised. 'We can short stocks, invest in exotic derivatives, trade with lightning speed.' And as market indices plunged, more and more institutional investors, universities, hospitals, other charitable endowments and pension funds, who had enjoyed double-digit gains in the 1990s, started turning to hedge funds, first in a trickle, and then in a wave.

Hedge fund portfolio managers and analysts called me much more often starting around that time. They wanted breaking, actionable news. They were interested in news tidbits, rumors that might move stock prices, negative rumblings about a product. They didnít want long discussions about a new product or detailed information about changing health care practices. Hedge fund managers were a frenzied lot. Often they would run into a meeting with me when I visited their office, fidget in their chair and dash out a few minutes later. Few seemed to care about the companies they invested in or their products. It only mattered what other investors thought and did and knew. By 2003 there were over 6,000 hedge funds, managing more than $600 billion.

Wall Street had changed, and not for the better.

Soon afterwards, I left Wall Street and started writing investigative articles for magazines on such issues as the corporate influence on Congress, the breakdown in oversight by the Food and Drug Administration, drug company efforts to shape federal payment policies. As I worked on my new career, pension funds, endowments and foundations poured more and more money into hedge funds. And nobody was setting any rules for them or watching what they were doing. Firms borrowed heavily to boost profits, further increasing risk, and exotic new derivatives were created. A major blow-out by a hedge fund could wipe out significant chunks of retiree savings.

But not many people seemed concerned about this in the mid-2000s. Instead, the buzz was about how much money hedge funds made their investors. Pensions and endowments didnít want to be left out.

At the time I worked on an article about the need to regulate hedge funds. In the course of researching the story, I learned more about what had happened to Amaranth, a hedge fund that had been a client of my former firm. At its height Amaranth managed assets of almost $10 billion and then, virtually overnight, it imploded. Between the end of August and the end of September, more than $6 billion of its funds effectively disappeared. When Amaranth went under, it was the largest hedge fund collapse ever.

A firm that for several years was besieged by pension funds, universities, hospitals and wealthy individuals begging to enter its elite circle of investors had gone belly up. A company that was up 15 percent one year, paying out hundreds of millions of dollars in bonuses, suddenly closed its doors the next. Why?

Amaranth, marketed as a diversified hedge fund employing a myriad of investment strategies, became totally dependent on its natural gas bets and its star commodities trader, Brian Hunter. He was one of two traders who in the summer of 2006 ruled the world of natural gas investing. The other was John Arnold, who had been Enronís chief trader of natural gas derivatives and whose enormous trades through his own hedge fund continued to dominate the commodity exchange after Enronís collapse. For months during 2006 these two young traders sized each other up, gauged the bets each had made, how they affected gas prices. They probed for weaknesses in their trading strategies. For months they waged a high stakes battle. One became a billionaire and the other collapsed a multi-billion dollar firm.

The story of what happened at Amaranth, I realized, was more than just a cautionary tale of two risk-addicted traders. It was a way to shine a light on a dark corner of Wall Street, where unregulated traders playing in unregulated financial markets take enormous risks with investorsí money. It was a way to understand the transformation that much of Wall Street has undergone over the past two decades, morphing from long-term investing into rapid-fire, frantic speculative trading. At every step of the way the breakdown of regulation raised the stakes for ordinary people. Lack of regulation of electronic and over-the-counter trading allowed the cowboys to take charge. Deregulation of the natural gas industry allowed wild fluctuation in the price of a vital commodity. And hedge funds, completely unregulated, could take massive risks with money individuals were counting on for retirement.

When Amaranth collapsed it could have been a wake-up call to Congress to rein in the massive wave of speculative trading in commodities, but of course it wasn't. Instead the speculative mania in commodities, mortgages, credit default swaps and a host of other derivatives continued until the 2008 crisis. Most hedge funds had double-digit losses in 2008. Over 1,100 funds folded between the last three months of 2008 and the first three months of 2009. Well-intended legislation that finally passed Congress in 2010, designed to rein in Wall Street, was watered down. Worse, since its enactment, tens of millions of dollars and thousands of lobbyists have been deployed to further shred its provisions and scuttle or delay implementation. Soon Wall Street speculators were back in business. By early 2012 there was 40 percent more speculative money in energy commodities than when oil prices were at their height in 2008. And today pension fund managers are pouring more money than ever into hedge fund investments. Only strong pressure from voters will convince lawmakers to get Wall Street under control.