But hedge funds later diversified their practices beyond that easy definition. These funds acquired a good deal of popular mystique. They made scads of money. Their notoriously high entry fees—up to 5 percent of the investment, plus as much as 36 percent of profits—served as barriers to all but the richest investors, who gave fortunes to the funds to play with. The funds boasted of having genius analysts and fabulous proprietary algorithms. Few could discern what they really did, but the returns, for those who could buy in, often seemed magical.
But it wasn’t magic. It amounted to the return of the age-old scam called “bucket shops.” Also sometimes known as “boiler rooms,” bucket shops emerged after the Civil War. Usually, they were storefronts where people came to bet on stocks without owning them. Unlike their customers, the shops actually owned blocks of stock. If customers were betting that a stock would go up, the shops would sell it and the price would plunge; if bettors were bearish, the shops would buy. In this way, they cleaned out their customers. Frenetic bucket-shop activity caused the Panic of 1907. By 1909, New York had banned bucket shops, and every other state soon followed.
This makes a nice change from the boring state-v-free-market rhetoric which has been passing for analysis. Although it is fun to watch the cognitive dissonance seep through The Economist. The free market platitudes and scare stories about how we must hold our ground and not be tempted by Communism seem half-hearted and sporadic, as if they are slowly realising that this isn’t just another post-Cold-War cafeteria argument.
Meanwhile, Paul Krugman is off joining a literary round table about a Scottish sf writer.