Hedging against the market

A question about hedge funds came up at the first Democratic presidential debate last night from moderator and NBC News anchor Brian Williams: Do hedge funds make America better in any way? It was directed to former senator John Edwards.

Earlier in the week, the news was about Edwards’ lawyering for a major hedge fund in New York, which some political observers believe could hurt Edwards’ presidential bid. During the senator’s first shot at the White House he has devoted some time talking about the Two Americas, one of the rich, the other of the poor. Now, he’s been talking again on the same tenor, the wage divide.

I’m not sure if what hedge fund managers make is market dictated. I am however certain of one thing: it is obscene. Last year’s earnings of the top bettor, James Simons, were $1.7 billion. Two others, Kenneth C. Griffin and Edward S. Lampert, took the cake of more than $1 billion each last year.

Here’s how James Cramer* of CNBC’s “Mad Money” has recounted his heyday as hedge fund manager as summarized by TheStreet.com:

It doesn't take much money to sway the stock market, Jim Cramer said on TheStreet.com TV's Wall Street Confidential video Webcast Friday.

In fact, when Cramer was short stock during his hedge fund days, meaning he was betting the stocks would fall, he would look to create a level of activity beforehand that could drive the futures lower, he told Aaron Task, the host of Wall Street Confidential.

Conversely, when he was long and wanted to make things "rosy," he would commit $5 million in capital to a handful of stocks and make sure they were higher, Cramer said. However, as the market is bigger now, an investor would need $10 million to knock stocks down or drive them up.

And sometimes, hedge fund investors boost the futures to create a false sense of excitement that can quickly turn negative when the sellers come in, Cramer said. He encouraged anyone in the hedge fund game to follow this strategy, as it's legal and a "very quick way to make money."

When Task asked if the fact that there are so many more hedge funds intensifies market moves, Cramer said hedge funds are positioned long and short, not just long like mutual funds.

It's "vital" for the next six days [trading days], after which it's "pay day," to control the market and not let it lift if your fund is short and/or badly trailing the S&P 500 year to date, he continued. Therefore, when market players are presented with a stock like Research In Motion (RIMM), "it's really important to knock it down because it's the fulcrum of the market today."

"A hedge fund that's not up a lot really has to do a lot to save itself now," Cramer said. "When you have six days and your company is in doubt because you're down, it's important to foment an impression that RIM is down, because RIM is the key today."

Although he estimated it would take between $15 million to $20 million to knock the stock down, he said it would be "fabulous" to do so because it would beleaguer all the longs who are keying on it. This is what we're seeing now, Cramer said. "When your company is in survival mode, it's important to defeat RIM."

RIM reported a really good quarter, it's a "terrific story" and the stock probably should be up. But being five days away "from making your quarter, you can't risk having RIM up this much," he said. (After trading as high as $140.11 intraday, RIM shares were recently down nearly 3% at $129.79.)

Similarly, it's important for market players who are short Apple (AAPL) to spread rumors that Verizon (VZ) and AT&T (T) don't like Apple's new phone.

Cramer said Apple is an "ideal short," and said if he were short the stock, he would call six trading desks and say he just got off with his contact at Verizon, who said that the company has no room for Apple.

"It's a very effective way to keep a stock down," he said. "What's important when you're in the hedge fund mode is to not do anything remotely truthful, because the truth is so against your view."

Maybe two weeks from now the buyers will come to their senses and realize everything they heard was a lie, but then again Fannie Mae (FNM) lied about its earnings, Cramer went on to say.
"It's just fiction and fiction and fiction," he said.

It's important for people to recognize that the way the market really works is that it has that nexus of hitting the brokerage houses with a series of orders that can push a stock down, after which rumors get leaked to the press and get on TV, Cramer explained. Then there is a "vicious cycle down."

On another note, Cramer said the Fed will have to cut rates and is "desperate" to figure out how quickly it has to cut them.

No wonder, presidential candidate John Edwards was taken aback.

The same question may be asked about private equity: Is it good for the public? This piece by Washington Post op-ed columnist Robert J. Samuelson makes for another interesting read. Samuelson describes private equity according to its critics as “sophisticated swindle that often cheats ordinary shareholders.”

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*Jim Cramer is also author of “Real Money: Sane Investing in an Insane World,” “You Got Screwed!” and “Confessions of a Street Addict.”