Hedge fund

My daughter asked me some questions about Hedge Funds and I thought you might be interested in my response. A group of wealthy individuals combine their cash to use for investments. They like this approach because they are not inhibited by any government regulations, like they would be, if they were selling stock to get money. They are called venture capitalist because they invest in high risk ventures that banks will not finance. These can be existing businesses that are in trouble or new start-ups that find it difficult to get seed money. In either case they are high risk and so the venture capitalist charge high interest. The venture capitalists are paid on what is called the 2 and 20 system. They get an up-front fee of 2% and then 20% interest. Sometimes the investors just offer money but often times they offer advice and this has led to a controversy. If it is just money and there income is a return on investment it is taxed at 15% but if it is pay for advice they are taxed at 35%. This difference is resolved by calling the income, “carried interest” which is a special category taxed at 15%. Sometimes the investors help the company and they make money but sometimes the company fails and they lose money. I will illustrate how this works using General Motors as an example where the federal government serves as the hedge fund. GM was going broke and the government stepped in to help. They cut back on their product line, laid off thousands of employees, closed down thousands of dealerships, gave the union part ownership in return for the union covering much of the pension cost and paid off suppliers with discounted dollars. At the end the government lost 26 billion and the president touts this as a success. If a private firm had done this and lost that much it would have been a colossal failure and would have bankrupted most hedge funds. This can serve as an example to show the difference between private enterprise and government. The government is not restrained by the necessity of earning a profit.