We make markets more efficient.

I’ve heard that line independently from a half-dozen guys at hedge funds to justify what they do and why they make so much money. Given that prices are a universal communication medium and the foundation of mature capitalism, doesn’t that imply these noble men (and in my experience, they’ve been exclusively men) the heroes of our society? Isn’t it their labor that enables the doctor, the teacher, the firefighter, and the scientist to do their jobs effectively? Are they not truly doing God’s work?

No. Of course not. Hedge funds make markets more efficient the same way that Union Carbide kills people. They don’t like when it happens and they avoid it when they can, but if it’s a necessary condition in order to make more money, then it happens.

At its core, making markets more efficient means causing prices to slip against you; to keep prices inefficient is to make more money. In contrast, a hedge fund which was truly in the enterprise of “making markets more efficient” would reward traders based on how much they were able to alter prevailing market prices, which is essentially the opposite of the system in place now.

Let’s take a constructive example. Imagine a hedge fund manager had an opportunity to make a couple million dollars and in doing so make prices efficient, or the opportunity to make hundreds of millions of dollars but keep prices inefficient. This was exactly the situation faced by John Paulson, and this lucid blog post makes a good stab at explaining how he effectively (and profitably) subverted the price system.

Now I’m not arguing that hedge funds should be banned, or even that they should be regulated. I’m just saying they shouldn’t be sanctimonious about what it is they do.