Boom and Bailout

[Robert Weissman <rob@essential.org>]

So, you are in charge of investing $4.5 billion. 

You hire two Nobel Prize economists to generate computer models on how to
invest in world bond markets. 

You borrow billions more and put down a big chunk on a bet that
differentials between certain world bond prices, out of kilter because of
the global crunch, will revert to their historic levels. They don't. You
lose $4 billion. 

Your clients -- who needed to pony up $10 million just to be in your hedge
fund -- are apoplectic. They call. They want to know what the hell is
going on. 

Boom and bust? 

Don't be silly. That's capitalism for the small guy. If we go to Atlantic
City or Las Vegas, make a bundle and then lose it all, then that's boom
and bust. For the rich, it's boom and bailout. 

So, you're John Meriwether, the bond trader who was forced to leave
Salomon Brothers in 1991 after a trading scandal. 

And you leave to start Long-Term Capital. And for the first couple of
years, you are making 30 percent return on investment for your millionaire
friends. And they are loving it. And then you lose the $4 billion. 

Who do you call? 

The Federal Reserve Board -- bailout central. 

So it was that on a hot, steamy New York September??? day, New York
Federal Reserve Bank President William J. McDonough received a phone call
from Meriwether and bailout fix-it man supreme David W. Mullins Jr., the
architect of the bailout of the savings and loans under President Bush. 

Big institutional investors in the hedge fund -- Merrill Lynch & Co.,
Goldman Sachs & Co., Bear, Stearns & Co. and Bankers Trust Corp. -- were
also calling begging for a bailout. 

These companies were of course seeking to save their own skin. But
McDonough put forth the official spin before a House of Representatives
Committee earlier this month. 

"Everyone I spoke to that day volunteered concern about the serious effect
the deteriorating situation of Long-Term Capital could have on world
markets," McDonough said. 

Ah yes, world markets. And so McDonough calls Fed Chair Alan Greenspan and
Treasury Secretary Robert Rubin??? and a bailout is arranged. 

Former Lehman Brothers partner and current financial columnist Michael
Thomas is right -- it was improper for the Federal Reserve to arrange a
private bailout. If Merrill Lynch and Goldman Sachs want to protect their
behinds by arranging for a private bailout, fine. But the Fed should have
stayed out of it. 

Or, as former Fed Chair Paul Volcker asked in a speech, "Why should the
weight of the Federal Government be brought to bear help out a private
investor?" 

"Capitalists now all want it one way," Thomas says. "They want to do
whatever the hell they feel like, but let someone else pay. It's called
privatizing the profits and socializing the risks." 

Hedge funds, which make complicated financial bets with millions and
billions of borrowed dollars and are almost totally unregulated, do indeed
pose risks to the economy. Because of the nature of their gambles, they
can lose huge amounts of money, leaving investors holding the bag (absent
a bailout). Even worse, they leverage borrowed money to exert
extraordinary influence over markets, and cause serious problems when they
overreact en masse to new fads. (That's a big part of why the value of the
dollar has plunged suddenly recently, for example.) 

But these are reasons why hedge funds must be subjected to regulatory
discipline -- not an argument for why high rollers deserve
government-orchestrated bailouts. 

With the global financial system in frenetic disarray, Long-Term Capital
is not likely to be the last financial player to go bust. If the
government is not able to act quickly to rein in hedge funds and other
unbridled financial activities, it should at least declare that no
bailouts will follow in the wake of Long-Term Capital. Each bailout makes
the next one more likely, as investors are given implicit assurances that
they will not have to face the downside of risky bets gone bad. 

The gamblers in Atlantic City don't get this kind of treatment. Neither
should those on Wall Street. 

Russell Mokhiber is editor of the Washington, D.C.-based Corporate Crime
Reporter. Robert Weissman is editor of the Washington, D.C.-based
Multinational Monitor.

(c) Russell Mokhiber and Robert Weissman

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