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Tim,
Thank you for the time and effort you took to answer my Hedge Fund
questions...very much appreciated by me and other readers as well, I'm
certain.
It's an intriguing subject because it provides insight into the inner
workings of institutions which control global capital flows and
therefore directly impacts markets which we all trade.
That makes this about the most "On Topic" topic I could imagine this
List discussing given the current global economic situation and the fact
that we are all impacteded one way or the other by these types of events
as they continue to unfold.
It's particularily intriguing to see two apparently co-existing
situations pointed out by yourself, BruceB, and Michael Paauwe. More
specifically:
You stated that "products have grown much faster than the risk
measurements used by the banking firms and much faster than the knowlege
of the regulators...I never like it when the market is so far ahead of
the government...it means they are not in control". In other words, we
have situations where proper metrics (and hence control mechanisms) have
not yet been developed to match the sophistication of certain
highly-complex and highly-leveraged transactions yet these transactions
have somehow been allowed to transpire!
We simultaneously have Michael Paauwe talking about, "simple
incompetence in financial management" and stating that "Banking 101 and
trading 101, would be a better starting place" regarding a solution to
the present situation. Both you and BruceB seem to be in agreement with
Michael's assertion given BruceB's statement that, "Unlike most other
assets, there is apparently no legal limit on the amount of leverage one
can obtain on bond holdings. If you have a bond portfolio with a face
value of $1,000, a bank can loan you $1,000,000+ with only those bonds
as collateral (incredibly stupid, but legal)" combined with BruceB's
statement that, "Tim Morge is absolutely correct in saying one of the
appeals of hedge funds is that there is very little regulatory control
over them (especially those based offshore)".
This is incredible.
Here we have ultra-sophisticated, highly-leveraged, multi-national
banking transactions taking place in situations where, as you have
stated, "...the people that are overseeing the use of the bank's risk
allocations only find out about the incredibly stupid overuse and abuse
of leverage by fund managers when there is a problem". And all of this
in an atmosphere which, according to Michael, "[any] Banking 101 and
trading 101" graduate would know to avoid. In other words: stupidity on
the part of those who know better seems to be the Common Thread.
To allow un-measurable, un-controllable, highly-sophisticated,
over-leveraged, multi-national banking transactions to take place is at
the very least Criminal Negligence, pure and simple...these are not
Stupid People we're talking about here unless one wants to take the
position that Bank Regulators, etc. flunked Michael's "Banking 101 and
trading 101".
It would be as if parents allowed 2-year-olds to play in the
street...or, as BruceB so aptly put it, "How in God's name did these
lenders not see this coming, and where the hell were the banking
authorities and accounting firms that watch these lenders?" BruceB, in
part, answered his own question by pointing out the apparent lack of
"legal limit on the amount of leverage one can obtain on bond
holdings"...but his major point remains just as well-taken; lack of
legal limit in no way implies a right to shirk one's responsibility to
not do Obviously Stupid Things...to claim and/or act upon such a
non-existant right is criminal.
It's good to hear that Congress is apparently going to be taking a look
at things. And, while I very much agree with Michael that, "...MORE
GOVERNMENT REGULATION isn't always the best solution" and that, "The
free market system just demonstrated that it is very efficient. It
brings down even the so-called best of the best, even 'the Master of the
Universe' and his nobel back room geniuses, when they FAIL to employ
BASIC MONEY MANAGEMENT PRINCIPLES. That's the moral of the story". I
can't help but point out that these failings have effected many, many
others in addition to the banks, Hedge Funds, etc. If the consequences
were well-contained, I would be in 100% agreement with Michael...let the
market punish the transgressors as it surely will. Unfortunately,
because so many others are involved, I think it imprudent to leave the
matter solely up to such market forces, no matter how powerful.
I'm therefore brought back to Stewart Taylor's comment, "As far as Im
concerned, these kinds of behaviors should be considered criminal and
the principles prosecuted under RICO. You can't convince me that the
vast majority of these guys don't know better. Ive been around to many
of them to believe otherwise."
I believe Stewart is inescapeably correct, and I believe your comments,
Tim as well as comments by BruceB, Michael, and others lend direct
support to what Stewart has proposed. The RICCO statutes require an
*organized* and *repeated* sequence of criminal activity. It appears a
strong liklihood that both these conditions have been met...the LTC
fiasco is certainly not the first and, in order for these transactions
to have taken place, a broad-based collusion on the part of many people
would have been required.
For these reasons, I would like to see Congress turn this investigation
over to the Justice Department for possible criminal prosecution. There
have been many people hurt by this and, for all we know, there remain
many more destined to end up on the Economic Chopping Block solely
because of the criminally-negligent behavior on the part of those who
knew better.
What I'm seeing here reminds me very much of what might as well be a
1920's Chicago-style, smoke-filled back-room of Good Old Boys whooping
it up at the expense of everyone else.
In these types of situations, criminal prosecution is far more effective
than Congressional investigation...just ask any corporate executive who
has spent time in Prison pondering the Sheer Stupidity of allowing his
company to pollute the Nation's air and waters.
I will grant the fact that all too few such Corporate Executives have
been led to experience the Joy of Prison, but nevertheless, I think it
safe to say their example has served an effective deterent to others who
may have been so inclined.
For similar reasons, we might want to consider applying the same
measures to another group of polluters apparently hell-bent on fouling
up our collective economic environment.
Dave
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