Posted on 08/03/2007 7:40:06 PM PDT by Sleeping Freeper
Regulations are never permanent, but that is not the purpose of the exercise. What it is trying to correct is not really volatility itself, it is trying to correct what amounts to a takeover of the market by an unstable system. It only seeks to fend off catastrophic volatility.
Hedge funds are a fairly new phenomenon, and as such follow a typical trend. At first, only a limited number of knowledgeable investors make big profits from the new gimmick, but then, as more and more clones of the concept come into play, the market becomes distorted by the expectations of unrealistic profits. In essence, imbalanced p/e ratios. But in this case, making money no matter if the market is bullish or bearish.
When too many investors try to have high earnings with low risk, disaster is not far away. So there will be regulation, the only question being will it be before or after the big correction that kills hedge funds like flies?
If it is wisely before, the very best that can be hoped for is that hedge funds look less attractive, so that many are culled due to lack of interest, and profits are more reasonable among the survivors. And thus, they lose their dominance of trades on the market as alternatives are sought and used.
Many will remain as fixtures, but more in balance with other systems in offering various degrees of risk and reward.
Regulation will come, one way or another, and despite the CATO Institutes aversion to it. The only question is will it be done proactively, to let the market restore its natural balance, or reactively, to pick up the pieces after a big collapse.
ROFLOL
The problem is August.
By September 10, it’ll be business as usual. Meantime, the presstitutes chained to their cubicals have to spew something.
The real problem with LTCM, though, seems to be that they did not keep to their own knitting. They were bond pros, perhaps the best collection of same the world has ever seen. Somehow, maybe through pure egoism, maybe not, LTCM got sidetracked into trading (hugely, btw) paired stocks and ''emerging market'' debt and X amount of other crap.
Also, pls note, LTCM didn't ''double-down'' on any of these positions. Their policy, uniformly, was to undertake huge positions (you can't believe how huge...neither could Merrill Lynch when the crunch came!) at the very start in whichever instruments they decided to trade. This enormous size is risky enough, but then LTCM exponentiated the risk by deliberately seeking fantastic leverage, spookily overgeared.
When these two tactics, combined, work and the markets cooperate, the trader looks like a hero. When they don't, when the dice come up ''snake-eyes'', the trader visits Tap City straightaway.
LTCM was not bailed out; the owner’s saw their equity go to zero. The Fed orchestrated a transfer of assets to 15 entities that are regulated.
The thing to understand is that debacles such as the current CDO/CMO mess come along about once a decade or so, willy-nilly, regulations or no. The 1970s saw the stupidity fondly (cough, choke) remembered as ''sovereign loans'' as well as the collapse of Herstatt. The 1980s saw the fiasco-cum-fraud of the S&L scandal. The 1990s saw the meltdown of the ''Asian tiger'' currencies, the LTCM collapse, and Russia's currency and bonds and, indeed, the entire economy committing seppuku. Why should the 2000s be any different? Answer: they aren't.
So far this decade, we've seen the bursting of the tech bubble (partly, btw, caused directly by the regulators' thoroughly misguided and, candidly, stupid actions regarding Microsoft). Now there's the CDO/CMO dinger. Ho hum. There'll be another currency collapse at some point, maybe before 2011, maybe not. I'll keep my ideas of just which currencies will tank to myself if you don't mind.
Regulators -- Cato Institute or not -- never fix anything. They just play an after-the-fact game of whack-a-mole. They're world champions at locking the barn after the horse has gone.
There is no way on this planet that they can regulate in anticipation of the next financial debacle to come down the pike, short of establishing a Soviet-like regime in finance -- which will not occur, some bureaucrats' wet dreams to the contrary notwithstanding.
One other thing. No one, and certainly not regulators, can fix 'stupid'. If private capital companies are sufficiently stupid as to lend 100%+ on homes or other properties to people who have at best shaky credit, they're going to find a means of doing so. And, ultimately, they're going to get burned. Real estate is no more a one-way market than is FTSE, NYSE, or NASDAQ, as these jokers are finding out, right now, to their chagrin.
Written by AP. Not an actual person. Could be one of those automatic text generator programs.
Thanks for the info; Internal margin controls at bear must have been non-existent or intentionally subverted for this to even be possible?
Part of the solution is to establish enforced limits on leverage. My broker will not allow me to establish huge uncovered positions, how do the hedge funds manage to get away with it?
Bear was LTCM's clearing firm, which is absolutely an eseential for a fund that deals in A) huge quantity and B) occasionally exotic positions. Jimmy Cayne, who ran Bear at that time, insisted -- no exceptions -- that LTCM keep $500 million on deposit with Bear, or Bear would not clear their trades.
All throughout 1998, until the bailout consortium began running things, LTCM **never** let its equity with Bear fall below $500 million. Sounds like pretty good internal controls to me.
LTCM got all its ''extra'' leverage by the simple tactic of saying to Merrill (for example) ''You do this trade our way, or we'll take the action to Goldman.'', and then running the permutations of counterparties. Rarely did they even have to go this far; counterparties were jumpting over the desk to ''lend out'', as they say, large parts of their balance sheet to LTCM.
Blame LTCM for being arrogant. Blame the counterparties, every last one of them, for being greedy.
As far as I know, Bear was **never** a counterparty in an LTCM trade. Bear made its money (a stack of it, too!) from clearing fees and what amount to ''service charges''.
Not so for funds. Trades between counterparties are negotiated one-by-one, and ''margin'' (not really in this case, but the term will do) is set at whatever level both parties feel comfortable.
LTCM took advantage here, too. Ordinarily, the party seeking capital pays a 'haircut' to the other party, as what amounts to a good faith bond. LTCM routinely and very aggressively insisted on ''no haircuts''. The amounts involved were so huge, and the profit to the counterparty so great (potentially), that almost all of LTCM's counterparties rather naively said, ''OK, no haircut.''.
This affair, I daresay, was the LAST time any of them have said ''no haircut''.
I read an article that described it as similar to an informal bankruptcy settlement.
The object of the exercise was the opposite of bankruptcy: to liquidate LTCM's positions WITHOUT default, without anyone (particularly themselves) failing.
Did they get enough assets to cover their $3.85 billion?
Meriwether and his crew turned right around in 2000-2001 and opened, would you believe?, another fund.
As well it should be. To the extent that any counterparty was a pension fund or other institutional investor that owes a duty to not engage in excessive risk, traders who engage in high levels of risk with under-capitalized contra-parties need to be told to find other employment. If all you are risking is your own money, go ahead and do your bets
Also, I believe that pension funds and domestic fiduciaries generally are prohibited by ERISA and other statutes from engaging, directly, in most of the types of trades that LTCM did. 'Directly' is the key word here; the statutes do not to my knowledge say anything about doing so indirectly.
A number of pension funds were LTCM's **investors**, believe it or not. I used to have a list of same, can't seem to find it right now (mutter...). Clearly, their investment in LTCM was at least an implied violation of the intent of the statutes, not to mention a clear breach of their fiduciary duties.
Can it really be the case that the law intends to say, ''Mr. Pension Fund Manager, you can't involve your fund in on-the-run/off-the-run bond trading, or British/German yield curve convergence, but it's perfectly OK for you to invest your fund's capital in a fund that does these sorts of trades.'' ??? Geez, I hope not.
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