I found the following commentary to be a good primer on the story behind
LTCM and the regulatory loopholes that helped make its existence possible.
But, before you begin perusing or skip to the next message, I was wondering
if anyone could answer a question on the environmental option market.
Since it was recently reported that the ozone hole over Antarctica has
widened even further this year (now an astounding 10.4 million square
miles), does this affect the value of a standard pollution credit? If so,
how?
thanks,
Jeff (who wonders if the media sees the irony of a NASA satellite, boosted
to space by rockets that eat up more ozone than any other individual human
act, reporting that the hole isn't shrinking as expected)
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Molly Ivins
Inside the Hedge Funds
AUSTIN, Texas -- A useful parable for our
times: Once upon a time (the late 1990s) in
the city of New York lived something called a
hedge fund, Long Term Capital Management
L.P. (Limited Partnership) by name.
Now, a hedge fund is an unregulated investment pool for the very
rich; Long Term Capital required a minimum investment of $10
million. It had borrowed money from the banks and brokerages it
did business with -- and many of their top managers had put
their own money into Long Term Capital. Richard Stevenson
reported in The New York Times, "In the case of Long Term
Capital, it quickly became clear that some of the world's biggest
and most sophisticated banks and investment houses had little if
any idea what bets were being made with the money they lent."
How can this be? Do we not have the best-regulated financial
system in the world? Have we not been busily and officiously
lecturing other countries in Asia and elsewhere about the
importance of strengthening supervision and providing better
information to investors?
According to The Washington Post, "Unlike most other financial
companies, operators of hedge funds answer to no oversight
institution, either state or federal, even though the funds make
speculative, multibillion bets with borrowed money in markets all
over the world." Because hedge funds rely on money borrowed
from a variety of sources, including commercial banks, the banks
are to some degree gambling with federally insured deposits.
According to the Times, a lot of hedge funds operate under an
exemption to the 1940 Investment Company Act. The exemption
was meant to allow family businesses that invest in securities to
avoid federal regulation. The exemption covers pools of money
that have fewer than 100 investors and don't offer shares to the
general public. Hedge funds can also operate under a 1996
amendment to federal securities laws that exempt from
regulation funds limited to fewer than 500 "sophisticated"
institutions or individuals -- those that invest more than $25
million or $5 million respectively.
Long Term Capital had some sophisticated investors, all right,
and look at what they invested in: Long Term Capital used $2.2
billion in capital from investors as collateral to buy $125 billion in
securities. Then, it used those securities as collateral to enter
into neato financial transactions valued at $1.25 trillion, as of the
end of August.
And did they put this money into steel, mining, timber,
manufacturing? Nope. They bet it on the premise that tiny
deviations in the traditional relationships between the prices of
various securities would eventually return to normal. Great
investment, eh?
So, Long Term Capital gets itself into all this trouble, and as they
say in the financial pages, "the fund would not be able to cover its
obligations if it were forced to hurriedly liquidate its positions." In
other words, it was bankrupt to the tune of $4 billion, with much
more than that riding on the final outcome.
Now observe carefully what happens next: The Federal Reserve
Bank of New York decides that the "sophisticated" investors in
Long Term Capital -- each of whom has had to pony up a
minimum of $10 million, recall, and can presumably afford the
risk -- should not be allowed to lose their money. And so, the New
York Fed brings in Goldman, Sachs, Merrill Lynch, UBS of
Switzerland, J.P. Morgan and others, and all together, they put
up $3.5 billion to bail out Long Term Capital.
So now, Long Term Capital can continue to bet that the interest
rate on corporate bonds will return to within 1 percent of the
interest rate on Treasury bonds, which is not exactly a
job-producing capital investment. Isn't that special? As they
rarely say in the financial pages, this is about greed and
stupidity, stupidity and greed.
In the meantime, should you get into financial difficulties,
Congress has been busy making sure there'll be no bailout for
you. Because banks, many of which so brilliantly invested in
Long Term Capital, have been pushing credit cards on more and
more "subprime" borrowers -- meaning working-class folks who
live paycheck to paycheck -- more and more people are going
broke. One crisis -- downsized, kid gets sick, divorce, car accident
keeps you away from work for a few months -- and there goes the
financial ballgame for that family, and it's into bankruptcy.
Under the new rules, a citizen declaring bankruptcy would first
have to meet a "means test." Under the House bill, if a family of
four earns at least $51,000 a year, they have to file under
Chapter 13 instead of Chapter 7. So instead of writing off those
credit card bills, filers are required to pay most or all of their
debts within three to five years under a court-ordered plan.
So you see, if you just had $10 million to invest with a gambling
concern, rather than the $51,000 the two of you make while
using credit cards, some Reserve Bank would come along and bail
you out. But in your case, forget about declaring bankruptcy --
you'll pay off those credit cards that the banks pushed on you.
Don't complain to me; why aren't you rich?