Molly Ivins: Inside the Hedge Funds

jeff.downing at jeff.downing at
Thu Oct 1 12:40:49 PDT 1998

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,



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)


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?

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