...the Brooklyn Bridge is falling dow-owwwn!
About five years ago, I read a book by Frank Partnoy, who teaches law at the University of San Diego and knows a lot about financial derivatives, called Infectious Greed. A very interesting book. I would use that currently popular ten-dollar word "prescient" but at the time he wrote it, in 2003, the meltdown of Long-Term Capital Management was already five years in the past. LTCM was leveraged at about 100 to 1 on its various market plays, and its market strategies were designed by a couple of Nobel Prize winners (Scholes & Black). The algorithms were worked out by enthusiastic math PhDs from places like MIT and Yale, just down the road from LTCM's suburban Connecticut headquarters. LTCM was maybe the first of the Ferrari hedge funds, hypermodern and built on the premise that computers could take advantage of tiny inefficiencies in the market by high-speed transactions that capitalized on arbitrage deltas multiplied millions of times.
Of course, one might ask: other than enabling the investors to buy one of those pretty white Colonials in Greenwich and a beach house in the Hamptons and a chalet in Gstaad, what is the social utility of this kind of bullshit? The answer, in modern America, is that you're asking the wrong question. No one cares about that morality crap anymore. You can make money at it, so shut up and go hug a tree.
Partnoy warned darkly that the web of derivatives in which LTCM and other hedge funds (and increasingly, investment banks) placed their bets had become so complex and interrelated that "systemic collapse" was always a looming catastrophe waiting to happen. Credit default swaps, the option plays of puts and calls, short selling, collateralized debt obligations, all these fancy financial contraptions which are not the equity thing itself but related to or derived from it made a tremor in the market reverberate through the whole system. So that the 100-year Black Swan, that improbable event ruled statistically nonexistent for all practical purposes by the geniuses at LTCM, that thing that just can't happen, happens anyhow in a way that no one, not even a math PhD from Yale, expects, because the system is just too damn complex and exotic for anyone to make 100% accurate predictions, especially when its functioning is influenced by factors like human emotions. Like panic. So LTCM, which could not fail, failed anyway when margin calls because of events happening in Russia and elsewhere exposed its ridiculously thin real capitalization. And the Feds rode to the rescue, led by Bill Clinton and Robert Rubin, because LTCM was "too big to fail."
Now if any of this sounds vaguely familiar that is not surprising. And did the federal government tighten up its regulation as the result of this massive failure and huge government outlay of "taxpayer" money? Uh...no. Indeed, led by scalliwags like Phil Gramm, the feds went exactly the other way and enabled even more risk taking by banks and hedge funds of all shapes and sizes, and leaving the huge market in credit default swaps, which by some estimates have a "notional value" of several hundred trillion dollars, totally unregulated by anyone except the Invisible Hand of the Market. And it was a bipartisan effort all the way, because Wall Street, not Main Street, is where the real money is, and Congress represents money. Christopher Dodd of Connecticut (no coincidence) helped Fannie Mae and Freddie Mac crash and burn, Chuck Schumer of New York is the hedge fund manager's best friend on taxation, Joe Biden helped roll the American consumer when bankruptcy "reform" was passed. One should have no illusions about any of this latter-day heroism by any of these guys, and when Dodd, with his surfer 'do and Pacino voice (huuu-AHH!), leads the charge to "save America," you can rest assured it ain't you he's saving, not unless you're holding on by your fingernails to your desk at Goldman Sachs or JP Morgan Chase.
Some ancient philosophers saw the right way to deal with what we have here. One of them, a Jewish Rabbi (so Judas called him), teacher, precocious Talmudic scholar and eponymous head of a famous religion borrowing his name, took a whip and scourge to the rabble infesting the people's temple. We don't have anyone representing our interests in Washington, D.C. at the present time, so the tables of filthy lucre are not going to be overturned by any righteous vindicator. The Democrats, whose prostration before Bush's demands seems so paradoxical, are not responding to The Decider at all, but to their true constituents on Wall Street. Only the "House Republicans" are balking at the deal, and how they got to that position is anyone's guess. Could they even be...sincere?
You might take heart in this realization. Partnoy was writing his book in 2003 about a bailout in 1998. That bailout simply set the stage for later bailouts, as the S&L bailout had set the stage for the LTCM bailout. Each one gets much, much larger than the last, as the potentiating effects of the derivatives connections force the market to the extremes. I think you can safely say that if Bush is right and all we have between us and Depression is this bailout, the system is not going to be saved. That Joker at the base of the house of cards is trembling right now. The Temples of Wall Street don't have to fear a new Jesus arising from the foreclosed precincts of Main Street, but Reality itself is going to exact its revenge.
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