Welfare for the Biggest
Boom and Bailout
Boom and Bailout
Say you are in charge of investing $4.5 billion.
You hire two Nobel Prize economists to generate computer models on how to invest in world bond markets.
You borrow billions more and put down a big chunk on a bet that differentials between certain world bond prices, out of kilter because of the global crunch, will revert to their historic levels. They don't. You lose $4 billion.
Your clients -- who needed to pony up $10 million each just to be in your hedge fund -- are apoplectic. They call. They want to know what the hell is going on.
Boom and bust?
Don't be silly. That's capitalism for the small guy. If you or I go to Atlantic City or Las Vegas, win a bundle and then lose it all, that's boom and bust. For the rich, the rules are different: it's boom and bailout.
So, you're John Meriwether, the bond trader who was forced to leave Salomon Brothers in 1991 after a trading scandal.
And you decide to start Long-Term Capital. And for the first couple of years, you are making a 30 percent return on investment for your millionaire friends. And they are loving it. And then you lose the $4 billion.
Who do you call?
The Federal Reserve Board -- bailout central.
So it was that on a late August day, New York Federal Reserve Bank President William J. McDonough received a phone call from Meriwether and bailout fix-it man supreme David W. Mullins Jr., the architect of the taxpaer-funded trillion-dollar bailout of the savings and loans under President Bush.
Big institutional investors in the hedge fund -- Merrill Lynch & Co., Goldman Sachs & Co., Bear, Stearns & Co. and Bankers Trust Corp. -- were also calling begging for a bailout.
These companies were of course seeking to save their own skin. But McDonough put forth the official spin before a House of Representatives Committee earlier this month.
"Everyone I spoke to that day volunteered concern about the serious effect the deteriorating situation of Long-Term Capital could have on world markets," McDonough said.
Ah yes, world markets. And so McDonough calls Fed Chair Alan Greenspan and Treasury Secretary Robert Rubin and a bailout is arranged.
Former Lehman Brothers partner and current financial columnist Michael Thomas got is right -- it was improper for the Federal Reserve to arrange a private bailout. If Merrill Lynch and Goldman Sachs want to protect their behinds by arranging for a private bailout, fine. But the Fed should have stayed out of it.
Or, as former Fed chief Paul Volcker asked in a speech, "Why should the weight of the Federal Government be brought to bear to help out a private investor?"
"Capitalists now all want it one way," Thomas says. "They want to do whatever the hell they feel like, but let someone else pay. It's called privatizing the profits and socializing the risks."
Hedge funds, which make complicated financial bets with millions and billions of borrowed dollars and are almost totally unregulated, do indeed pose risks to the economy. Because of the nature of their gambles, they can lose huge amounts of money, leaving investors holding the bag (absent a bailout).
But these are not an argument for why high rollers deserve government-orchestrated bailouts -- if anything, these are reasons why hedge funds must be subjected to regulatory discipline.
With the global financial system in frenetic disarray, Long-Term Capital is not likely to be the last financial player to go bust. If the government is not able to act quickly to rein in hedge funds and other unbridled financial activities, it should at least declare that no bailouts will follow in the wake of Long-Term Capital. Each bailout makes the next one more likely, as investors are given implicit assurances that they will not have to face the downside of risky bets gone bad.
The gamblers in Atlantic City don't get this kind of treatment. Neither should those on Wall Street.
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This article appears with the authors' permission. Russell Mokhiber is editor of the Washington, D.C.-based Corporate Crime Reporter. Robert Weissman is editor of the Washington, D.C.-based Multinational Monitor.
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