Issue 224 of SOCIALIST REVIEW Published November 1998 Copyright © Socialist Review
'Congress is sending a strong message that no one should be allowed to act irresponsibly and simply wash their hands of the consequences leaving others to pay the price,' pronounced Republican demagogue Dick Armey recently as the House of Representatives passed a law tightening bankruptcy laws. To whom does the self-righteous Congressman refer? The high flying gamblers from Long Term Capital Management, the investment hedge fund whose bets recently went sour, threatening to hurl the international banking system into disaster? The 71 banks and other financial institutions that carelessly lent Long Term Capital $90 billion, enabling the hedge fund to use its mere $4 billion capital base to wage bets involving $1.25 trillion?
No. The week after Long Term Capital came within hours of going belly up, Congress--acting at the behest of major credit card companies--directed its fury at the growing number of ordinary consumers who file personal bankruptcies after becoming buried in debt. The credit giants say current bankruptcy laws are too lenient on consumers--'welfare for borrowers', according to Tom Layman, chief economist for Visa.
That phrase is ironic, since the vast majority of those filing for personal bankruptcy find themselves indebted precisely because of the government's weak social safety net. Millions of people who find themselves downsized or who become ill must resort to borrowing simply to pay their bills. The number of Americans filing personal bankruptcies last year rose to 1.4 million--triple the figure for 1980.
Washington's politicians are likely to put a new personal bankruptcy law in place by January which will force working class consumers to pay off credit card and other debts over a period of years, at standard interest rates. It should be noted that the law will continue to allow the wealthy to pour their assets into property in one state while declaring bankruptcy in another.
The bailout of Long Term Capital Management at the end of September is further proof. Long Term Capital was known as 'the Rolls Royce' of investment hedge funds (with hedge referring not to shrubs but to a form of betting), which rose to prominence amidst the Wall Street feeding frenzy of the mid-1990s. Founded in 1994 by a particularly greedy and arrogant band of Wall Street bond traders, physicists, Nobel laureate economists and computer programmers, Long Term Capital's 'rocket scientists'--as they became known on Wall Street--claimed to have found a foolproof method of betting on bond prices. This was based upon computer models and mathematical equations which compared the current prices of bonds, stocks and currencies with their historical values. In return, they demanded a 2 percent management fee, and a 25 percent annual 'incentive' fee. A writer for the business newspaper Barron's recently described them as 'affluent, BMW-driving, Dom Perignon-drinking, Vail-vacationing, Hampton-weekending, Greenwich-living erstwhile masters of the universe.'
Long Term's chief officer, John W Meriwether, achieved stardom in the 1980s as a Wall Street bond trader for Salomon Brothers. True, he was forced out after his department was caught making trades on behalf of clients who knew nothing about them. And he has been known to wage multi-million dollar bets for a lark--once on a golf outing, he bought a dozen lobsters, taped numbers to their backs and raced them against his golf partners. A 1989 book, Liar's Poker, describes Meriwether and his Salomon Brothers boss making a $10 million bet on the serial number of a dollar bill. But these displays of arrogance only added to Meriwether's legendary status to the cut-throats on Wall Street.
Wealthy investors--including the government of China and the Bank of Italy--lined up to invest the $10 million minimum demanded by Long Term Capital. They accepted that the bets were shrouded in secrecy, as required by Meriwether, now based far off Wall Street in Greenwich, Connecticut. Financial giants like Merrill Lynch, JP Morgan, Goldman Sachs and Europe's largest bank, Switzerland's UBS, loaned freely to Long Term Capital, lured by its high returns--20 percent in 1994, 43 percent in 1995, and 41 percent in 1996. In the first three years, investors more than doubled their money.
But the rocket scientists' formula was flawed, as it turned out. Two factors threw them off. Firstly, their formula was based upon 'historical values' which did not predict the possibility of the massive financial meltdown that began on 17 August when Russia devalued its currency and defaulted on part of its debt. Long Term Capital had bet massively that US long term bond prices would go down and other bond prices would go up. But instead the trends went in the opposite direction--investors pulled out of Russia and fled to the so called 'safe havens' of US bond treasuries, driving prices up. Secondly, a growing number of hedge and other investment funds were waging the same bets using similar formulas in the same markets, and they all tried to bail out at the same time.
Long Term Capital's equity stood at $4.1 billion on 1 August; $2.3 billion on 1 September, and $600 million by 21 September--90 percent of its equity was wiped out in just 55 days. But the bankers who had lent so freely to Long Term Capital over the last few years were not about to let it go under. Federal Reserve chairman Alan Greenspan explained that if it went bankrupt, it would lead to a 'fire sale' of its gigantic portfolio of bonds onto the market with massive reverberations throughout the world economy. The New York Federal Reserve organised an emergency bailout on 23 September, involving an array of international lenders, including six banks, along with Merrill Lynch and Goldman Sachs, who together coughed up $3.5 billion to keep the firm afloat. But all they did was buy time. By 9 October Long Term Capital had already used up $1.9 billion of the bailout money.
And the fallout has just begun. Hedge fund adviser George P Van predicted in mid-October, 'It is not over. We have a domino effect.' That same week another hedgefund, Ellington Capital Management, was teetering on the edge of collapse, while the future of yet another fund, Convergence Asset Management, looked bleak. Merrill Lynch, which estimated its losses from the debacle at $1.4 billion, announced that it would cut its global workforce by 3,400 jobs. 'Crony capitalism' is not an Asian distortion of the free market, but a feature of capitalism itself.
Sharon Smith