Long-term headache

Futures, Nov 1998 by Szala, Ginger

This decade is strewn with examples of bright people who thought they had built a better mousetrap that could consistently extract an abnormal return from financial markets.... [But] no matter how skillful the trading scheme, over the long haul, abnormal returns are sustained only through abnormal exposure to risk."

- Federal Reserve Chairman Alan Greenspan, in Congressional testimony on Oct. 1, 1998.

Much has been written about the Long-Term Capital Management debacle - and its (at least temporary) bailout by several banks and securities firms, which was organized by the Federal Reserve Bank. But in reading Greenspan's testimony closely, I'm amazed - and perhaps thankful - by his nonchalance of the event. At one point he noted that "what is remarkable is not this episode, but the relative absence of such examples over the past five years. Dynamic markets periodically engender large defaults."

True, large market moves have caused some of the largest defaults. Just ask the folks involved with Orange County or Nick Leeson of Barings fame. But that shouldn't be taken lightly. What John Meriwether and his band of Nobel minds did was bet the bank because they knew they could. And that the banks and firms loaned to these characters without even knowing what they were doing - is astounding.

Hedge funds are anything but I've said that before. That doesn't make them bad elements - not at all - but does make them financially risky. Thus, they should be held to the litmus test as are other known risky products, like futures funds. But they are not, and that is the problem. I question what these endowment funds were thinking when they invested with a fund that wouldn't provide any disclosure on what it was doing. It just goes to show not only the individual investor gets snookered.

Further, I question how Greenspan, of whom I have the greatest respect, can actually say no additional regulation needs to be placed upon these funds; after all, it is professionals trading with professionals. Then why did the Fed have to intervene to orchestrate a safety net to prevent the roiling effect a massive liquidation of Long-Term Capital would create, which could seriously affect the markets - and firms across the board? Who, then, would this hurt but the moms and pops of the world who have no knowledge of Long-Term Capital Management, don't belong to the same clubs and certainly don't have the $10 million minimum to invest? Greenspan can say that professionals understand risk management, and thus have enough of an incentive to police themselves, but history proves this isn't true. And when these types of debacles happen - especially when firms that also serve the individual investors of the world are troubled and stumble it does affect the little guy.

Was it right for the Fed to intercede and organize a bailout? Perhaps. Should there be new regulations on OTC markets? Probably. I only say this knowing the intensive amounts of scrutiny futures traders endure. It's only right that those who play in an even bigger league, and could impact the markets more dramatically, also should be kept in line. John Meriwether can play Liar's Poker all he wants. He just should understand that when his bluff is called, he has to pay up.

E-mail me at gszala@futuresmag.com