Bill
Here's an interesting take claiming to have the "real story" behind the involvement of the CB of Italy in LTCM. If accurate, might be news to some. Also in German at the URL below.
JimG
4. Oktober 1998
The Al Capone Link of LTCM
Not since Al Capone tried with Mafia-methods to hijack the American Economy during Prohibition, has anything of a similar scale been attempted.The Bank of Italy, being aware of the impossibility of bringing Italian interest rates to converge with those of Germany, in time for the introduction of the Euro next year in view of the
infinitely higher risk for investors in holding a share of the highly indebted Italian state debt than that of Germany, colluded with the Long Term Capital Management Fund of U.S., for the Fund to purchase Italian bonds in order to narrow and eventually close the interest gap, between the two countries, thereby demolishing the last obstacle to the road of Italy managing to off- load all its debts on ist unsuspecting neighbours and partners in the European Union. For once the Euro is a going concern, the European Central Bank will not be able to differentiate between several classes of debtors in the Euro group; it is committed to defend the currency by seeing to it, that the debts of all members are paid, at whatever cost to its pooled reserves or the welfare of the Union as a whole or and each and every member.
And this is the way the cookie crumbles.
Whilst there is a full 2 percentage point difference between the short term interest rate of the two countries, in the longer term by some miracle this gap was narrowed down to an infinitesimal 1/8 %. This miracle gave rise to great rejoicing by otherwise agnostic but completely reckless Euroenthusiasts, who saw in this convergence, an Act of God. Admittedly the financial community was duly impressed and the trustful rolly -polly Germans good natured as ever noticed nothing, until eventually being asked paradoxically by the Great Wizard of Oz, Allan Greenspan himself, to take a stake in the bailing out of LTCM.(Deutsche Bank a big contributor to the rescue fund, claims it had never loaned to, nor is a shareholder of the fund).
The Germans feeling frightfully honoured for being admitted this time to the inner circle of the international financial fraternity did not even demur at rescuing their own grave diggers, probably because at the time of the rescue package being established, the cause of the near failure of the LTCM was still considered to have been the Russian default.
But this is the real story.
Six years ago when Italy got thrown out of the European exchange-rate mechanism it was mooted within the corridors of the Italian Central Bank that owing to the ever more preponderant share of wager-like transactions in international financial markets, whether for so called derivatives or straight forward short sales, one ought to be able to influence the salient parameter of the economy by the selective, appropriate, and above all intelligent use of the power of highly geared funds, backed by a powerful respectable central banker, such as the Bank of Italy. At that time other bona fide deals representing underlying real goods or services were already being eclipsed, by the flood of speculative currency trade. An Italian academic Professore Alberto Giovannini was asked to explore such possibilities in the Mecca of Funds, namely Wall Street. There he met the supposedly highly intelligent but ineffectual Messrs. Merton and Scholes, Nobel prize laureates, who introduced him to John Meriwether, recently dismissed from Salomon Brothers as part of a deal with the Securities and Exchange Commission, in a matter that concerned a share rigging charge settled out of court for $ 70 millions. In the course of time the fund was set up with official participation by the UIC = Italian Exchange Fund and The Professore joined the the Meriwether team, building up sufficient steam in order to stabilise the lira. Owing to its Central Bank connection the fund could draw on enormously extended credit lines. As we know in it hey-day it could mobilise funds in excess of the fortyfold worth of its capital and that was the astronomical
figure of $200.000.000.000., surely a figure sufficient amongst other things also to stabilise the lira.
The downfall of the fund can only be partly attributed to the default of the Russians, although of course, they no doubt also invested in the emerging markets. However owing to the American economy gathering steam up to the end of July, the hedge fund expected, a rate hike in the U.S. This would have meant lower quotes for thirty year treasury bonds a favourite with hedge funds. Therefore they sold these bonds short, in order to buy them at a subsequent hoped for discount.
Only few people realise that even a small lowering of the interest rate, can have a disastrous effect for anyone short of long term fix interest bonds. A quarter of one percent rate cut, can result in a price hike in excess of 4%, or a mere < $ 8.000.000.000, on $200bn. This explains the discomfiture of the hedge fund, as well as Mr. Greenspan's dilemma worthy of that late Roman leader, Cunctator. Does
he bankrupt the hedge funds by lowering the rate of interest, or does he bankrupt the debtor nations, who can no longer service their debt?
There is no easy answer for Mr.Greenspan, because he tarried to long skimming the froth, the hedge funds created in the first place. Unfortunately for the world, this is no longer a private problem of Mr. Greenspan alone.
Although the Mafiosi of the LTCM are not accountable to the EU, Signor Antonio Fazio, the Governor of the Bank of Italy ought certainly be asked some pertinent questions regarding the purchase of Italian long term debt by his henchmen at the expense of the other member states of the
European Monetary Union, by his colleagues in that Union.
P.G.Szabo
Albertinaplatz Economic Consulting Unit
Copyright 1998, All rights reserved. Albertinaplatz Communication Consulting GmbH. & Co. KeG
email:acc@albertinaplatz.com
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