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Gold/Mining/Energy : Gold Price Monitor -- Ignore unavailable to you. Want to Upgrade?

To: scotty who wrote (17454)	9/4/1998 9:14:00 AM
From: Gabriela Neri	Respond to of 116766

A great article by Dizard. He and Crudelle have nailed it on the head. Buy gold, Sell Rambut. ILLIQUIDITY DROWNS HEDGE FUND MANAGERS By JOHN DIZARD ------------------------------------------------------------------------ WHAT happened? Those hedge fund managers still in possession of their capital and sanity are trying to figure how they, the smartest people in history, went wrong. People who are ordinarily little ladies and gentlemen have been edgy almost to the point of rudeness. Now that we all understand that the Russian bankers are actually crooks, and that the rest of the world is not run with the honesty and transparency of a Minnesota PTA, the question remains: What could we have done better? The crash in equity values really started with a crisis in the fixed income markets, so let's look there. There were failings on two levels. The worst - and it's important for those self-important Washington policy people to understand this - is that the crash started not with a market failure, but with a failure of government policy. Or a couple of failures. The first was one of the supposed foreign policy successes of the Clinton Administration, the Mexican bailout of a couple of years ago. Over the protests of cantankerous free market idealogues, Robert Rubin and his friends at the International Monetary Fund made it possible for the greedheads of the world to get their premium interest rates, and, when trouble hit, all their money back at the expense of the rich world's taxpayers. This introduced what is known as moral hazard. That means that you get the idea that there are no consequences for risky behavior. There were countries that were too sensitive to fail, such as Mexico, and countries that were dangerous to fail, such as Russia, and countries that were too important to fail, such as Korea. This was a really, really bad idea. Rubin and the rest of them should have let the investors in Mexico understand the meaning of the word fear, and of discipline, fear's master. The sense of invulnerability, of floating through the clouds above the mortals actually working for a living, was reinforced by fixed exchange rates, or a kind of fixed exchange rates. This meant that if you put your money into a very dangerous place such as Russia, or a very speculative place, such as Thailand, you would not only be bailed out - always - but you could get your money back in dollars whenever you wanted it. Guess not. The fixed rates created an illusion of low risk and stability that had to be dispelled at some point. The other failure was the crash of the valuation models that had created a delusion of total control among the managers. Jim Grant, the editor of Grant's Interest Rate Observer, adds that this all revealed that Wall Street sophisticates were just as naive as the Worth Magazine readers they sneered at. Also, as Grant says, The sophisticates believed that incremental returns were available for anyone who could tinker with the model. The model, yes. This is the black box of a software package that will tell you when Greek drachma bonds are a better value than German Bunds. The problem with everybody's models of relative value - and they were all pretty similar - is that they would indeed be able to calculate the relative value of different fixed-income securities. But what they couldn't calculate was how prices would be affected by a drying up of market liquidity. The models might well be right in the long term, but with gigantic positions leveraged up the wazoo, the losses and margin calls would eat up all the hedge fund's capital before the value was realized. This is what is known in statistics as gambler's ruin. As one very smart fixed income manager told me, The models are based on markets coming into equilibrium. They don't deal well with disequilibrium." Now we know. So there are now attempts being made to model the effect of illiquidity. In the end, though, the models will probably be inadequate, and the managers will have to apply better judgment. Because all models are based on the idea of liquid, continuous markets, and we've seen once again that they become illiquid and discontinuous really fast. . ------------------------------------------------------------------------ MORE BUSINESS NEWS