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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: porcupine --''''> who wrote (814)	9/25/1998 7:56:00 PM
From: Freedom Fighter	Respond to of 1722

LONG TERM CAPITAL WAS JUST TOO BIG TO FAIL By JOHN CRUDELE ------------------------------------------------------------------------ HERE we go again with the too-big-to-fail concept. Late Wednesday night the Federal Reserve and a contingent of banks and brokerage firms put together a last-minute plan to save a hedge fund known as Long Term Capital - which nearly wasn't as long term as its founder, former Salomon Brothers bigwig John Meriwether, had hoped back at its inception in 1994. Long Term, which until this week was quietly plying its trade in tranquil Greenwich, Conn., needed $3.5 billion in emergency funds from the likes of Travelers, Goldman, Sachs, J.P. Morgan and 13 others in order to keep its doors open. And you can bet that the Fed privately assured each that they wouldn't incur losses. But the bailout didn't occur just to keep Long Term in business. The Fed was mainly worried about a domino effect should this particular hedge fund fail. Since each of these hedge funds trades with one another (and with banks and brokerage firms), the problems at one become the problems of another - sort of like passing an infectious disease around in the playground. And with the world financial system already in bad shape, it's not surprising that the Fed got involved quickly and actively. In fact, a highly placed source tells me that the Fed was very concerned about the fragile nature of the whole financial system because of Long Term Capital. Long Term Capital by itself just wasn't that important. The trouble was that this hedge fund wasn't merely investing, it was gambling. Just like every other fund is doing nowadays. In an investment climate where you have a better chance of staying solvent in a casino, Meriwether and his braintrust had managed to leverage their already large portfolio so much that - by one estimate - they had a humongous $125 billion at risk at one point. The bet has since been whittled down to only $80 billion. But even that number is huge compared to the $4.8 billion Long Term had under management at the beginning of this year. This was a big wager. Sort of like putting not only your house but your three kids into the pot and then finding out it's a card game in which the other guys - folks running outfits with names like Japan, Russia and China - have made the rules. Not that betting is wrong. Remember that old investment adage, the bigger the risk, the bigger the potential reward. The flip side, of course, is the bigger the risk, the bigger the potential loss. This is the bulwark of capitalism. Businessmen and investors have been doing it ever since George Washington planted his first crop and let his fortune ride on its success or failure. John Meriwether took his chance when he formed Long Term Capital. And his investors took their chances when they entrusted money to him. Nobody is bailing out someone who bought an overpriced house in the 1980s. Or someone who has run up his credit card bills. But John Meriwether, who left Salomon Brothers under the cloud of a government bond auction-rigging scandal, got bailed out. Meriwether was bigger than everyone else. The too-big-to-fail tradition has a short but storied history. Chrysler was too big in the 1970s to be allowed to fail. The company is thriving today, but it ended up costing taxpayers many millions to help a few thousand workers who would have ended up finding employment elsewhere. And banks that were staggered with losses in the early 1990s were also too big to fail. Mexico was even too big to fail. The U.S. government felt compelled to pump billions into its economy a few years ago because failure, we were told, would be catastrophic. Even if you buy the argument that Chrysler, Mexico and big banks should not be allowed to collapse, how does this apply to a gambling operation like Long Term Capital? It doesn't, unless Long Term Capital's demise posed a threat to a lot of others. And Meriwether knew what he was doing. Long Term was proudly publicizing that it had a gain of 20.1 percent in just the first four months of 1996. Its gains for 1995 topped 42.8 percent. Everyone on Wall Street knew Long Term Capital was in the casino. Now that the precedent has been set, more hedge funds will need help. And even some of the banks and brokerages who ponied up as much as $250 million apiece to save Meriwether might need assistance soon. Meriwether isn't the only one taking outsized risks. With financial markets collapsing around the world and with esoteric financial derivatives going bad, there will be other funds that have gambled enough to have won themselves a spot in the too-big-to fail list. And don't forget banks, brokerage firms and maybe a few companies here and there. Maybe even Chrysler. And if you are one of the institutions whose investments are getting clobbered but not enough to qualify as a too-big-to-fail, perhaps a few extra risky bets will get you into the club. If the financial situation around the world gets bad enough, Washington will find itself alone as the gambling partner with a lot of losers. Washington and you, the taxpayer.