Tuesday, October 14, 2008

Mrs. Born vindicated

Long Term Capital Management was a hedge fund established in 1994 with over a bilion dollars in capital and controlled assets of over 100 billion dollars in its heyday. It had two Nobel-prize winning economists on its board. And yet it suffered huge losses and had to fold up, with its capital wiped out by losses, in early 2000.

Did anyone have a clue, at that time, that this was possible? The answer is no, but a qualified no. Because LTCM was heavily into derivatives and as far back as in 1997, Mrs. Brooksley Born, then head of the CFTC , warned in congressional testimony that unregulated trading in derivatives was a serious threat to the regulated economy and could bring about its downfall and asked for greater transparency.

George Soros is on record saying that he avoids derivatives as he does not really understand them. Warren Buffet, five years back, called them weapons of mass financial destruction.

But, Mr. Greenspan still has unshakable faith in those. His argument is that it is not the derivatives themselves but a lack of integrity in the financial community which has brought about the current crisis. According to him, those peddling derivatives were not as reliable as “the pharmacist who fills the prescription ordered by our physician.”

But then Alan Greenspan was the one who has fought against regulating this sector for as long as one can remember. He was instrumental in getting Mrs. Born silenced in 1997 and eventually getting rid of her. He has been telling every congressional committee trying to put reins on a wild west type derivatives market that it would be a mistake to regulate those 'highly specialized' markets and to let the specialists do their work without any government supervision or stifling regulation. And look where that has brought the world's financial system to, on the verge of collapse.

In hindsight, had Mrs. Brooksley Born's warnings been listened to, back in 1997, and proper regulatory mechanisms put in place then, we wouldn't be facing this financial turbulence now.

1 comment:

Vinod_Sharma said...

You sure understand the subject better than me. The meltdown has forced people to call for greater government control. I think that is fundamentally a bad idea because the government is made up by people who are otherwise no different but who quickly manage to increase their importance and wealth without assuming responsibility and accountability. And there is no end to this process which winds up killing enterprise eventually.

Perhaps better self regulation is the answer with some serious penalties, not golden parachutes for greedy executives.