…it’s called the LTCM (Long-Term Capital Management) failure, and it happened back in 1998. And the exact same investment firms that are collapsing now are the same ones that had to pump money into LTCM in an organized bailout by private firms. Except this time, every company is its own LTCM.
I found this all out while reading a great book “When Genius Failed” which is a very in depth look at the entire life of LTCM. I’m sure you’re thinking that sticking a spoon in your eye would be more fun than reading a story about a hedge fund, but it’s an amazing read. Best part: you’ve already heard of all the financial instruments that sank LTCM: credit default Swaps, mortgage backed securities, leveraged positions; all of same players are there.
It also is a concrete example of another book I’ve been trying to get through, “Fooled by Randomness“. That one is a little more theoretical with the author quoting several obscure economists. However, the basic idea is that many times, proficiency at picking stocks (or betting on horses, or playing blackjack) is really the result of dumb luck, not the skill of the stockpicker. The problem comes when the picker and those around him believe that he really does have great skill at picking stocks. At some point, the picker’s lucky streak ends, the markets turn against him during some “once in 100 years” event that no one believed could happen, and the picker “blows up” and loses everything (and then some).
Ever notice these “once in 100 years” economic events seem to happen fairly often?
When the TARP first came up for a vote, I was yelling at congress to approve the damn thing and get these garbage securities out of the system. I have no problem with government intervention when the economic train has gone off the rails. Usually, markets are rational and move in predictable ways. But when the humans in the system get spooked, rationality goes out the window and everyone is working with primal instincts from 10,000 years ago. The system just can’t fix itself from within.
The problem is that interventions need to be quick and decisive and not wrapped up with so many rules that nobody wants the help. I just don’t understand why the Treasury is taking so long to start buying up the assets. They keep saying it’s because it is hard to gauge the value of each of these securities because they’re all different and very complex.
Bullshit. The value is what the market determines. Use a reverse auction where the security owners set the price they will sell the security for. Treasury Dept takes the amount the bank paid for the security (require them to open their books to allow them to partake in the auction) minus the amount they will sell the security for. That’s the loss that will be recorded on the bank’s books for the security. Treasury starts buying the securities with the highest calculated loss and works their way down. You want the securities off your books? Suck it up and take the loss.
As much as we’d prefer to not have the economy collapse, if we don’t cause enough pain to the banks and investors this time, they’ll just do the same crap with another bubble in a decade and we’ll be in the same mess as now (or worse).