When Genius Failed: Lowenstein Talks LTCM
Brett D. Fromson: The derivatives, in a sense, are pure credit.
Roger Lowenstein: They're bets.
Brett D. Fromson: You believe that I will pay you back because I tell you that.
Roger Lowenstein: If you agree to pay me a certain amount of money for every run that the Red Sox score this season and we have no idea how many runs they're going to score, and I have no idea if you made the same bet on the Indians and the Tigers, too.Brett D. Fromson: And, ultimately, the only guarantee you have that I'm going to pay you is that I tell you I'm going to pay you. Roger Lowenstein: Right. Brett D. Fromson: Or you can sue me in court. Roger Lowenstein: Right. But it hasn't cost you anything to make that bet. So that's my concern. Brett D. Fromson: Now, with regard to disclosure on derivatives, the bank regulators do see some information themselves because there's a difference between bank disclosure and brokerage firm disclosure. Roger Lowenstein: Yes, they do see some and investors see some, but it's not broken down for the average or even the pretty sophisticated investor who really understands. It's not in a form that the average investor could say, "OK, if rates in Germany do this, this institution is going to have this much exposure." There are also no limits on that exposure. Don't forget, a regulated bank has limits on the loans it can make as a portion of its capital. Why not with derivatives as well? Brett D. Fromson: Are there any regulations on banks regarding their derivative positions? Roger Lowenstein: No. Brett D. Fromson: Now the Securities & Exchange Commission has agreed to accept a voluntary disclosure from the big Wall Street houses, I believe. But it's not required. The SEC has not pushed that hard on that. Frankly, none of the financial regulators have pushed that hard on disclosure in terms of making it required. Roger Lowenstein: Derivative or hedge fund disclosure? Brett D. Fromson: Derivative. Roger Lowenstein: Yes, there is some, there certainly is some derivative disclosure required. The SEC has a pretty full plate. The Federal Reserve has been champion of the need that derivative transactions introduced, and has been pushing to relax requirements. Brett D. Fromson: Now doesn't this attitude on the part of the Fed also reflect a belief in markets as potentially perfect vehicles? Which is funny, coming from a regulator. Roger Lowenstein: Yes, well certainly as self-correcting vehicles. Greenspan was asked about hedge fund risk shortly before LTCM went under and he said that these funds will be regulated by the people who finance them. And that was an astonishing comment, because as it happened, the case of LTCM was nothing but a demonstration that the banks exercised no control at all. They created the problem.
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