Opinion> Molly Ivins> Molly Ivins September 29 1998 09 29

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Molly Ivins September 29

AUSTIN, Texas — A useful parable for our times: Once upon a time (the late 1990s) in the city of New York lived something called a hedge fund, Long Term Capital Management L.P. (Limited Partnership) by name.

Now, a hedge fund is an unregulated investment pool for the very rich; Long Term Capital required a minimum investment of $10 million. It had borrowed money from the banks and brokerages it did business with — and many of their top managers had put their own money into Long Term Capital. Richard Stevenson reported in The New York Times, "In the case of Long Term Capital, it quickly became clear that some of the world's biggest and most sophisticated banks and investment houses had little if any idea what bets were being made with the money they lent."

How can this be? Do we not have the best-regulated financial system in the world? Have we not been busily and officiously lecturing other countries in Asia and elsewhere about the importance of strengthening supervision and providing better information to investors?

According to The Washington Post, "Unlike most other financial companies, operators of hedge funds answer to no oversight institution, either state or federal, even though the funds make speculative, multibillion bets with borrowed money in markets all over the world." Because hedge funds rely on money borrowed from a variety of sources, including commercial banks, the banks are to some degree gambling with federally insured deposits.

According to the Times, a lot of hedge funds operate under an exemption to the 1940 Investment Company Act. The exemption was meant to allow family businesses that invest in securities to avoid federal regulation. The exemption covers pools of money that have fewer than 100 investors and don't offer shares to the general public. Hedge funds can also operate under a 1996 amendment to federal securities laws that exempt from regulation funds limited to fewer than 500 "sophisticated" institutions or individuals — those that invest more than $25 million or $5 million respectively.

Long Term Capital had some sophisticated investors, all right, and look at what they invested in: Long Term Capital used $2.2 billion in capital from investors as collateral to buy $125 billion in securities. Then, it used those securities as collateral to enter into neato financial transactions valued at $1.25 trillion, as of the end of August.

And did they put this money into steel, mining, timber, manufacturing? Nope.

They bet it on the premise that tiny deviations in the traditional relationships between the prices of various securities would eventually return to normal. Great investment, eh?

So, Long Term Capital gets itself into all this trouble, and as they say in the financial pages, "the fund would not be able to cover its obligations if it were forced to hurriedly liquidate its positions." In other words, it was bankrupt to the tune of $4 billion, with much more than that riding on the final outcome.

Now observe carefully what happens next: The Federal Reserve Bank of New York decides that the "sophisticated" investors in Long Term Capital — each of whom has had to pony up a minimum of $10 million, recall, and can presumably afford the risk — should not be allowed to lose their money. And so, the New York Fed brings in Goldman, Sachs, Merrill Lynch, UBS of Switzerland, J.P. Morgan and others, and all together, they put up $3.5 billion to bail out Long Term Capital.

So now, Long Term Capital can continue to bet that the interest rate on corporate bonds will return to within 1 percent of the interest rate on Treasury bonds, which is not exactly a job-producing capital investment. Isn't that special? As they rarely say in the financial pages, this is about greed and stupidity, stupidity and greed.

In the meantime, should you get into financial difficulties, Congress has been busy making sure there'll be no bailout for you. Because banks, many of which so brilliantly invested in Long Term Capital, have been pushing credit cards on more and more "subprime" borrowers — meaning working-class folks who live paycheck to paycheck — more and more people are going broke. One crisis — downsized, kid gets sick, divorce, car accident keeps you away from work for a few months — and there goes the financial ballgame for that family, and it's into bankruptcy.

Under the new rules, a citizen declaring bankruptcy would first have to meet a "means test." Under the House bill, if a family of four earns at least $51,000 a year, they have to file under Chapter 13 instead of Chapter 7. So instead of writing off those credit card bills, filers are required to pay most or all of their debts within three to five years under a court-ordered plan.

So you see, if you just had $10 million to invest with a gambling concern, rather than the $51,000 the two of you make while using credit cards, some Reserve Bank would come along and bail you out. But in your case, forget about declaring bankruptcy — you'll pay off those credit cards that the banks pushed on you. Don't complain to me; why aren't you rich?

Molly Ivins is a columnist for the Fort Worth Star-Telegram. To find out more about Molly Ivins and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate web page at www.creators.com.