Long-Term Capital and HR 10

Deregulation of the nation’s financial system has been sailing through the Congress like an Alice in Wonderland fantasy in which banks, insurance companies and securities firms live happily ever after–and certainly never never fail.

This sugar plum world of finance is beginning to unravel. Ironically, it is happening just as the Senate is trying to rush the big deregulation package–HR 10–into law.

With headlines blaring news about an overnight $3.5 billion bailout of a Greenwich, Connecticut hedge fund called Long-Term-Capital Management, a lot of people are beginning to take a second look at the high rollers who have been promoting HR 10 in the Congress while rolling the dice with the Long Term Capital.

Not surprising, the big banks and big securities dealers who have been lobbying the hardest for passage of HR 10 are deeply mired in the Long Term Capital debacle. Merrill Lynch and Company has been the most prominent promoter of financial deregulation, running full page advertisements and sending its top executives to join the lobbying forces knocking on the doors of U. S. Senators.

Merrill was involved in setting up Long Term Capital and many of its clients are in the fund and facing sudden losses. Merrill announced it had exposure of $1.4 billion to the ailing hedge fund and among the investors were senior Merrill investors including David Komansky who has been omnipresent at virtually every major-lobbying session on Capitol Hill on HR 10.

Not only are many of the big players in the lobbying efforts on HR 10 involved with Long-Term Capital, but the Federal Reserve–which the Senate proposes to anoint as the chief regulator of HR 10 conglomerates–is riding to the rescue of Long-Term Capital.

The Federal Reserve called in three of the banks it regulates–Chase, J.P. Morgan and Bankers Trust–and “suggested” that they each pony up $300 million to bailout Long Term Capital. Then they put the arm on Merrill Lynch and 11 other financial firms came up with similar sums to provide the $3.5 billion bailout of the hedge fund.

The role of the Federal Reserve as the arranger of a bailout for the high flyers is raising a lot of questions.

A former Federal Reserve Chairman–Paul Volcker–asked: “Why should the weight of the Federal Government be brought to bear to help out a private investor?

Tougher questions were asked at the House Banking Committee during hearings on the bailout. Few of the Members seemed satisfied with Federal Reserve Chairman Alan Greenspan’s bland answers.

Greenspan repeatedly returned to fears about the ripple effects of a failure in the “fragile” world markets as a justification for the Fed’s scheme to rescue Long-Term Capital. As part of his defense, Greenspan conjured up a vision of what he called the “potential for damage to economies of many nations, including our own.”

Words about “fragile markets” and scary financial scenarios were missing from Greenspan’s testimony when he was promoting the glories of HR 10 to the Congress. Lacking were expressions of concern about a weak disjointed federal regulatory system faced with heavy new burdens under HR 10. Such comments would not have promoted Greenspan’s fervent desire to have HR 10 adopted quickly and his agency installed as the dominant federal financial regulator.

Testimony just before the bailout of Long-Term Capital raise major questions about just how well Greenspan and the Federal Reserve are monitoring or controlling risks in the financial system.

As the New York Times reported, a week before the bailout, Greenspan testified to Congress that “bankers knew exactly what they were doing in the policing of hedge funds and their attendant risks.” He assured Representative Richard Baker of Louisiana that risk in the hedge fund lending was “well under control.”

The decision to bail out Long-Term Capital raises major questions about how far the Federal Reserve feels its authority reaches to arrange rescues of failing corporations. It also focuses new attention on the “moral hazard” created when the federal government bails out mistakes of private corporations.

In addition, it places a big spotlight on a critical question about HR 10 and the trillion dollar conglomerates it authorizes. These conglomerates will be “too-big-to-be- allowed-to-fail.” In short, conglomerates that will be candidates for huge taxpayer bailouts. In the handling of Long-Term Capital Management, Alan Greenspan and his colleagues at the Federal Reserve reveal a tendency to rush to judgment on rescuing private corporations. This bodes ill for the taxpayers if HR 10 is enacted and its provisions placed under the wing of the Federal Reserve.

The Long-Term Management debacle raises enormous questions for the nation’s economy and the “fragile markets” to which Greenspan now alludes. It raises big questions about the judgment of the Congress in its rush to merge banks, securities firms, insurance companies and industrial firms under common ownership.

The collapse of Long-Term Management and the Federal Reserve’s clumsy maneuver to save the high flyers might have some indirect public benefit if it would cause the Congress to rethink its love affair with HR 10. Greenspan belatedly sees “fragile markets” here and abroad. If his vision is 20-20, then this is an extremely poor time to uproot the entire financial system and face the risks of placing most of the nation’s economic resources in a few mega corporate hands with little regulation.