Bonfire of the securities
Posted by aogSunday, 14 September 2008 at 22:13 TrackBack Ping URL

As I read stories like this one about the impending collapse of various trading houses, what strikes me is the thought that many of these were founded long before I was born, but failing during a relatively short period of my life. I am sure some might claim that it’s because of deregulation in the last few decades, but these firms existed before the Great Depression and survived the “lawlessness” of pre-FDR banking. What’s special about modern times that is bringing them down? The softness of having had it too easy for too long? The enervating effects of depending on regulations rather than their own accumem? A general lost of a sense of responsibility? All of the above? It’s a bit of a mystery to me.

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Ali Choudhury Sunday, 14 September 2008 at 23:18

Modern times aren’t special. Think of Barings, LTCM, the British investors in US railroads, the Savings & Loan mess, Kidder Peabody, Orange County, junk bonds and so on. There’s no institutional memory built up in firms which have survived and witnessed these. There is constant pressure to exploit financial innovations they don’t understand for the sake of more money.

Annoying Old Guy Sunday, 14 September 2008 at 23:36

Wasn’t Barings brought down basically by one rogue trader, rather than systemic error? LCTM had a rather brief corporate history (6 years from founding to bankruptcy). The S&L crisis was a direct result of government regulator intervention (depositor insurance). Kidder Peabody I remember only as a name. Orange County is actually probably just the leading edge of a huge wave of pension related bankruptcy and I think is therefore a different kind of thing. And didn’t junk bonds turn out, long term, to be decent investments? I know there was a big scandal in California about that, where the state dumped the bonds which were picked up by an investor who made huge piles of money off it.

Gronker Monday, 15 September 2008 at 03:26

The difference today is the appearance of the truly global economy. No longer is the dollar the worlds safe haven. The low hanging fruit of the worlds “safe seeking” money is not pouring in here any more. Our banks have to compete for that fruit and some are not faring so well. The mortgage crisis is a symptom more than a cause.

Because of the need for consistent top and bottom line growth to keep stock prices on a upward path in a time of the dollars decline (and to keep dividend paid), banks took risks they may not have taken 10-15 years ago.


Annoying Old Guy Monday, 15 September 2008 at 10:33


So you’re with Mr Choudhury in that it’s just another shake up, driven by globalization? After responding and pondering, am I starting to find Choudhury’s point more plausible.

Harry Eagar Monday, 15 September 2008 at 11:41

What Ali said. Besides, these old companies were among very few survivors. The slaughter during the free market panics was much greater than now (Permian v. Cretaceous), and of course during the New Deal era, there were no panics.

LTCM is still around and, last I checked, profitable.

The mixture of commercial and investment banking guaranteed a panic. That was a big part of the Crash of ‘29. The people who rise to command great financial enterprises are not very intelligent and are not motivated by a desire for the general well-being. So what do you expect?

Enjoy your creative destruction and your new Obama master!

Annoying Old Guy Monday, 15 September 2008 at 12:07

LCTM must have recovered from their bankruptcy in 20001. The USSR didn’t have any bank panics either, but I am not sure that means their banking regulation structure was optimal in the long term.

1 Gosh, you are quite correct Mr. Eagar, it would be wonderful if people writing about things had some knowledge of events of 10 or 20 years ago.

Ali Choudhury Monday, 15 September 2008 at 13:34

My brother appears to to have taken off with my copy of Charles Morris’ [i]Money, Greed and Risk[/i] so my posts aren’t going to have as much depth as they should. Suffice it to say that financial markets frequently come up with new things like leveraged buy-outs, junk bonds, derivatives, bond arbitrage, futures trading etc. which get adopted with enthusiasm when it looks like they’re money-spinners. Bankers take on risks they don’t understand and eventually come a cropper. Once the disaster’s passed, they get a better handle on how to use them properly just in time to prepare for the next fad. The behaviour of rogue traders is of a piece with this and lending to risky borrowers when times are good. The warning signs tend to be there but senior management ignores caution for bonus chasing.

It is a pity that Lehman’s dead. A couple of friends worked there and from what I could tell it seemed one of the few firms on Wall Street run by human beings. Their chairman worked there continuously for forty years which is nearly unheard of.

I don’t know if regulation is going to require a return of Glass-Steagall. The market may probably do the job instead.

cjm Monday, 15 September 2008 at 13:40

Arthur De Vany has some good work in this area. my rudimentary understanding of his theory is that institutions/companies are always planning for the expected/average events, and not the exceptional events. power series stuff.

Gronker Tuesday, 16 September 2008 at 10:37

I think people forget that market contractions are a very healthy part of the business cycle. Weeding out the weak, the overextended, the stupid is healthy. It will happen eventually anyway, but a good deep downturn forces the issue. When the market turns upwards again (as all markets do), its all the stronger because all the players have been tested and passed.

I agree with Ali that new risky behaviours are a contributing factors and mark the end of a cycle. Companies can get away with these things in good times, and die by them in the rough ones. Not to beat a dead horse, but Risk/Reward is the crux of all these arguements.

At the end of cycles, some companies who have experienced a long stretch of growth try to maintain their “trajectory” by using riskier and riskier behaviours. This is somewhat artificially driven by the managements pressure to maintain and build stock prices. Some people think that banks are immune to this kind of pressure, but they are not.

Peter Burnet Tuesday, 16 September 2008 at 10:45

It’s not a world I know much about, but Ali’s comments about rogue traders and management seeking bonus’s worries me more and more. Proponents of free-markets tend to present these huge institutional players as unified, rational actors pursuing a considered self-interest, but the reality for a lot of them seems to be an internal dog-eat-dog mess of short-termers looking for the quick flashy kill before the huge bonus is voted on and the headhunter comes knocking. Down below are the rogue genius’s on the edge doing things nobody understands or smooth MBA types downsizing, upsizing or doing whatever it takes to be noticed—anything but running a tight, sensibly cautious ship or showing any institutional loyalty. The criminal law can come down hard on the out-and-out crooks, but the culture itself raises a lot of questions. Also, the whole corporate governance business that was supposed to protect minority shareholders, etc. seems to be a tool for ongoing judicial civil war in many cases.

Annoying Old Guy Tuesday, 16 September 2008 at 11:24

The criminal law can come down hard on the out-and-out crooks, but the culture itself raises a lot of questions. Also, the whole corporate governance business that was supposed to protect minority shareholders, etc. seems to be a tool for ongoing judicial civil war in many cases.

Excellent argument for the inefficacy of most regulation.

And I can’t speak for other free market types, but I have always been aware that of the internally chaotic nature of any human enterprise. But like many things, local chaos doesn’t preclude global direction.

Peter Burnet Tuesday, 16 September 2008 at 12:06

Chaos is one thing, false loyalties another.

Gronker Tuesday, 16 September 2008 at 18:33

Caveat emptor, Peter.

If you invest your money into anything and just assume that someone else will “protect” your interests, you are a fool. Nobody loves you, nobody takes care of you, nobody is assigned your the task of watching out for you…but you. Any one tells you otherwise is selling something.

“Corporate governance” was not put in place, it exists because owners of a company (stockholders) elect people (board members) to direct a company for the interests of the owners. There is nothing in this process about “the little guy”. All stock holders have the same value for their stock, so you are represented in this way.

But if you think this somehow exempts you from doing your own research into the company and its governance, you are mistaken. Companies have the responsibility to provide open and complete books. And investors have the responsibility to read them. Its really that simple.

If you dont have the time, inclination or skill to do this, dont invest in stocks. Invest in safer products like bonds, mutuals funds, or something you do have the skill and interest in to watch your investment. The market is not for everyone.

Harry Eagar Friday, 19 September 2008 at 15:30

‘LCTM must have recovered from their bankruptcy in 2000’

Yes, it did and was then shut down — in the black.

Brand problems, I guess.

Free markets are like sin. Nobody really believes in either one.

People — unless they are barking mad — do what they believe is the right thing to do, even if they tell other people that this is not what they believe.

Now the free marketeers have gotten what they angled for, they don’t like it and are running for New Deal nostrums. Too late, it may be.

I am amused.

Annoying Old Guy Friday, 19 September 2008 at 15:38

People — unless they are barking mad forced by the government to do otherwise — do what they believe is the right thing to do, even if they tell other people that this is not what they believe.

Fixed that for you. Otherwise, you were coming dangerously close to Hayekian economics.

Also, I would challenge you to find a single free marketer, especially among the ranks of the post-Juddians, who were angling for any of this. For example, one who thought Fannie Mae / Freddie Mac were ever good ideas.

Harry Eagar Saturday, 20 September 2008 at 20:01

FMx2 are not the problem. At least, not the original problem.

All of you were angling for this. You wanted unobstructed financial markets, you lobbied for decades to undo the New Deal barriers to self-dealing and self-delusion. I will have more to say about this at Restating the Obvious, although I am not sure how soon. It’s election day here and I’m busy. But you don’t even have to read it, really. The title will be “Unthinking the thinkable.”

With that hint, you should be able to write it yourself without any help from me.

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