Hedge fund rescue raises fundamental questions Big bets and bailouts against the free market

The Outlook

October 04, 1998|By Kristine Henry

ON Sept. 23, the New York Federal Reserve Bank brokered a $3.6 billion bailout of Long-Term Capital Management, a hedge fund that had leveraged $2.2 billion in capital into bets valued at from $90 billion to $1.25 trillion or more, according to various estimates. The bailout's justification: If the hedge fund went under, markets worldwide could implode, and financial institutions that had extended billions in credit to the fund would fall like dominoes. In other words, Long Term Capital was too big to fail.

Ironically, on the same day as that meeting, the Fed blessed the marriage of Travelers Group and Citicorp, Other mega-mergers include that of BankAmerica and NationsBank.

In light of Long-Term Capital's near collapse, does it make sense to foster the creation of even bigger "too-big-to-fail" institutions? What about the free market, which demands that failures be allowed to fail?

Thomas DiLorenzo, Professor of economics, Sellinger School of Business, Loyola College

There are a lot of big companies that have succeeded very well because of mergers. I would say bigness per se is not necessarily a bad thing.

In the bailout of the hedge fund, that's a horrible idea not because it was a huge company, but because by doing so it encourages bad business in the future. If you try to alleviate the pain of some sort of behavior by subsidizing the behavior, it may encourage that behavior.

The real issue is the injustice of other people having to pay the cost of losses incurred by the hedge fund.

It's not a government bailout per se, but the government pressured banks to give that capital to this bankrupt company and that's in effect a tax. It's totally unjust. What these people want to do is earn higher reward from riskier investments, then when it's not working out, they want other people to cover the losses. It's hypocrisy and downright theft when you think about it.

Kenneth Guenther, Executive vice president, Independent Bankers Association of America

Obviously, it doesn't make sense to have too-big-to-fail institutions if the regulatory structure is not up to regulating them. Long-Term Capital raises questions about the regulatory structure at this time.

I think it's very clear that if the regulators have to make a choice between the safety of the financial system and the free market, the financial system will win. There is no free market and there never will be. It's the height of hypocrisy to talk about the free market in one breath and bail out Long-Term Capital, because the Fed twisted your arm, in the next breath.

We're not questioning the bailout. We think they acted to prevent more serious damage. But we are also saying that having done it, get off our case in terms of saying the free market works and that investors can regulate hedge funds as Chairman Greenspan said earlier.

Gary Robbins, President, Fiscal Associates, economic consultants, Arlington, Va.

The interesting thing here is that Long-Term Capital was not a particularly large institution. We have a fairly small institution pushing itself up through leveraging to become the equivalent of a large institution. To the extent that we have speculative operations like that, then some sort of cross-checking among various lenders has to be at least attempted.

The very bad side effect of bailouts is that to the extent that you break down market discipline, you invite more people to engage in that activity and that's bad. That's really the rap against what the IMF has been doing on a world-wide basis.

What we need is for the marketplace to provide discipline and have people realize they will get disciplined if they operate in excess.

Pub Date: 10/04/98

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