October 14, 1998
At the same time that Bill Clinton and his economic aides are
demanding billions more for the International Monetary Fund (IMF), the
Federal Reserve arranged for a $3.65 billion bailout of its friends in
an investment group running a ""hedge fund'' in Connecticut. The
Republican Congress should demand the details about this bailout and
get the answers to some tough questions.
The failed investments were managed under the name Long-Term
Capital Management (LTCM) even though its most of its investments were
extremely short term. It has operated in near total secrecy since its
founding a few years ago, and the bailout has been shrouded in secrecy.
Its most prominent partner is the former vice chairman of the
Federal Reserve Board, David W. Mullins Jr. Its investors include top
executives at the leading investment banks, including Merrill Lynch, as
well as powerful foreign banks. Treasury Secretary Robert Rubin's
former employer, Goldman Sachs, has a significant ownership stake.
At its peak, LTCM controlled contracts involving $160 billion. It
placed large short-term bets on securities issued by foreign
Unless Congress investigates what this fund was really doing, the
public may never learn the full extent of the scandal. The Hong Kong
government has blamed hedge funds like LTCM for disrupting its capital
markets, and is currently trying to trace the money flows into and out
of its markets.
What is known is that the Federal Reserve inexplicably arranged a
multi-billion (that's billion) dollar bailout of LTCM without any
public scrutiny. The softball questions asked of Alan Greenspan at the
recent Congressional hearing revealed almost nothing about the reasons
for LCTM's collapse or details about the bailout.
Greenspan cryptically testified that ""substantial damage could
have been inflicted on many market participants, including some not
directly involved with the firm, and could have potentially impaired
the economies of many nations, including our own.'' He compared the
LTCM bailout to the intervention by J.P. Morgan in the Panic of 1907, a
disturbing comparison since most economists now admit that bad monetary
policies were the leading cause of the Great Depression.
Since Greenspan asserted that LTCM was so-o-o important to the
U.S. economy, the public has a right to know what is going on. The Fed
can't have it both ways by arguing that LTCM is so vital that the Fed
had to intervene, but that the public can be kept in the dark.
Greenspan's testimony was self-contradictory, which is an
additional reason why Congress should investigate further. Greenspan
testified that LTCM pursued ""a strategy that was destined to fail,''
and yet the bailout perpetuates that same strategy.
Greenspan also testified that it was regrettable that the LTCM
partners were allowed to retain a small stake in the reorganized fund.
Yet the bailout was designed to achieve precisely that result.
The same day that the Federal Reserve intervened, there was a
pending private offer made by a group led by Warren Buffett, which
would have provided $3.75 billion to fund LTCM, and another $250
million to buy out the interests of the current LTCM investors. This
exceeded the funds provided in the Fed-arranged bailout, but the
current investors would have lost 95 percent of their investments.
Instead, the Federal Reserve Bank of New York intervened and
presented an offer that was far more advantageous to the LCTM
management, but less good for the American public. LTCM's personal
investors received $405 million for their interests, which was $155
million more than the private offer, plus a guarantee that an
additional $3.65 billion would remain in LTCM for three years.
That's not all. Under the private Buffett offer, the LTCM
investors would have been cut off from future recoupment of their
investment. Under the Fed plan, the failed management will be kept in
place indefinitely and the LTCM investors will likely be able to recoup
an additional hundreds of millions of dollars.
So far, the Federal Reserve is saying that no taxpayer funds are
involved in this enormous bailout. But how can we be sure when the
details of the deal remain secret?
At a minimum, the involvement by Federal Reserve officials used
government power, and taxpayers bear the risk of large losses at the
banks used by the Fed to finance the bailout. The principal cost to
the taxpayer may turn out to be in the form of guarantees, which can be
just as costly as actual dollars, as the S&L collapse proved.
The real risk to the American public is this secret gambling by
the Federal Reserve with our economy. The Fed's derailing of a private
purchase of LTCM in order to advantage its politically well-connected
friends is both an outrage and an endangerment of our country's
At a recent high-dollar fundraiser, Bill Clinton declared that
more taxpayer funds for the IMF are essential to American prosperity.
""That's a big issue'' in the upcoming elections, he warned.
A big issue, indeed. If the Republican Congress would do its job
and uncover why LTCM collapsed and why the Federal Reserve arranged its
bailout, then the voters can make sure that powerful men behind closed
doors don't gamble with our prosperity.