Devil Take the Hindmost

In re-reading much of Edward Chancellor's excellent "Devil Take the Hindmost - A History of Financial Speculation" over the holiday weekend, a few passages took on added significance this time through - they are related here today.

First, an intriguing crossing of paths of Charles Keating and Alan Greenspan in the mid-1980s. Recall that the last national real estate boom/bust occurred in the late 1980s, culminating in the Savings and Loan Crisis a decade and a half ago. When re-reading some of the history of this period, it almost seems quaint. The estimated cost of the S&L crisis of $150 billion seems pretty tame compared to today's Fannie and Freddie liabilities alone.

Although reckless in his speculations, Keating displayed great care in cultivating politicians and regulators. He provided campaign funds to nine senators and several congressmen, and offered lucrative jobs to several of Lincoln's bank regulators and auditors. At one point, he even succeeded in getting a man heavily in debt to Lincoln appointed as commissioner to the Bank Board, the body ultimately responsible for regulating Lincoln's affairs. If he couldn’t bribe bank regulators with employment, Keating threatened them personally with lawsuits.

He hired the economist Alan Greenspan, later Chairman of the Federal Reserve, to support Lincoln's application to increase its "direct investments" to more than 10 percent of assets. (In a letter he must have come to regret deeply, Greenspan wrote to the California bank regulator that the management of Lincoln and American Continental was "seasoned and expert ... with a long and continuous track record of outstanding success in making sound and profitable direct investments.")

In another letter dated 13 February 1985, Greenspan claimed that Keating's management had turned Lincoln into "a financially strong institution" which would not pose any risk of loss to the federal insurer "for the foreseeable future." Greenspan was paid $40,000 for writing the two letters and testifying on Keating's behalf.

When regulators discovered that Keating was concealing losses and had exceeded the regulations on direct investments, he used his friendly senators, later dubbed the "Keating Five," to browbeat the head of the Bank Board.

And, on the Long-Term Capital Management bailout:

The standing of the U.S. Federal Reserve was also damaged by the LTCM affair. Among John Meriwether's partners was a former vice-chairman of the Federal Reserve named David Mullins ...

Mullin's friend and former colleague Alan Greenspan was also embarrassed by events at LTCM. For several years, Greenspan had vigorously resisted calls to regulate both the derivatives markets and hedge fund activities. Only a couple of weeks before the bailout, Greenspan had insisted to Congress that hedge funds were, in his words, "strongly regulated by those who lend them money." Yet the leverage at LTCM showed clearly that this was not the case.

Throughout the years of the bull market, Greenspan had delivered a series of opaque and ambiguous speeches, half warning of the dangers of speculation and half congratulating America on its economic revival. After the LTCM bailout, complaints were raised that Greenspan had failed to do enough to stem the growth of a stock market bubble caused partly by excessive monetary growth. The reputation of the man who not long before had been described by a member of Congress as a "national treasure" was beginning to look as fragile as the stock market itself.

Shortly after the bailout of Long-Term Capital Management, Paul Volcker, Greenspan's predecessor as Federal Reserve Chairman, asked, "Why should the weight of the federal government be brought to bear to help out a private investor?" No answer to Volcker's question was forthcoming, except that both Greenspan and Treasury Secretary Robert Rubin insisted that technically there was no "bailout" since federal money had not been used. (Nor was it satisfactorily explained why an earlier offer for LTCM led by Warren Buffet of Berkshire Hathaway had been turned down. Apparently Buffet's offer left no residual value for LTCM's partners or investors, who after the Fed-sponsored bailout still retained a 17 percent annual return on their original investment.)

A few years earlier, the Federal Reserve had passively stood by while Drexel Burnham Lambert, an investment bank with some five thousand employees and a history stretching back into the nineteenth century, was deserted by its envious Wall Street competitors and collapsed because of liquidity problems.

Long-Term Capital Management, on the other hand, a mere four-year-old upstart with only two hundred employees but partners and investors drawn from a cabal of finance professors, central bankers, and the cream of Wall Street, was considered more important than Drexel and simply "too big to fail".

Echoing Pecora's accusation of Wall Street's "heads I win, tails you lose" ethics in the 1920s, Representative Bruce F. Vento, a Democrat of Minnesota, accused Greenspan of having "two rules, a double standard: one for Main Street and another one for Wall Street." The Fed's involvement in the bailout of LTCM resembled the type of "crony capitalism" which the United States was continually decrying in Asian countries. Thus, at a crucial moment in the global financial crisis, the moral authority of the U.S. government and its ability to dictate economic policies to other nations were undermined.