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Let's remember that this is not "capitalism" in a classical sense. Federal Reserve policies have created "financialism" where leveraged speculation has been exc

Let's remember that this is not "capitalism" in a classical sense. Federal Reserve policies have created "financialism" where leveraged speculation has been exceedingly profitable. The typical leverage of a hedge-fund is 5-to-1, even 10-to-1. Meriwether of LTCM fame ran a "conservative" fund this time with 14-to-1 leverage. That kind of leverage is the direct outcome of the 1% interest rates the Fed ran for a while (banks borrowed at 1%, lent to the hedgies at 4-5%, pocketing a nice spread, and the hedgies used that cheap money to run their own leveraged speculation ...) They get 20% of the upside if they win, and get to walk away if they lose. The net result is a transfer of wealth from productive classes of society towards speculative classes. This is what primarily caused the heightened inequality we witnessed in the last several years. I say all this as an entrepreneur with a libertarian bent. From an individual point of view, it is perfectly rational to speculate this way. It is the Fed policy that created the incentives to speculate. My point is that Wall Street riches have not been fairly earned in a capitalistic marketplace, but in an artificial environment fostered by the Fed.

ctkrohn 19y ago
I don't think you can argue that excessive leverage is the result of low interest rates. LTCM, which was levered around 30 to 1, operated in an environment where the Fed funds rate was around 6%, not 1%. Likewise, Japan has had extremely low (even 0%) overnight interest rates since the 90s, but there hasn't been an explosion of Japanese hedge funds to the extent that there's been an explosion of American ones. People have found ways to lever themselves rather through derivatives, rather than simple borrowing of cash... e.g. if you want levered exposure to a portfolio of high-grade corporate bonds, you don't borrow money and invest in cash bonds. You get an investment bank to structure a bespoke synthetic CDO tranche which, according to your single-factor Gaussian copula model, gives you exactly the risk and return that you want. If you want levered exposure to interest rates, you don't borrow money and speculate on Treasury notes; you pay (or receive) on an interest rate swap whose notional amount is far greater than the amount of cash you have. With the current state of derivatives regulation, people will be playing these games whether Fed funds is at 0% or 10%. I will grant you that giving fund managers a call option on their returns isn't a great idea. It has the advantage of being cheap, since the value of a call option is less than the underlying. But at the same time, the value of a call option increases in value as the volatility of the underlying increases. So not only do hedge fund managers have incentive to get good returns, they have an incentive to get volatile returns as well -- this leads to perhaps more risk-taking than is necessary. Edit: and the funny thing is that JWM Partners, Meriwether's post-LTCM fund, is supposedly down 20% this year. To be fair, they apparently did a pretty good job from 2000-2008 or so.
- kingkongrevenge 19y ago
  Speculative bubbles have always and everywhere been about inflation of the money supply. Dutch tulips, south sea bubble, mississippi company, 20s stocks, nikkei, dot coms -- it's ALWAYS been about the money supply. Here is why finance has changed so much and become such a big deal since the early 90s: http://www.mises.org/content/nofed/makegraph.php?tms=true&unit=lin&range=max&bars=true&size=med&Make+Graph=make http://www.mises.org/content/nofed/makegraph.php?tms=true&#3...
  - ctkrohn 19y ago
    What's the methodology and data behind that graph? The fact that it refers to "True Money Supply" rather than established measures like M1, M2, M3 has me rather skeptical.
    - astine 19y ago
      I did a search and found the chart in context: http://www.mises.org/content/nofed/chart.aspx?series=TMS http://www.mises.org/content/nofed/chart.aspx?series=TMS The TMS is heterodox measure, but it has been in use for years.
  - vlad 19y ago
    What change does the graph illustrate? Each 10 year period is double what it was before. It's not a linear function but it wasn't in the first place. Thanks.
    - kingkongrevenge 19y ago
      There is an inflection point in 1995 when reserve requirements were dramatically lowered, permanently as it turned out.
- startingup 19y ago
  My point is that real owners of capital (i.e people who saved the capital) will not lend to create the kind of leverage these hedgies have employed. Imagine you are a billionaire. Will you lend to (which is different from having an equity stake in) Meriwether so he can lever up his fund 14x with your borrowed money? Yet, banks have freely lent to them, because they could, in turn, borrow from the Fed. The Fed (i.e us taxpayers) have operated as the ultimate patsy in the system, providing a one way bet to the speculating class. The evidence of it is the relentless expansion of the total credit in the system (as a percentage of GDP). Literally, the Fed has allowed the creation of total system-wide credit at 2-3 times faster rate than GDP growth, for many, many years running. No matter what happens now, most hedge fund managers got theirs. As has already been observed, 8 years of feverish levered returns followed by one year of total wipe-out of capital still makes the managers ahead!
maximilian 19y ago
This is going to sound stupid, but could you (or whoever) explain what leverage means? I'm plenty good at math but i'm a super newbie at the financial sector lingo.
- rms 19y ago
  5:1 leverage means trading with 5x borrowed money and 1x real money. This drastically multiplies potential gains, losses, and overall risk.

ctkrohn 19y ago

I don't think you can argue that excessive leverage is the result of low interest rates. LTCM, which was levered around 30 to 1, operated in an environment where the Fed funds rate was around 6%, not 1%. Likewise, Japan has had extremely low (even 0%) overnight interest rates since the 90s, but there hasn't been an explosion of Japanese hedge funds to the extent that there's been an explosion of American ones. People have found ways to lever themselves rather through derivatives, rather than simple borrowing of cash... e.g. if you want levered exposure to a portfolio of high-grade corporate bonds, you don't borrow money and invest in cash bonds. You get an investment bank to structure a bespoke synthetic CDO tranche which, according to your single-factor Gaussian copula model, gives you exactly the risk and return that you want. If you want levered exposure to interest rates, you don't borrow money and speculate on Treasury notes; you pay (or receive) on an interest rate swap whose notional amount is far greater than the amount of cash you have. With the current state of derivatives regulation, people will be playing these games whether Fed funds is at 0% or 10%. I will grant you that giving fund managers a call option on their returns isn't a great idea. It has the advantage of being cheap, since the value of a call option is less than the underlying. But at the same time, the value of a call option increases in value as the volatility of the underlying increases. So not only do hedge fund managers have incentive to get good returns, they have an incentive to get volatile returns as well -- this leads to perhaps more risk-taking than is necessary. Edit: and the funny thing is that JWM Partners, Meriwether's post-LTCM fund, is supposedly down 20% this year. To be fair, they apparently did a pretty good job from 2000-2008 or so.

kingkongrevenge 19y ago
Speculative bubbles have always and everywhere been about inflation of the money supply. Dutch tulips, south sea bubble, mississippi company, 20s stocks, nikkei, dot coms -- it's ALWAYS been about the money supply. Here is why finance has changed so much and become such a big deal since the early 90s: http://www.mises.org/content/nofed/makegraph.php?tms=true&unit=lin&range=max&bars=true&size=med&Make+Graph=make http://www.mises.org/content/nofed/makegraph.php?tms=true&#3...
- ctkrohn 19y ago
  What's the methodology and data behind that graph? The fact that it refers to "True Money Supply" rather than established measures like M1, M2, M3 has me rather skeptical.
  - astine 19y ago
    I did a search and found the chart in context: http://www.mises.org/content/nofed/chart.aspx?series=TMS http://www.mises.org/content/nofed/chart.aspx?series=TMS The TMS is heterodox measure, but it has been in use for years.
- vlad 19y ago
  What change does the graph illustrate? Each 10 year period is double what it was before. It's not a linear function but it wasn't in the first place. Thanks.
  - kingkongrevenge 19y ago
    There is an inflection point in 1995 when reserve requirements were dramatically lowered, permanently as it turned out.
startingup 19y ago
My point is that real owners of capital (i.e people who saved the capital) will not lend to create the kind of leverage these hedgies have employed. Imagine you are a billionaire. Will you lend to (which is different from having an equity stake in) Meriwether so he can lever up his fund 14x with your borrowed money? Yet, banks have freely lent to them, because they could, in turn, borrow from the Fed. The Fed (i.e us taxpayers) have operated as the ultimate patsy in the system, providing a one way bet to the speculating class. The evidence of it is the relentless expansion of the total credit in the system (as a percentage of GDP). Literally, the Fed has allowed the creation of total system-wide credit at 2-3 times faster rate than GDP growth, for many, many years running. No matter what happens now, most hedge fund managers got theirs. As has already been observed, 8 years of feverish levered returns followed by one year of total wipe-out of capital still makes the managers ahead!

maximilian 19y ago

This is going to sound stupid, but could you (or whoever) explain what leverage means? I'm plenty good at math but i'm a super newbie at the financial sector lingo.

rms 19y ago
5:1 leverage means trading with 5x borrowed money and 1x real money. This drastically multiplies potential gains, losses, and overall risk.