Let’s play Russian Roulette. My rules.
I’m betting $1,000 the chamber will be empty. You hold the gun to your head and pull the trigger. Click. You owe me $1,000. Next round, same rules, you hold the gun to your head and fire. Click. Now you’re down $2,000, but why complain? You’re still alive, aren’t you? Isn’t that worth $2,000?
Next round, you’re not so lucky. Since there doesn’t seem to be anyone left to collect the bet I just lost, I take my $2,000 and go looking for the next patsy.
If my rules seem unfair, at least they’re founded on well-established precedents. Big hedge funds and investment banks have figured out how to make billions on heads-I-win, tails-you-lose games of high risks and very high but entirely one-sided rewards.
It’s a sweet deal. They take your investment money – along with that of other investors like pension funds – and make huge bets on derivatives at, say, thirty to one leverage. So two billion dollars acts like 60 billion, and a 20% gain in a currency arbitrage or a commodities play or credit default swaps earns $12 billion – of which they keep 20% on top of the big fees they charge you each year just to invest in the fund.
Or they get it wrong ... blow $12 billion, and the hedge fund goes bust.
Leverage works both ways. You and the pension plan retirees may see your entire investment go up in smoke. The hedge fund manager loses maybe his desk and his fax machine, but he’s still got the billions he’s "earned" in prior quarters and years, so he skips away, somewhat chastened but ready to set up his next magic show.
Oh, and that $12 billion dollar meltdown?
There’s always the chance that it could trigger a cascade of failures in other funds and big investment banks like Bear Stearns. Then the Fed has to bail out the losers to save the system – until the day comes when the next big crisis metastasizes beyond the Fed’s powers of salvation, and the whole financial system and possibly the economy crashes, as in the 1930s.
But if the Fed does succeed, guess who pays whatever it costs? You and those pension plan participants and the rest of us taxpayers. First you lose your money, then you pay to save the people who lost the money you entrusted to them.
Call it Hedge Fund Roulette. Or Big Banker Bingo.
It’s an addictive form of gambling in which the winners always keep their winnings, but when they lose, they don’t pay.
The public pays – and for what? For the privilege of living in the presence of such brilliance? True, investment banks sometimes do contribute to the health of the economy, but not when their main energies are being devoted to bundling up worthless loans into worthless securities and rating those securities AAA to sell them off to the ignorant, the gullible, the inattentive, and the daft.
Of course people have a right to risk their own money. Some may even be trusted to risk other people’s money, in their role (and under the strictures of fiduciary responsibility) as managers of mutual funds, pension funds, public or private trusts.
But I’m not allowed to bet your house on the horses.
Why should anyone be given a license to risk the entire financial system or the economy as a whole in a scheme for personal profit?
The largely unregulated shadow banking system risks a global financial collapse or a depression that could inflict untold misery on hundreds of millions of people for many years to come. Even if all goes well, they’ve risked your wellbeing and mine for their own personal gain. If they win, they win big. If they lose, they don’t pay – you do.
It’s now clear that this is the game a great many financiers have been allowed to play. As Wall Streeters, they know that for huge gains, you have to take huge risks. Imagine how much you can make if you risk the whole country!
Presumably, that’s why there’s talk about reform, but look who’s talking. Key players in financial system reform include Senator Richard Shelby — a mega-landlord, real estate developer, and title insurance magnate in Alabama – and Treasury Secretary Henry Paulson, former chairman of Goldman Sachs, who doesn’t want to place limits on leverage or on the extremes in risk-based executive pay and bonuses that made him rich. What meager changes Paulson recommends are tantamount to requiring boldface type on the restroom signs:
"Employees much wash hands of all responsibility."
Cross posted from The Horse You Rode In On