The real clowns are the bankers

Every time a boom ends, bankers come out looking like plonkers. How could they have been so stupid?

IT'S A CURIOUS thing about prolonged periods of prosperity, but human beings appear quite incapable of having them without eventually drowning the effect in an orgy of financial excess. It was true of the high rolling 1980s, and it now appears true of the boom of the 1990s.

Generally, it is the financial excess itself which brings these periods of prosperity to an end. That was certainly so in the 1980s and it seems to be true of the 1990s, too.

Each time the excess takes different forms, which is why bankers and others have such difficulty in seeing or correcting the position until it is too late. But the unifying feature is nearly always an explosion in credit. It is therefore reasonable to see bankers and financial markets as invariably instrumental in the boom and the bust of the business cycle.

Bankers nearly always come out of the process looking like plonkers. How could they have been so stupid, is the common refrain every time a boom ends in a bust of bad debts. What clowns, what idiots!

Last time it was dodgy financiers and entrepreneurs who stung the banks - Robert Maxwell, Michael Milken and the like. This time the fault seems to have been in an over-expansion of credit within financial markets themselves. The chief beneficiaries were the hedge fund operators and the proprietary trading operations of big investment banks.

Armed with Nobel Prize-winning economists, state-of-the-art computer modelling and mathematical equations that only they understood, they came guaranteeing 30 per cent-plus returns a year. We've found the secret, they said - just turn on, tune in and drop out.

Hedge funds are just the latest manifestation of that old, deluded belief that money doesn't need to be earned, but can be conjured up out of nothing. Only now is it becoming clear how close to the edge it brought us. Martin Taylor, chief executive of Barclays, likens the near-collapse of John Meriwether's Long-Term Credit Management to a mile-wide meteorite heading towards the earth. For a long time, everybody ticked along blissfully unaware of the cataclysmic threat coming at us from outer space.

Thanks to the efforts of the US Federal Reserve in hurriedly organising a rescue, disaster has been averted, but, boy, how appalling it could have been. For the time being, the crisis is over, but we are still seeing some of its after-effects in the markets, with both the FTSE and Dow sharply off. To extend Mr Taylor's metaphor, the meteorite has in the end missed us, but the shock of discovering how close to Armageddon we were has left a severe state of the jitters.

To understand the enormity of what's happened, it is worth revisiting some of the detail. LTCM is one of the largest hedge funds around, and it applies a much higher degree of leverage than other, smaller funds. Those who ran the fund were people of high reputation in financial markets. Also, LTCM confined itself to apparently "safe" trading strategies in G7 bonds. As a result, bankers were more than happy to lend on favourable terms. In any event, by the end LTCM, a fund with capital of just $4bn, was playing these markets to the tune of anything up to $100bn.

One of LTCM's strategies was the so called "convergence play" - the assumption that Italian bonds would converge ahead of monetary union with lower yielding German bonds. Unfortunately nobody bargained for the crisis in emerging markets. The Russian meltdown caused a general flight to safety in financial markets and the spread in this and other positions widened, rather than narrowing as it should have done. This took place at a time when bankers and investors were reigning in everywhere. The cost of credit was rising and its availability was shrinking. As always in such events, bankers began to foreclose.

What made the situation much more serious than a normal bankruptcy was the size of the sums involved. The hedge fund industry as a whole is said to total some $300bn, but the use of bank borrowings, or leverage, means its exposure to markets is much greater. To have allowed the enforced liquidation of such a large fund's positions might have had a disastrous effect on markets. The losses would have caused a domino effect through the banking system, resulting in multiple bankruptcies among hedge funds and other proprietary trading operations.

In the end, then, this was less a case of the crisis in emerging markets striking at the heart of the Western financial system, which is how it has been widely portrayed, than a necessary piece of emergency surgery by the Fed to stop US markets causing a global financial meltdown. The only link with the turmoil in emerging markets was that this had caused Western bankers to become more risk-averse. The difference is an important one, for the lessons we are learning from all this are more to do with the West than the East.

The most important of these is quite how fragile and reckless Western financial markets had become. John Meriwether and other hedge fund operators are only able to run the trading strategies they do, most of which rely on massive positions for wafer thin margins, because credit is available to them at very limited cost. This in turn is because at the top of every banking cycle there is always a huge excess of capital desperately searching for a home. In other cycles the money has gone into property, small business, and sometimes to crooked financiers. This time round it went to hedge funds.

The hope has to be that the worst is now over. Obviously there are other hedge funds and investment banks in a perilous condition, but none of them appear to be as large as LTCM. A debacle of this sort must prompt regulatory action, and the rules are bound to be tightened. But actually the position may be self correcting. Banks have presumably learned their lesson, and the cost of credit to hedge funds will now rise, curtailing their ability to run the sort of positions in markets they have.

In the meantime, we are all going to have to live with the fallout. Some huge losses have been sustained in the banking system and elsewhere as a result of the turmoil in financial markets. For the real economy - our pockets and our jobs, that is - the effect cannot be anything other than negative in the extreme.

PETER MANDELSON, President of the board of trade, is feeling more than a little fed up with our Outlook item yesterday in which we said he had been lobbied by PowerGen over its bid for East Midlands Electricity before taking up his present post - and justifiably so.

I'm happy to make clear on his behalf that he was not lobbied, and indeed could not have taken the decision giving PowerGen conditional clearance if he had been. The rules are clear on these issues - Trade Secretaries are required to stand aside and let someone else take the decision if there is a connection of this sort.

Sport
Laura Trott with her gold
Commonwealth GamesJust 48 hours earlier cyclist was under the care of a doctor
Life and Style
Upright, everything’s all right (to a point): remaining on one’s feet has its health benefits – though in moderation
HealthIf sitting is bad for your health, what happens when you stay on your feet for a whole month?
Arts and Entertainment
Peter Griffin holds forth in The Simpsons Family Guy crossover episode
arts + ents
News
Orville and Keith Harris. He covered up his condition by getting people to read out scripts to him
People
PROMOTED VIDEO
Sport
France striker Loic Remy
sportThe QPR striker flew to Boston earlier in the week to complete deal
Arts and Entertainment
Gal Gadot as Wonder Woman
arts + entsFilmmaker posted a picture of Israeli actress Gal Gadot on Twitter
Sport
Vincenzo Nibali rides into Paris on the final stage of the 2014 Tour de France
Tour de FranceVincenzo Nibali is first Italian winner since Marco Pantani in 1998
News
Bryan had a bracelet given to him by his late father stolen during the raid
people
Arts and Entertainment
Chris Pratt stars in Guardians of the Galaxy
arts + ents
Arts and Entertainment
Pedro Pascal gives a weird look at the camera in the blooper reel
arts + entsPrince Oberyn nearly sets himself on fire with a flaming torch
News
Danny Nickerson, 6, has received 15,000 cards and presents from well-wishers around the world
newsDanny loves to see his name on paper, so his mother put out a request for cards - it went viral
Arts and Entertainment
Zoe Saldana stars in this summer's big hope Guardians of the Galaxy
filmHollywood's summer blockbusters are no longer money-spinners
Sport
Red Bull Racing's Australian driver Daniel Ricciardo (C) celebrates with Scuderia Ferrari's Spanish driver Fernando Alonso (L) and Mercedes' British driver Lewis Hamilton
sport
Arts and Entertainment
comedy
Arts and Entertainment
Public vote: Art Everywhere poster in a bus shelter featuring John Hoyland
art
Arts and Entertainment
Judd Apatow’s make-it-up-as-you-go-along approach is ideal for comedies about stoners and slackers slouching towards adulthood
filmComedy was dominated by the romcom at its most insufferable
Sport
Tour de France competitor Bartosz Huzarski’s legs have highlighted the gruelling nature of the race, after he posted a picture on Facebook showing extremely prominent veins stretching from his feet and all the way up his legs
Commonwealth Games
Life and Style
Elle Kaye demonstrates the art of taxidermy
food + drinkFood revolution taken a step further in new ‘edible taxidermy’ class
News
A rub on the tummy sprang Casey back to life
video
Sport
Halsall broke her personal best in the 50m butterfly
Commonwealth GamesEnglish swimmer is reborn after disastrous time at London 2012
Arts and Entertainment
O'Shaughnessy pictured at the Unicorn Theatre in London
tvFiona O'Shaughnessy explains where she ends and her strange and wonderful character begins
News
ebookA unique anthology of reporting and analysis of a crucial period of history
Life and Style
Workers in Seattle are paid 100 times as much as workers in Bangladesh
fashionSeattle company lets customers create their own clothes, then click 'buy' and wait for delivery
Arts and Entertainment
Red Bastard: Where self-realisation is delivered through monstrous clowning and audience interaction
comedy
Arts and Entertainment
booksForget the Man Booker longlist, Literary Editor Katy Guest offers her alternative picks
Voices
The Express offices in the 1930s when writers (such as Orwell) were paid around £2 weekly
voicesWebsites offering your ebooks for nothing is only the latest disrespect the modern writer is subjected to, says DJ Taylor
Life and Style
A cut above: Katy Guest at The Ginger Pig
food + drinkThe Ginger Pig's hands-on approach to primary cuts
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Application Support Analyst / Junior SQL Server DBA

£40000 - £45000 per annum: Ashdown Group: An established professional services...

Senior Risk Manager - Banking - London - £650

£600 - £650 per day: Orgtel: Conduct Risk Liaison Manager - Banking - London -...

The benefits of being in Recruitment at SThree...

£18000 - £23000 per annum + Comission: SThree: SThree, International Recruitme...

Test Analyst - UAT - Credit Risk

£280 - £300 per day + competitive: Orgtel: Test Analyst, Edinburgh, Credit Ris...

Day In a Page

A new Russian revolution: Cracks start to appear in Putin’s Kremlin power bloc

A new Russian revolution

Cracks start to appear in Putin’s Kremlin power bloc
Eugene de Kock: Apartheid’s sadistic killer that his country cannot forgive

Apartheid’s sadistic killer that his country cannot forgive

The debate rages in South Africa over whether Eugene de Kock should ever be released from jail
Standing my ground: If sitting is bad for your health, what happens when you stay on your feet for a whole month?

Standing my ground

If sitting is bad for your health, what happens when you stay on your feet for a whole month?
Commonwealth Games 2014: Dai Greene prays for chance to rebuild after injury agony

Greene prays for chance to rebuild after injury agony

Welsh hurdler was World, European and Commonwealth champion, but then the injuries crept in
Israel-Gaza conflict: Secret report helps Israelis to hide facts

Patrick Cockburn: Secret report helps Israel to hide facts

The slickness of Israel's spokesmen is rooted in directions set down by pollster Frank Luntz
The man who dared to go on holiday

The man who dared to go on holiday

New York's mayor has taken a vacation - in a nation that has still to enforce paid leave, it caused quite a stir, reports Rupert Cornwell
Best comedians: How the professionals go about their funny business, from Sarah Millican to Marcus Brigstocke

Best comedians: How the professionals go about their funny business

For all those wanting to know how stand-ups keep standing, here are some of the best moments
The Guest List 2014: Forget the Man Booker longlist, Literary Editor Katy Guest offers her alternative picks

The Guest List 2014

Forget the Man Booker longlist, Literary Editor Katy Guest offers her alternative picks
Jokes on Hollywood: 'With comedy film audiences shrinking, it’s time to move on'

Jokes on Hollywood

With comedy film audiences shrinking, it’s time to move on
It's the best of British art... but not all is on display

It's the best of British art... but not all is on display

Voted for by the British public, the artworks on Art Everywhere posters may be the only place where they can be seen
Critic claims 'I was the inspiration for Blanche DuBois'

Critic claims 'I was the inspiration for Blanche DuBois'

Blanche Marvin reveals how Tennessee Williams used her name and an off-the-cuff remark to create an iconic character
Sometimes it's hard to be a literary novelist

Sometimes it's hard to be a literary novelist

Websites offering your ebooks for nothing is only the latest disrespect the modern writer is subjected to, says DJ Taylor
Edinburgh Fringe 2014: The comedy highlights, from Bridget Christie to Jack Dee

Edinburgh Fringe 2014

The comedy highlights, from Bridget Christie to Jack Dee
Dame Jenny Abramsky: 'We have to rethink. If not, museums and parks will close'

Dame Jenny Abramsky: 'We have to rethink. If not, museums and parks will close'

The woman stepping down as chair of the Heritage Lottery Fund is worried