Cutting a Wide Swath
from Winter 1998
Last time this country had a financial meltdown L. William Seidman was there to clean it up. As head of the Federal Deposit Insurance Corp. and the Resolution Trust Corp., Seidman waded through the chaos that was this country’s worst banking crisis since the Depression and pulled the industry up by its bootstraps. Since that time, Seidman’s experience has been in high demand. Currently he serves as a consultant for the World Bank, giving advice to businesses and governments around the globe. He also offers his frank opinions every week as CNBC’s chief commentator. We sat down with Bill recently and asked him to comment on this year’s hedge fund debacle and the collapse of worldwide financial systems. In his straight-shooting style, here’s what he had to say.
On hedge funds…
“Directors and policymakers need to know exactly what they are conversing about before they push a course of action or decide hedge funds’ social utility. There’s a world of hedge funds out there—four or five thousand—doing every kind of operation man has identified. They don’t all deal in derivatives. Some are just investment funds, selling short and playing the margins. Long-Term Capital was, in part, focused on the relationship of bond prices, taking advantage of short-term price anomalies in other countries. Its bet was that, over time, market imperfections would move back toward a narrow, stable range. But some factors—like disasters—don’t fit easily into formulas. The main point is that these funds are unregulated.
“Federal Reserve Chairman Alan Greenspan said not to worry about hedge funds, because investors will supervise them so they’ll operate appropriately. But what we have seen, and what company boards should never forget, is that in some of these areas even the most sophisticated money managers just aren’t very good at it. More important, their concern is to make money, not to make sure all runs smoothly.”
On Long-Term Capital…
“With Long-Term Capital, everyone just assumed that you couldn’t go wrong with a couple of Nobel Prize winners with a calculator. People should know better than to blindly jump in with the herd instinct. If everyone is doing something, if everyone thinks it’s grand, sit down.
“In Long-Term Capital’s case, people rushed in without understanding how vulnerable it was. How could banks do so and not know how much leverage was involved? They were captivated by the mystique of the little black box promising riches inside, only to find marbles rolling around. We don’t yet know of anything that moves from the foolish to the criminal, or even of vulnerability to shareholder lawsuits. But heads will roll before this is over, as they already have at Merrill Lynch and Swiss bank UBS.”
On the global free market…
“Look back in history at the United States. We developed the Federal Reserve, FDIC, FTC, and all the rest, because we found that unregulated systems led to huge panics and severely impacts the way people lived. The ‘Wild West’ was too unnerving. We created the SEC to make sure people had real information, which is necessary for all markets to be efficient.
“Much of the world, certainly the emerging markets, are still riding through the ‘Wild West.’ But technology has made the whole world into one marketplace. Everyone is now on the world stage. Fifty percent of the world’s growth was coming from Asia, and its downturn hit the U.S. on many fronts, from shipping in the West to the reduced demand for breadbasket products. Kansas banks have problems because Indonesians and Koreans got fouled up.
“We need to create a world marketplace that won’t destroy the domestic marketplace. There was once a motor oil ad employing images of dinosaurs to drive home the message that nature in the raw is seldom mild. That should be an economic slogan to remind those who oppose all regulation, because when the market works, its harshest responses, its disciplinary actions, are very destructive on the innocent.
“We need a world financial structure, but we don’t have a world government—and don’t want one. But without one, how do we go about constructing a global financial structure? Marketplaces without structure tend to destroy things. Instead of being run like a championship prize fight, they turn into a barroom brawl.
“Look what happened to Russia. I once wrote Gorbachev a letter suggesting that he not get rid of government. My point was that it takes a lot of government to make democratic free-market capitalism work—to run the bankruptcy systems and to reveal needed information and everything else. Unfortunately, some gurus advised him that if he just got rid of government, market capitalism would bloom like flowers in the spring. Now they’ve got a lovely lawn of crabgrass.
“Of course, even if we get the global structure we need, there will always be countries offering an unregulated show, and some investors will flock to them. They’ll get the risk they deserve.”
On regulation in general…
“I’m instinctively opposed to regulation, because we all know the tendency of regulators to keep creeping toward more control. Regs that were put in for good reason advance until they become a handicap. Still, left fully unrestrained, plenty of capitalists will bop you on the head and take your wallet, as they did in Russia and elsewhere.
“Regulation is a difficult balance. I was very involved in airline deregulation, something I’ll probably start taking some heat for shortly, as some airlines are now going too far. Deregulation was needed, but things always change. We have to avoid absolutist positions and accept that the degree of regulation must be constantly adjusted.”
On government bailouts…
“There’s definitely a public misconception out there that Long-Term Capital received a government bailout. Creditors just took over the company, a typical prepackaged insolvency that avoided technical bankruptcy. This was not a bailout. The owners lost 90% of their ownership. I don’t know why [House Banking Committee Chairman] Jim Leach and others think we should have let it go to bankruptcy. No federal money was involved. My understanding is that all the Federal Reserve did was lend its office and warn the company to get moving to avoid what Greenspan termed a ‘disorderly marketplace.’
“It’s what we should have done with Mexico. Then we might not have had Asia and all the rest affected by the moral hazard of using government money to bail people out. Most of those who lost huge amounts in Russia had seen the bailing out of Mexico and assumed the world wouldn’t let Russia go down. They didn’t just lose a financial bet, they lost a political bet. Some critics of the way Long-Term Capital was handled demonstrate inconsistency. Leach, for example, was big on using public money to bail out Mexico and pushed the same for Indonesia. Leach does raise legitimate questions of whether the parties involved represent entities with too much power doing business together, but I’m not sure what the alternatives in this matter are.
“Private approaches to replace the government in roles like deposit insurance have been suggested many times, but they’ve never been accepted as a substitute for government. Is there really a market out there for companies to get into? There’s nothing wrong with exploring this, but given what we know now—or don’t know—the risks are likely to be too high. Most outfits would feel they have better things to do with their money. It sounds good in theory, maybe not in practice.
“We don’t know exactly what is waiting for us with other hedge funds, but so far, the problem isn’t in the same league as the S&L crisis. The banks involved have lost some profits, but they’ve had bigger losses from other bad moves and downturns. What is important now is to look at the whole structure of hedge funds. Without regulation, they are loose cannons that, under certain circumstances, could cause a world of financial trouble.”
On the leadership gap…
“This past fall, international bankers met again in Washington, D.C. at meetings structured around the World Bank, IMF, and private associations like the International Institute of Finance. The Brazilian Finance Minister poked fun at the content of most banking pronouncements, which he characterized as ‘Progress has been made. Problems remain. There is no room for complacency.’ Against this staid backdrop, what are the prospects for moving toward sound global rules?
“It’s a very difficult time, with so much disruption in the system and the free market getting a bad name in Asia. The United States will have to take the leadership position, supported by Europe and Japan. But while the United States is not politically crippled, it isn’t at full force. Although we need to hold fast to the rule of law, it would be better if this impeachment thing would go away.”
