All the Devils Are Here [62]
First came the 1994 Mexican crisis, which had Mexico’s creditors bracing for a default of its sovereign debt, an event that would have sent tremors through the global economy. The crisis was averted when the Treasury Department and the Fed, after weeks of around-the-clock effort, maneuvered to have the Exchange Stabilization Fund loan Mexico $20 billion, guaranteed by the United States. That was followed, in short order, by full-blown crises in Russia (which did default), Asia, and Latin America, as well as near crises in Egypt, South Africa, the Ukraine, and elsewhere. Each time, the three men helped contain the crisis while keeping it walled off from the U.S. economy. They did the same in the fall of 1998, when a giant hedge fund, Long-Term Capital Management, collapsed. An LTCM bankruptcy could have been devastating for Wall Street, since the big firms were all on the hook for tens of billions of dollars of LTCM’s losses, both as lenders and as counterparties.
“In late-night phone calls, in marathon meetings and over bagels, orange juice, and quiche, these three men . . . are working to stop what has become a plague of economic panic,” Time wrote breathlessly. “By fighting off one collapse after another—and defending their economic policy from political meddling—the three men have so far protected American growth, making investors deliriously, perhaps delusionally, happy in the process.” Who wouldn’t be smug after being described in such terms? Time called them “The Committee to Save the World.”
One thing the article glided over, though, was why these crises kept taking place. To the extent the Committee to Save the World had answers, they were as smug as that cover photo. The developing world, they said, was new to this business of trusting in markets. They didn’t act enough like, well, us, with our supremely efficient market-driven economy. “A Thai banker who breaks the rules by passing $100,000 to his brother-in-law puts the whole system at risk,” is how the author of the article, Joshua Cooper Ramo, characterized their thinking.
Even the Long-Term Capital Management disaster didn’t dent their enthusiasm for the way our own markets had evolved. LTCM was a firm that relied entirely on the tools of modern finance, chief among them derivatives, risk models, and debt. Its leverage ratio was a staggering 250 to 1, meaning that it had borrowed $250 for every $1 of equity on its balance sheet. The notional value of its derivatives book was more than $1.25 trillion, and the fact that LTCM traded almost exclusively in derivatives was the central reason it had been able to accumulate so much debt. Derivatives didn’t come with capital requirements. Derivatives transactions could be done entirely with borrowed money. And derivatives positions housed in secretive hedge funds—even massive, bring-down-the-system positions—didn’t have to be disclosed to anyone.
Yet when Greenspan was asked about the Long-Term Capital Management crisis, he shrugged it off as the price of modernity. Faster markets, he told Ramo, gave rise to “the increased productivity of mistakes”—whatever that meant. Added Ramo, paraphrasing Greenspan: “Computers make it possible to push a button and destroy a billion dollars of wealth.” Clearly, the staggering increase in the number of derivatives contracts, with notional value topping $50 trillion by early 1999, didn’t cost Greenspan any sleep. He liked derivatives. He especially liked the fact that they were unregulated. As one former Capitol Hill aide later put it, Greenspan viewed the derivatives market as akin to “the way the Europeans once viewed the New World. It was a virgin market. A beautiful, unregulated, free market.” Summers felt likewise.
But Rubin was different. Derivatives made Rubin