How Wall Street Collapsed--The Last Time

Forbes ^ | 10/30/2009 | Charles Gasparino

[bruinbirdman]

[Excerpt]

"Sometimes our technology, in creating these securities, outpaces our ability to cope with them." That's what Larry Fink told the New York Times in May 1987 when asked about Howie Rubin's trading disaster. In the past, Fink would have made that statement to a reporter and then celebrated with his team the fact that one of his competitors, particularly one like Merrill Lynch, which he saw as a pesky upstart in the field he aimed to dominate, was now being nailed with massive losses.

But Fink wasn't celebrating, because, much like Howie Rubin, he had just gotten his first real education in risk. And like Rubin, Fink and his team thought they had it all figured out. In the second quarter of 1986, Fink had made an opposite bet from Rubin--all of his research pointed to higher interest rates and a reduction of prepayments from mortgage holders, and he was having one of his best runs.

With that in mind, Fink began gambling even more with esoteric Collateralized Mortgage Obligation strips, and, like Rubin, he would end up losing big. Unlike in Rubin's case, the full extent of the losses wasn't immediately apparent. When the Rubin fiasco became public, Fink and his team thought they had their position hedged--meaning that they utilized a classic technique to reduce losses by making an offsetting trade, thus minimizing the losses that had beset Rubin.

But, as Fink was about to discover, his hedges were losers as well. His former boss Tom Kirch now worked for Fink and was attending an executive committee conference in Carmel, Calif., enjoying the beautiful northern California weather in the quaint town where Clint Eastwood was mayor.

During a break, Kirch went back to his hotel room and received an urgent message to call the First Boston trading

[Pelham]

We used to have safeguards such as the Glass Steagall Act. It was dismantled by the likes of Bill Clinton and Phil Gramm.