The one crucial nugget that he, and many managers/bankers/traders made again this time was to be found here:
“There was almost no price at which Fink could unload his positions. First Boston was stuck, and so was he. Fink had received not just his first real education in risk but also a lesson in how Wall Street really worked.”
These clowns in the late 80’s and again in this debacle, forget that there is risk in limited liquidity. When the turds hit the turbine blades, people want to be in cash or something really, really liquid, like short-duration Treasury bills. Something on which you can get a bid day or night, in US markets or offshore markets, so if there is a need to shift one’s positions, you can do it.
This was part of the problem in the late 80’s, and it is a huge problem again now. It was the problem in the auction rate securities markets, it is the problem with CDO’s, it is the problem with various derivative contracts, etc.
What is most strange about this fascination by Wall Street and The City with illiquid instruments is this: the long-term trend of markets is to make trading easier, faster and more of a commodity over the long term. All attempts at creating one-off or specialized instruments almost always are swimming upstream of the long-term flow. I learned this having been in the hay market in ag - there are no futures on hay, on any exchange, in any market. Why? Because hay isn’t a commodity. There’s good hay, bad hay and supreme quality hay - there’s grass hay, grain hay, alfalfa hay, mixes of all of the above, pea hay, soybean hay, peanut hay, you name the legume, at some point someone has tried to cut it for hay.
This results in a cash-only, private-contract market. This is opposed to markets like wheat, corn and soybeans, where there are standards the crop must meat - X% moisture, Y pound per bushel volume, delivered to registered commodity terminals, etc. You can buy and sell contracts and futures on commoditized grains all day long - because these crops have been made into a commodity.
In mortgages, the trend has been to create “conforming” mortgages, which when bundled are easily securitized. Fannie/Freddie have been doing this since the Depression, and until recently, it worked pretty well.
So when the debt markets started creating these idiotic, almost illiquid CDO’s, CDO-squared, etc - they were, in effect, twisting their own rope from hemp grown by dubious lenders and mortgage brokers, tying it into a hangman’s noose and then either sticking their own heads through the noose or selling positions for other fools to stick their heads through a noose. And when the noose started getting a little snug, they decided that the way to solve that problem was to stand on a wobbly chair (ie, lever up).
This is the same thing, repeated over and over again throughout history with investments - and is one of the reasons why debt deflations and the really painful credit collapses often involve real estate (whether commercial, ag or residential) - because when the crap hits the fan in real estate valuations, real estate is, always has been, and likely always will be, very illiquid.
I have no time frame for these particular derivitives. This article sets it about 1986.
Warren Buffet puts the big shift at the time the big brokers went public. Before, they bet their own (partners') and private clients' money. After they went public, the risk was on the shareholders. The shareholders, of course, only make money after the partners took their fees, but took all the risk.
These broker IPOs started about 1987 or so. [And GS was the last of them to do it?] This is the big reason they wanted to void Glass-Steagall, so they could get their hands on bank deposits?
Long Term Capital was the first institution [hedge fund] to supposedly have global meltdown exposure. It was private. When it went bust however, Greenspan put the screws on the brokers and banks responsible for providing the seed loans that were leveraged and made them pony up hundreds of millions to cover LTC?
yitbos