Editorial

From Risk to Monopoly?

By Gil Roth | October 3, 2008

Or is it more like Trouble? Operation? Twister?

Last month in this space, I wrote about something called "risk management" and the ways in which major investment banks ignored the rather clear lessons of the past in their valuation of risk. To illustrate this, I focused on the lessons derived from the collapse of a hedge fund (LTCM) in 1998. You may recall this passage:

[A]fter a few years of spectacular results from these humongously leveraged deals, LTCM expanded beyond its reach, extended bets into areas in which it had less expertise and found itself steamrolled . . .

As well as this one:

The one exactitude I can see? Everyone underestimates the downsides.

Well, since I wrote those words:

  • the world's largest insurer admitted that it hadn't insured against the failure of its own default obligations, requiring a government bailout/buyout of $85 billion,
  • two "government sponsored enterprises" responsible for guaranteeing trillions in securitized mortgages collapsed and required some real government sponsoring,
  • a kindasorta major investment bank went belly-up after making huge investments in derivatives tied to giving mortgages to bad credit risks,
  • a bigger investment bank sold itself to raise capital after making huge investments in derivatives tied to giving mortgages to bad credit risks,
  • the remaining major investment banks voluntarily restructured themselves as commercial banks, which are subject to higher regulatory scrutiny and leverage requirements (and lower compensation packages!), after, well, you know the drill by now . . .
  • and a number of local U.S. banks have failed (13 so far in 2008, compared to 27 from 2000-07), requiring FDIC takeover, while several national banks have been bought out at bargain prices. Oh, and my dad decided he needs to take all the money out of his bank account . . . and keep it in a safe deposit box at the same bank. (?)

As I write this, the House of Representatives just shot down a bill that would've given the Treasury and the Federal Reserve unprecedented power to interfere in financial markets, with approximately $700 billion in funds to buy up securities backed by terrible mortgages. This would enable the holders of those securities to write off their losses painlessly, leaving them free to, um, ignore the lessons of the past.

I'd chalk this up to the general ignorance of our elected and appointed officials, were it not for Treasury Secretary Paulson's long-time ties to the companies and industry that would benefit from his hastily assembled plan.

So, in the spirit of I-told-you-so, let's return to When Genius Failed, the chronicle of the collapse of LTCM and its short-term bailout. Writing the book in 2000, shortly before the dot-com bust, author Roger Lowenstein noted:

Permitting such losses to occur is what deters most people and institutions from taking imprudent risks. Now especially, after a decade of prosperity and buoyant financial markets, a reminder that foolishness carries a price would be no bad thing. Will investors in the next problem-child-to-be, having been lulled by the soft landing engineered for Long-Term, be counting on the Fed, too? On balance, the Fed's decision to get involved - though understandable given the panicky condition of September 1998 - regrettably squandered a choice opportunity to send the markets a needed dose of discipline.

Now, I understand that there are good reasons why these investment banks and other groups wound up in the world of subprime lending. Sure, some must have been tempted by the heady returns while blinding themselves to the risks, but I can imagine that others entered that market out of peer pressure; that is, they knew subprime was a risky field, but the alternative was not getting in on it, not showing the quarterly earnings growth that competitors were showing, and ultimately getting acquired due to a depressed stock price.

Or the third path: exiting the subprime market (mostly) in time like JPMorgan Chase, which is now in position to buy up "distressed assets" like Bear Stearns and Washington Mutual, one of those aforementioned failed banks. (Of course, they'll somehow go out of business by the time this sees print.)

Hard to believe, but it looks like we've finally returned to the point where Pharma stocks look like a safe haven!

Gil Roth has served as editor of Contract Pharma since its inception in 1999.

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