So a hedge fund in Connecticut that most people have never heard of has suddenly become front page news. Sound familiar?
OK, so that's probably as far as the actual resemblance between Bayou Securities and the infamous Long Term Capital Management goes. At this point, it's not clear whether Bayou went into a sudden death spiral, or whether investigators are really looking at a case of simple theft. Besides, what's a mere $500 million? LTCM blew through $4.5 billion—in 1999 dollars.
Don't be too impressed with my memory for finance history. That number was literally at my fingertips because I was halfway through rereading Lowenstein's When Genius Failed when Bayou hit the fan. And I was doing that for some perspective after struggling through the report issued just last month by the same folks who autopsied LTCM (as I mentioned in this
post). That report came out on the heels of warnings from the ex-SEC chairman Donaldson and even some mild expressions of concern from Fed Chairman Alan Greenspan.
Somehow all this makes the hedge-fund registration rule that Donaldson barely managed to push through seem pretty tame. After all, even with a broker-dealer arm that was regulated by NASD, no one seems to know what's going on at Bayou—not even, according to the Wall Street Journal, who its auditor was. If, as it seems so far, Bayou hurts no one but its investors, it should still be considered a flashing red warning light.
As Lowenstein put it in 2000: "Investors have a pretty good idea about balance-sheet risks; they are completely befuddled with regard to derivative risks. . .as the use of derivatives grows, this deficiency will return to haunt us."
Oh, and by the way, our sister magazine points out this month that the global credit derivatives market—roughly a trillion-dollar market when Lowenstein wrote the above quote—will pass $8 trillion in 2006.
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