Tantamount to financial terrorism

Neil Barnett

26 April 2008

Neil Barnett says hedge funds should be forced to reveal their trading secrets, to deter them from the kind of market manipulation that has recently hit Icelandic banks

Of course there was little sympathy for the vaguely thuggish Bear Stearns. Few on Wall Street had forgotten how the investment bank had walked out of talks on rescuing the stricken hedge fund Long Term Capital Management (LTCM) in 1998. There was, therefore, considerable schadenfreude, not only among the hedge funds, when Bear in turn was denied a bail-out and eaten up by JPMorgan.

But the next day Lehman Brothers, a far more blue-blooded institution, came under similar speculative attack from hedge funds. A storm of rumours about the bank’s health caused its stock price to dive by 50 per cent. More seriously, some Lehman clients were panicked by specific — but false — rumours that both Merrill Lynch and the government of Singapore had broken their relationships with Lehman because it was in trouble. Had the bank not been able to reassure its clients, this rumour could easily have proven self-fulfilling. Lehman survived by a whisker, and has now filed the details of the episode with the Securities and Exchange Commission. Whispers of illiquidity, while profitable for short sellers, are poison for a bank.

The arrogance, aggression and secrecy of the hedge funds which participate in this kind of activity is off the scale. Some appear to believe that they exist in a realm removed from social, moral and legal responsibility. Many do not publicly list addresses or contact details and will not interact with the press if they are reachable at all — although evidently some are also happy to retail unattributable lies to journalists when it suits them.

Free financial markets are desirable in order to mobilise capital and increase standards of living and wealth. It is stretching the definition of free markets to include the liberty to vandalise financial institutions, attack sovereign countries and deliberately destroy value on a huge scale.

It is surprising that after the US Federal Reserve organised the rescue of LTCM, it and the SEC failed to create a regulatory architecture that would rein in hedge funds. Banks, for example, are quite happy to submit regular reports of their loan exposure to their central bank or regulator. Why, then, cannot hedge funds be compelled to make confidential declarations of their positions — especially short positions — to the same authorities? This would, at the very least, aid retrospective investigation where market manipulation is suspected, and would serve as a deterrent. Failing that, the last resort in the face of such terrorism might be extreme rendition to the sun-baked cages of Guantanamo Bay — or perhaps, more appropriately, to a chillier island prison in the North Atlantic.
www.neil-barnett.com

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Chris De Vere

May 2nd, 2008 10:37pm Report this comment

Neil Barnett describes the behaviour of Hedge funds in shorting Iceland's currency and banking stocks as "financial terrorism". In doing so, he is missing the real culprits.

Bank deposits were originally treated as deposits for safekeeping and to be one hundred percent available, just as if goods were being stored in a warehouse. In other words, the funds on deposit could not be lent out to others in a process of credit expansion. Laws going back to Greek and Roman times have upheld this.

However, laws in more recent times have broken this principle by obscuring the difference between deposits for safekeeping and loans, legalizing fractional reserve banking and credit expansion. The great beneficiaries of this have been the banks themselves which have been able to greatly increase their profitability and governments which have been amongst the first and biggest beneficiaries of that credit expansion. Indeed, fractional reserve banking can only exist as partnership between the banks and governments, the governments having a monopoly on the issue of currency and a central bank to bail the banks out as a lender of last resort.

The Hedge Funds are therefore only pointing out what is essentially true: that in a fractional reserve banking system, the banks are technically insolvent; and the ability to trade in this way was only made possible by the legalizing of fraudulent activity.

I draw one’s attention to Jesus Huerta de Soto’s book, “Money, Bank Credit and Economic Cycles”.

David Jones

May 17th, 2008 5:34pm Report this comment

Chris De Vere makes a very noble post, but misses the point entirely, that the reason people deposit their money with banks in modern times is not only for safe keeping but to ensure a rate of return.

A bank that is required to keep funds '100% available' cannot produce a rate of return much higher than that of the depositor that chooses to store his banknotes under the bed.

Indeed a depositor who has done his homework, would weigh up in advance the level of risk/return that is acceptable before he chooses the institution that he places his funds with.

It is a brave cause to campaign against the evils of fractional banking, but much like the man spending his life in the street wearing the 'end of the world is nigh' sandwich board, the rest of the world is going to carry on around you regardless.

As for the hedge funds, they have been betting against Iceland in one way or another for the past decade... and they are still waiting for the collapse.

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