Size matters. My male colleagues don't always agree with me on this, but my view is well documented. Size matters. Big house, big car, big bucks, big cigar. It all counts in how we value ourselves and the others around us. The more money an investment manager, trader or financial guru makes, the more money he or she (although it's usually a he on the size thing) is likely to get to manage. And if you lose, better to lose big. People will look at you in awe if you lose big. Plus, you have so much muscle that you're likely to take a lot of other people down with you.
Cast your mind back to Nick Leeson and the Barings debacle. Nick wasn't going down without a fight. If he was going to lose big he was going to make sure that everyone else would lose too. A couple of million in losses would have simply seen Nick out of a job. A couple of hundred million meant everyone else was gone too. It also meant the book and the movie. People love the books and the movies about banks going under.
The Fed obviously thought that the US banking system couldn't afford the systemic risk involved with the massive $4 billion (£2.7 billion) losses posted by Long Term Capital Management last week. (Long Term Capital Management is a completely different outfit to the Japanese Long Term Credit Bank, which has featured in this column from time to time and is also a financial basket-case. It certainly makes one think that Long Term isn't exactly going to be the buzz-name for the future.)
Long Term Capital Management was what is known as a Hedge Fund. Hedge is probably another misnomer because when Eastern European markets collapsed this summer, LTCM wasn't exactly hedged to weather the storm. But it was a highly leveraged fund whose assets have been estimated at somewhere around 100 times its capital.
Rather interestingly, it's founder, John Meriwether, who used to work for Salomons, had sent a letter around to investors a couple of weeks ago which apologised for the losses and mentioned that it could be a good time to invest more with the fund.
However, investors took a diametrically opposed view, and the banks with whom LTCM had facilities were getting just a tad worried. And so was the Fed. Because if LTCM failed it ran the risk of collapsing the US financial system.
The banks had massive exposure to LTCM and Bear Stearns, as its clearing agent, estimated its exposure at $500 million.
So the moral question was raised once again. Should you put money into rescuing an institution (or a country) that had completely mismanaged its affairs? If you bail out one, where does it stop? Initial estimates put total exposure of the financial markets to LTCM between $10$40 billion. However, more recent rumours had put the exposure in the region of $100 billion.
LTCM is supposed to have had positions in almost every market at this stage and every unexplained move has been put down to them unwinding positions. One pundit opined that it was because LTCM had huge US government bond positions that the authorities were especially worried. If LTCM cut these positions it could have led to chaos in the US bond market.
In the end, the Fed engineered a bailout plan for LTCM and some of the country's largest banks were involved.
Since hedge funds have been able to operate outside the regulation authorities until now, the calls for them to be brought into the regulatory fold have intensified. The sound of stable doors being slammed shut as stallions bolt for the hills is deafening.
Fairly predictably, the commentary from other fund management managers was hedged too. Although many were critical of LTCM and felt that they were too secretive about their investment strategy, no one was going to condemn Mr Meriwether for just doing his job - even if it all ended in tears. Many, nervously, said that there were probably other funds in big trouble. One manager, an optimist, said that the good news was the "too big to fail doctrine".
So what is that telling us? That you can use all the fancy derivatives you like, but if you get your market wrong or your view wrong you will still lose money. And size matters.
It matters, too, to the captains of industry who have found their share options to be worthless in the recent equity market falls. Apparently managers are complaining that their rewards packages are not now rewarding them enough. If they don't get their options repriced, they'll have to leave the company and go somewhere where they're more valued. It's not their fault, they say, that share prices are down, because it's part of the worldwide slump. Nothing to do with their management - in fact, if they weren't doing a great job the share price would be down even more. No comment, of course, on the fact that the huge surges in share prices which brought p/e ratios to ridiculous levels and added enormous value to their holdings, had more to do with "irrational exuberance" than stunning management. Naturally.
However, I did see a report that the chairman of the Australian company, Broken Hill Proprietary, apologised to shareholders for poor performance at the recent a.g.m. He also apologised for poor investment decisions. Mind you, he was retiring (not resigning, I noticed!) and so he probably felt that he could unburden himself to the shareholders whose shares have fallen in value from about 20 Australian dollars (£7.86) to 12 (£4.71).
The ups and downs of the market have also forced the partners of Goldman Sachs to abandon their floatation plans. This didn't take a hedge fund "black box" to anticipate. Goldman's has seen a fall in third-quarter profits and the savaging that other financial shares have taken lately would have left the partners with only millions instead of billions for their troubles. It must be very frustrating for the Goldman partners - but then it's always frustrating to have the fruits of years of hard labour whipped from under your nose. Most of us only see small fruit. The partners of Goldman were seeing entire gift-wrapped fruit baskets. With champagne.
As I said, size matters.
Sheila O'Flanagan is a fixed-income specialist at NCB Stockbrokers
