Peter Fuchs Speaks

I don't know this guy or know of this guy, but his comment on Floyd Norris's blog today is good.

A timely column that I hope will find a wide audience.
Let me say a note about myself - I have been a banker in Tokyo for much of the period in which the hedge funds established their global dominance thanks to 2 factors that fueled their ambitions as their bankers let go their inhibitions (in ways macro fund giants Soros and Tiger could not have begun to imagine.
Most important - I believe - is the congruence of factors that allowed Morgan Stanley and Goldman Sachs to become monster-sized proprietary hedge funds, honed by their own skills and by the new new thing called credit default derivatives. Infinity borrowing was possible in the world of hedge funds, and largely unseen by regulators and other investors. Long-Term Capital should have taught us a lesson, but we chose instead to believe what the “sell-side” brokers were telling us. Unbeknownst to most of us, they realized that Long-Term was on to a good thing, a great thing. That $16bn bonus pool, mostly paid out to prop traders, at Goldman Sachs last year ought to have been the warning signal, but it went unheeded.
The transmogrification of MS and GS into the ghouls of Wall Street was due to largely to three factors that are closely inter-twined. First is the notion of IRR, or the return to actual capital employed by the hedge fund, and the rewards that accrued to that particular metric (and the urge for ever higher leverage that it implies in larger and larger deals) and two, the invention of credit derivatives, which ostensibly reduced counter-party risk and ratcheted up the amount of gearing possible.
I would add the availability of the yen carry, which allowed hedge funds to pile up Nikkei arbitrage positions vast in scale based on short-selling yen loans.
The strategy for normal investors and regulators at this point is to let this selling pass, and then allow markets to rebound, with no public money injected until the arb unwind is done. But also heed this advice - do not let John Mack or his counterparts on the Street walk away from this without censure or penalty. Moral equivalents of tarring and feathering are their due.— Peter Erik Fuchs