Betting on the Economy

[Leth]

Betting on the economy
Reformer.com
Thursday, November 29

In that giant casino known as the U.S. economy, there is always someone who can count the cards, work the odds and beat the house.
The Financial Times reported Monday that a California hedge fund, Lahde Capital, saw a 1,000 percent return this year. That's not a typo. By betting against the U.S. subprime mortgage market, Lahde Capital returned to investors 1,000 percent of their initial investment, or a total profit of more than $20 billion. It's being called the most profitable single trade of all time.

Other hedge funds that recognized early signs of the growing credit disaster also made out big. The FT reported that John Paulson's New York-based Paulson & Co., which has $28 billion under its management, also bet against the subprime market and has made at least $12 billion so far.

That's there's always someone lurking to make a fortune off someone else's misfortune is not exactly news. It's just that now, in the age of extreme capitalism, the world is not divided into winners and losers. It is divided between predators and prey.

Like any card sharp who knows when to hold them and when to fold them, Andrew Lahde has decided to start distributing the winnings to investors.

"The risk/return characteristics are far less attractive than in the past," Lahde wrote in a letter to his shareholders. "Our entire banking system is a complete disaster. In my opinion, nearly every major bank would be insolvent if they marked their assets to market."

Where is Lahde putting his winnings? Gold and other precious metals, he said.

This glimpse into the world of big-time investing is instructive. A few years ago, people made big profits from taking mortgages given to people who did not have the resources to pay them, then rebundling those mortgages into securities bought by banks and fund managers. Or, more accurately, they made a lot of money as long as house prices kept rising.

When house prices stopped rising, and the terms for those who took out adjustable rate mortgages changed, the result was predictable. Millions of homeowners now can't make their payments and, as a result, defaults and foreclosures are soaring.

You didn't need a crystal ball to see this one coming. It seems to happen in every generation. Investors and money managers ride a wave of speculation and begin to think that the fundamentals of the economy have changed. The old rules no longer apply, they think, until those old rules come back to bite them.

The old joke in the banking world about the 3-6-3 rule -- pay 3 percent interest on deposits, charge 6 percent interest on loans and make it to the country club by 3 p.m. each day -- has an element of truth to it.

If a financial institution makes loans to qualified borrowers who have the ability to repay them with interest, it will make a profit.

The problem is that, depending on which estimate one goes by, there is more than $500 billion of worthless securities on the balance sheets of some of the world's biggest banks. And, no one is sure how much larger that figure will grow and how much more damage will be done to the global economy.

The people wise enough to remember the trouble that comes with lending money to people who can't repay their loans are making money off this mess. The people who believed that markets only go in one direction are getting clobbered.

That is why, in the words of social critic and author James Howard Kunstler, "the leading religion in America is not evangelical Christianity, it is the worship of unearned riches, and its golden rule is the belief that it is possible to get something for nothing."

For hedge fund managers such as Lahde and Paulson, they got rich by making the correct bet at the correct time. Then there are the millions of Americans who bet that housing values would keep increasing indefinitely, the banks who bet that rising real estate values would allow borrowers to keep paying and the fund managers who bet that securities made up from these shaky mortgages would continue to appreciate in value. All of them are losers.

Unfortunately, these losses in the economic casino are not confined to the people who placed the bets. When the savings & loan industry collapsed under the weight of bad loans and risky investments in the late 1980s, it cost the federal government more than $125 billion to clean up the mess. But that was only one small sector of the economy and the damage was more or less contained.

Since housing has become the lynchpin of the American economy, the current crisis is cutting across every sector. Any business associated with home building is hurting right now. The U.S. Labor Department estimates that nearly 100,000 financial services jobs related to credit and lending have been lost.

The ripple from the collapsing housing market is now spreading into the retail market, with everything from department stores to car dealers starting to feel the pinch. Add to all this soaring food and energy costs and the collapsing value of the dollar, and we are looking at a major economic crisis. And no one is totally sure how bad things will get before they start getting better.