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October 28th, 2008

Brooksley Born, chairperson of the "Commission" during the Clinton administration, forewarned us about the financial tools (ab)used when businesses are left to govern themselves.  Here are the best quotes from her remarks to committee after the LTCM bailout in 1998:

LTCM managed to borrow $125 billion, approximately 100 times its capital, and to use those borrowings to enter into derivatives positions with a notional value of approximately $1.25 trillion, or 1000 times its capital. ... LTCM generally insisted that it would not provide OTC derivatives counterparties with initial margin. LTCM's swap counterparties and other creditors reportedly did not have full information about its extensive borrowings from others and therefore unknowingly extended enormous credit to it.

... insufficiency of the internal controls applied by the firm itself and its lenders and counterparties, including value-at-risk ("VAR") models. ... The prudential controls of LTCM's OTC counterparties and creditors, the parties that presumably had the greatest self-interest in assessing LTCM's financial wherewithal, also appear to have failed. They were reportedly unaware of the fund's extensive borrowings and risk exposures.

Italics and bold are mine -- to emphasize both the failure of Libertarian concepts of self-regulation and the need for, at minimum, transparency enforced by the government.  The rest of her rhetoric is far too big government even for my taste but it's interesting to read in current context.