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It Starts Like This . . . ?

03/31/2021

I have long argued there is an important distinction between a recession and a financial crisis.  Recessions come-and-go, usually fixing themselves, before scaling new heights afterwards.  On the other hand, a financial crisis can happen quickly, do more damage, and need government assistance.  A financial crisis is much worse than a recession and requires eternal vigilance.

For the past week, Wall Street has been rattled by a “family office” in New York that borrowed amazing amounts of money to make speculative investments.  These highly-respected banks made huge loans to a convicted inside-trader.  While it is too early to reach conclusions, it is not too early to have questions.

First, where were the banking regulators, who insist on “know-your-customer” rules?  As a retired banker, I recall investigating a 20-year client whom regulators thought needed more due diligence.  They were wrong!  In fairness, the U.S. based banks did much better than foreign lenders!

Second, where were the securities regulators, who insist on full disclosure?  For instance, disclosure is required when control over 5% of publicly-traded shares in reached.  It looks like that was “ignored” by using swaps, which gives “conditional control.”  There was no disclosure.

Third, does hiding behind the label of “family office” permit behavior prohibited for hedge funds?

Do you remember the collapse of Long Term Capital Management in Connecticut in 1998, where the hedge fund required government assistance to close-out their position in options?  That caused a similar hiccup in the stock market but nothing more.

Still, while the beginning of a financial crisis would look like this, looks can be deceiving.  This is NOT the beginning of a financial crisis!  There is too much liquidity sloshing around the global economy for a financial crisis in the foreseeable future . . . but keep your eyes open!

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