Schadenfreude is tricky stuff. Wall Street barely had time to savor the travails of erstwhile prosecutor-turned New York governor Eliot Spitzer before most of the world's markets seized up last month. Spitzer famously pounced on e-mails to crack down on rampant investment banking conflicts of interest; in July the efforts of his staff to use New York State Police records to tar a political adversary came to light, exposed in part through an e-mail trail.
But what should have been a summer's worth of self-satisfied sniggering evaporated as quickly as the year-to-date gains on a quantitatively run hedge fund, when the woes of subprime mortgages moved rapidly through other credit markets and into stocks. Senior executives like UBS CEO Peter Wuffli and Bear, Stearns & Co. president Warren Spector were shown the door, and the high-flying hedge funds of such titans as Goldman, Sachs & Co. took a tumble.
All of which goes to show you can fool all of the people just so long before enough wake up from their dreams of untold riches or an addition to their breakfast rooms and discover that they and others can't pay their debts: So the sorrows of the very poor who took out loans they could never hope to repay spread rapidly to the very rich who had taken out loans that they could no longer repay. Finally, through leverage, we have found a way to narrow the widening gap worldwide between poor and rich, as peasants and kings lie down together in the driveway of the foreclosed house of cards.
Ay, yay, yay, one is tempted to shout, what was everyone thinking? In this issue we attempt to make sense of the summer's market ructions in "The Loss of Liquidity," a special report beginning on page 43. The first piece in this multipart package, "The Ponzi Nation Topples," was penned by Edward Chancellor, an editor with breakingviews.com who contributes each month's Inefficient Markets column. To give credit where it is certainly due, Chancellor foretold the coming end of the credit market bubble in a February article in this magazine titled "Ponzi Nation." In this month's follow-on piece, he explains how the market bubble built up, attributing much of the blame for the current problems to "the misguided actions of central bankers and the myopic self-interest of participants in the credit markets."
"In the Eye of the Storm" by Staff Writer Pierre Paulden gives us a rare look at the operations of the secretive Dallas-based Highland Capital Management. The most powerful nonbank investor in the $1.25 trillion market for high-yielding corporate loans, Highland last year turned sour on the excesses of the market, battened its hatches and is now looking to buy distressed assets on the cheap.
Elsewhere in the package former Wall Street risk-management executive Richard Bookstaber examines how seemingly disparate markets tend to act in concert in "The Myth of Noncorrelation"; four market experts ponder where the U.S. dollar will go; and, finally, we note the newfound resilience of emerging markets, led by China.