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Scary Stuff

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Many individuals, companies and countries like to act as if they were laws unto themselves but, unfortunately for them, reality keeps intruding into their misguided dream worlds.

If anything, experience in the increasingly globalized and technological world of the early 21st century is proving more and more how interdependent we are, not how much we can thrive or survive on our own.

What brings this to mind (for those of you who were wondering “where is he going with this?”) is the mushrooming crisis that started in the subprime mortgage area and has spread like an arsonist’s dream to a tightening of credit all along the board, in markets here and abroad.

In the real estate market, one of the unintended consequences of this crisis is that now even good credit risks are paying the price and facing a harder time and greater scrutiny in getting mortgages.

But the interdependency is more startling when you begin to see how many companies around the globe invested in paper that consisted of securitized subprime mortgages. You expect such investments in hedge funds, of course, but they’re also turning up in bank and insurance company portfolios (witness AIG, which may have been the first to disclose its exposure, but assuredly won’t be the last insurer to do so.)

There was even a mention in story in the New York Times, if I remember correctly, that some money market funds (those icons of safety and security!) might have some exposure to the subprime mess.

Technology has made this possible because all the slicing and dicing of tranches with differing risk exposures and the way they move around the world at lightning speed would not be possible without the power of computers.

In a way, it’s analogous to the way the spread of infectious diseases like SARS is facilitated by air travel. Before you know it that international traveler has landed in New York from Hong Kong and is sneezing on the D train rumbling through Brooklyn.

Had that person been on a slow boat from China, the symptoms would have shown up long before he landed here and he would have been quarantined.

But back to the subprime catastrophe. There’s no doubt that hedge funds are feeling the pain. Because of our interdependency this means that sooner or later we’ll all be feeling the pain, not only those rich investors who made bundles while the getting was good.

You know the situation is serious when a firm like Goldman Sachs has (with the help of a bunch of rich investors) to inject some $3 billion into one of its hedge funds that had lost some 30% of its value in only one week. The move was undoubtedly made to shore up confidence and show that Goldman was standing behind its fund. But there’s also no doubt that it caused some investors in other quarters to head for the doors if they hadn’t already.

The sad thing is that we never seem to learn. It should have been a tell-tale sign when all the ‘oohs’ and ‘aahs’ went up after some hedge fund managers were revealed to have made billions in compensation in one year. This, if anything, should have shown us that gravity was being defied somewhere in the system and that we were due for a Wily Coyote moment as a result.

If we can draw one lesson from our interdependent system, perhaps it should be this: If something looks too good to be true, start getting scared, very scared, because sooner or later we’re all going to pay.