Washington, 29 September 1998 (RFE/RL) -- The U.S. Federal Reserve (Central Bank) is widely expected to lower at least one of its key interest rates late today.
But since stock traders around the world have already factored in the expected decrease in rates the Fed charges banks in the United States, the move is not anticipated to cause any radical changes in stock markets which continue to be volatile.
The only real shock for stock traders would be if the Fed did not lower interest rates at least one-quarter to one-half percent. The interest rates the Fed charges banks pretty much determine the rates the banks themselves charge for loans to private customers.
Fed Chairman Alan Greenspan's comments to a congressional committee last week that a slow down was a greater danger for the American economy than inflation prompted analysts and traders to predict the interest rate cut at today's meeting of the Fed's policy- making open market committee.
The expected move will be generally welcomed by the Finance Ministers and Central Bank governors of the world who are beginning to gather in Washington for the annual meetings of the International Monetary Fund (IMF) and the World Bank.
Russia's very uncertain situation will be a key topic in the halls and meetings rooms around the formal sessions next week. But IMF Managing Director Michel Camdessus made clear again on the week-end that no further tranches of IMF loans will be released until Moscow puts together a credible reform program.
"They can't solve their banks' problems by printing money," he said at a meeting of European Union finance ministers and central bank governors in Vienna Saturday. "They should have no illusions that they can solve their problems with lax monetary policy."
Perhaps of more immediate concern to the finance ministers, central bank governors, and the thousands of commercial bankers and investment leaders who are also gathering in Washington around the official meetings, is the long-term situation of hedge funds.
These little know and even less understood funds have been controversial fixtures on the global financial scene because of their speculative buying and selling of currencies. Malaysia's Prime Minister blamed hedge funds, such as those run by financier George Soros, for forcing the value of his country's currency down. He has tried to ban then from buying and selling in that East Asian country.
Others defended them as sophisticated operations necessary in the global economy to help investors and lenders protect themselves against unexpected fluctuations in increasingly complex markets.
However, when one of the world's largest such funds, New York-based Long-Term Capital Management, had to be saved with a $3.5 billion bailout from banks and financial institutions last week, it sent shock waves through the global financial system.
The shock waves, set off because no one had any idea of the extent of the exposure these funds had in global markets, got worse when the world's largest commercial bank, Switzerland's UBS, said it would have to take a loss of over $680 million this quarter because of its previously undisclosed stake in the fund.
Other banks are expected to have similar losses because of loans and investments they made to Long-Term, which at one point apparently had market exposure of $200 billion, a figure vastly larger than the entire national output of a nation like Hungary.
Hedge funds make their money by literally placing bets on disparities between the current prices of bonds, stock, currencies and other securities and their historical values. The bets, made with other such funds, are that the disparities will widen or narrow. To further hedge the bets, a fund frequently makes bets on both sides of the question, an action that is supposed to offset one risk against another.
All of these bets were based on sophisticated computer programs which looked for tiny fractions of differences in different markets around the world. The winnings on these bets are generally small with a one million dollar trade often earning $1,000 or less. But when multiplied by hundreds of millions of dollars in hundreds and thousands of such bets, the hedge funds can make thousands of millions of dollars quickly. In addition, much of the betting was done on borrowed money, using it as a lever to make higher profits.
What happened to Long-Term capital, however, was that when Russia's currency devaluation, and debt moratorium and forced rescheduling sent the global financial system into a spin, all of the history backing up the bets changed. Suddenly, the gaps reversed direction and Long-Term found itself forced to pay up its bets as well as repay its loans.
To keep the fund from collapsing, 14 financial institutions put up $3.5 billion in new capital -- and took 90 percent ownership of the fund. The rescue was put together by the U.S. Federal Reserve because officials said the various bets and arrangements made by hedge funds are so tangled that the collapse of one fund could bring down the entire system.
What makes this all so scary for the global financial system, in addition to the still unknown exposure of other banks and funds to this particular hedge fund, is that hedge funds are virtually unregulated anywhere in the world and are the least transparent -- or most secretive -- of almost any financial enterprise.
A call for greater transparency, and regulation, is apt to surface at the Washington meetings as everyone quietly tries to learn just how extensive the risk is already.