Why secrets will always be leaked

ONE OF the more interesting of the many sub-plots of the Long- Term Capital Management bailout is the forthcoming unwinding of the firm's positions. Many of those positions are sufficiently large that, if disclosed, they will move markets.

The price of gold rose on Monday in Tokyo after speculation swept through the market that Long-Term Capital needed to cover a short position of 100 tons of gold. Probably most of the people who acted on the speculation had no idea whether Long-Term Capital actually was short gold. But as long as no one knows for sure what Long-Term Capital holds in its portfolio, any speculation, however absurd, will be taken seriously. If these guys were capable of getting long Danish mortgage bonds, they could be long, or short, anything.

The Long-Term Capital portfolio is said to control the equivalent of $1,000bn in market positions. Whatever the actual number, the Long-Term Capital portfolio is huge and unstable. And the presence of a huge, unstable portfolio will trigger all sorts of weird reactions in the markets. Speculation about Long-Term Capital's portfolio will continue to move markets, mainly because some of the speculation will be true.

On the face of it, of course, everyone who knows the actual contents of the portfolio has a deep interest in keeping them secret. The six Wall Street firms that now own Long-Term Capital - Goldman Sachs, Merrill Lynch, Travelers, JP Morgan, Morgan Stanley, UBS - want to divest themselves of a pile of securities without alerting the markets to the details.

If the market gets wind of the fact that the Long-Term Capital portfolio contains, say, $10bn of French government bonds, those bonds will tank. No one at these five firms wants that to happen. Yet.

But the interests of the group differ from the interests of the individual firms. The group is in fact a kind of cartel, a cartel of financial information. The forces pulling it apart are the forces that pull apart any cartel. Those who cheat can get rich quick. And those who don't cheat run the risk of being reamed by those who do.

If Long-Term Capital is long $10bn of French government bonds, the head of Goldman Sachs, Jon Corzine, now knows it. With that information Mr Corzine can do one of two things: he can sit on the infor-mation and hope everyone else in the cartel does the same; or he can quietly instruct one of his traders to sell short French government bonds, in anticipation of the Great Unwinding. If you were Mr Corzine, what would you do?

Spokesmen for some of the firms have insisted there is a Chinese Wall between the Long-Term Capital bail-out and their traders. This is, of course, nonsense. The firms haven't merely the right but the responsibility to use their inside knowledge for financial gain. The goal of the bailout is to spread the risk of the Long-Term Capital portfolio, with a view to shrinking it to nothing. If the firms that now own this risk are able to offset it through discreet actions of their own, all the better.

Mr Corzine probably could not control his traders even if he wanted to. A slow, deliberate unwinding of Long-Term Capital is almost impossible on today's Wall Street. We live in the age of free agency, when the interests of the firm and the interests of its traders aren't identical.

In theory, of course, the Goldman Sachs trader doesn't wish to see his firm lose a lot of money on the Long-Term Capital portfolio. In practice, though, he is concerned mainly with the bottom line of his own trading books. Once the Goldman trader has established his short position in French government bonds, he will want others to follow, quickly. After all, what good is it betting on the panic that follows the news that $10bn of French govern- ment bonds are about to be sold if the news never actually materialises?

So the Goldman trader will leak the news to his favourite reporter, and the reporter will print it. And the Long-Term Capital portfolio will be exposed, an inch at a time, coaxed out by people who stand to gain at its expense.

And the PhDs in Greenwich, Connecticut, will be made to look even more foolish than they now do.

Michael Lewis is the author of 'Liar's Poker', a depiction of the US investment bank Salomon Brothers during the 1980s, when LTCM founder John Meriwether ran the bond trading operation there.