Long Term Capital Management was a hedge fund that started in 1994 and was on the verge of bankruptcy in 1998. It was leveraged at 100:1 on risky bets and was hit by the Asian economic crisis. It was bailed out not by taxpayers but by banks and investment houses, which got a modest return before the company collapsed. Here are some important quotes.

Supporters of the bailout stressed that the Federal Reserve only facilitated the deal, and that the $3.5 billion in rescue capital came from 16 large banks and brokerages, rather than from taxpayers. Yet the critics pointed out that the rescuing banks are backed by taxpayers through federal deposit insurance. Moreover, they enjoyed that federal backing while throwing the money at Long Term Capital that enabled it to pursue its exotic–and, for three years, very profitable–speculations. “Why should the weight of the Federal Government be brought to bear to help out a private investor?” demanded former Fed Chairman Paul Volcker. “It’s not a bank.”

And…

At the peak of its borrowing, the secretive fund reportedly carried a debt load 100 times as great as its net assets, or ownership capital. This would be like putting down $1,000 of your own money to buy a $100,000 house–in a flood plain on the San Andreas fault. “Most hedge-fund managers believe that a leverage ratio in excess of 50 to 1 is exceptionally large and very risky,” says Hunt Taylor, executive director of Tass Management, a hedge-fund consulting firm.

Now banks were only leveraged at 30:1.

Jon Corzine was a senior partner at Goldman Sachs that orchestrated the bailout, and as a result he was forced out of Sachs into public life as Senator and Governor of New Jersey. His predecessor, who forced him out because of the risky bailout of a risky fund? Henry Paulson.

Rather crude and not for kids.

Speaking of conflicts of interest, it should be noted that Paulson’s three immediate predecessors as CEO of Goldman Sachs — Jon Corzine, Stephen Friedman, and Robert Rubin — each left the company to become a U.S. Senator, chairman of the National Economic Council, and Treasury Secretary in the Clinton administration, respectively. If there isn’t a conspiracy theory website about this, somebody should really buy www.goldmansachsisinfiltratingthegovernment.com.

Also funny, Obama’s mental notes

An email that went out a few days ago sent to me by my friend, Chris (no the other Chris):

Dear Fools:

We need your help.

Treasury Secretary Henry Paulson has put together a plan that is actively under debate and allows the Treasury to invest in assets that are crushing bank balance sheets. We view this plan as being an important step in allowing the global financial system to recapitalize itself. We agree with financial intellectual titans Warren Buffett and Bill Gross, as well as both presidential candidates, that the Paulson Plan needs to be passed and will benefit Main Street.

We believe that if the Paulson Plan is done correctly, American taxpayers will profit not only from the return of lending capacity to our banks, but also from these troubled investments. However, the plan should embrace the tenets of free-market capitalism. The government should demand equity stakes in the banks.

We think taxpayers deserve to benefit from a deal soundly rooted in free-market principles. We, the undersigned, encourage you to call the people who represent you in the House and Senate and demand that the approved deal include provisions for equity ownership. Go to www.house.gov and www.senate.gov to find the phone numbers for your elected representatives.

Finally, even though these are extraordinary times, we stand by our belief that the best way to build long-term wealth is through equity ownership. Just look at who is doing a lot of buying of late — Warren Buffett.

We encourage you to take a few minutes — now! — to call your elected officials and let them know that there needs to be an equity component for taxpayers.

Onward,
Tom Gardner, CEO and Co-Founder, The Motley Fool
Scott Schedler, President, The Motley Fool
Bill Mann, Senior Advisor, Motley Fool Hidden Gems, Pay Dirt, and Global Gains

P.S. We have opened a discussion board where Fools can gather to talk about this important issue. Please come and share your opinions.

I sincerely thought this was a joke, given the greeting, but then realized that Motley Fool addresses its mailing list that way in general. I never thought I would read someone explain how “rooted” they are in Free Market principles, and in the same breath push Government equity ownership in banks as the lynch pin issue required for the bailout to be “Free Market”.

The issue here is two-fold: First, the Government getting a return on investment does not equal taxpayers getting a return on their investments. I don’t think anyone has believed that for years. Second, there is no evidence that the Government WILL get a return on its investment. Actually, there is ample evidence that it will NOT.

Like Ron Paul said yesterday, (paraphrasing) “Typically, the reason assets are illiquid is because they’re not worth anything.”

The Government proposes to “create” a false market on useless assets; banks are waiting for them to do it so they can get them for next to nothing; and the “taxpayers” are supposed to make a profit? And in addition, the real pushing point is that all of this will be OK if the Fed has an equity stake in the entities they’re buying useless assets from.

Paulson must indeed think that we are fools.

Has the world gone topsy turvy? These guys are partisan jerks, but Krugman is right about Paulson’s arrogance.