Last week the inability of a Wall Street securities company to make a $160 million interest payment to the Chase Manhattan Bank sent a chill and a shock through the international financial markets of the world.
And although the liability of the company, Drysdale Government Securities, later turned out to be at least $270 million, the problem moved off the front pages when Chase belatedly agreed to assume the losses, rather than pass them on to others for whom Chase originally said it was acting only as agent. The Federal Reserve Bank also took extraordinary steps to calm the markets.
But the situation in financial markets is fraught with danger. Many banks, savings and loans, corporations and other financial institutions are skating on thin ice. A default like Drysdale could happen again because no government body, not the Securities and Exchange Commission or the Federal Reserve, is now empowered to prevent the big wheeler-dealers from getting overcommitted.
The fact that a small, almost new, firm like Drysdale, operating on a relative shoestring could persuade a major, experienced bank like Chase to expose itself to a $270 million loss says something rather serious about the current state of financial markets, and about the lack of adequate government supervision.
It also says a lot about Chase, which violated the No. 1 rule of the high-powered financial wheeler-dealers -- know the people you're dealing with. Chase, of course, will cut its loss to $135 million, writing it off against its taxes this year. Thus, you and I and other American taxpayers will also pay $135 million for Chase's learning experience.
When one raises the question of lack of surveillance of financial markets in general, or of controls -- specifically -- on the futures markets, or of inadequate margin requirements in commodity or other markets, administration officials blandly say: "We must allow markets to function unregulated."
In essence, Washington's attitude is that some will survive and some will go bankrupt -- and so be it. That, of course, covers industrial corporations as well.
But financial institutions are not merely entrepreneurial, like corporations, affecting only their owners, managers, and employees. They also have a fiduciary relationship -- they hold or transfer money in trust for others. To allow a firm like Drysdale to get so overextended that it goes belly up is irresponsible.
It is regulating markets through bankruptcy.
Drysdale borrowed bonds from Chase as part of a high-rolling scheme of buying and selling of government securities that ballooned to a portfolio of at least $6.5 billion, although its own capital was only about $20 million. No one is quite sure yet just how Drysdale high-rolled itself into a jam. But when the interest came due on borrowed bonds, Drysdale didn't have enough cash in the till.
You can be relatively sure that if you or I were to borrow from the Chase bank, we would be required to put up adequate collateral to cover repayment and interest: there appears to be one standard for ordinary people and another for those who deal in billions.
None of this would have happened were it not for the huge sums of money floating around, easy and questionable credit lines, the willingness of Wall Street plungers to take high risks in an environment of high interest rates -- and no government cop on the street corner.
In a speech in Venice less than two weeks ago, just before the Drysdale story broke, Henry Kaufman, with uncanny foresight, had said, speaking of financial deregulation:
"[The] unique combination of generally subnormal performance of the economy and deregulated financial markets full of entrepreneurial zeal has produced a significant liberalization of credit standards and practices." He pointed out that corporations are massive borrowers in short-term markets, even though they are losing money hand over fist, in a way that "would have been unacceptable to lenders and business managers 20 or even 10 years ago."
Kaufman feels the time has come to require reserve requirements in futures markets, and indeed, against money market funds, although the latter were not directly affected by Drysdale. Thomas A. Russo, a securities lawyer, suggested in a New York Times article that defaults like Drysdale's might be avoided by a self-regulatory body for the government securities industry, similar to the system used for the stocks and bonds traded on the national exchanges or over the counter.
Amazing as it may seem, the government's current authority over the government securities market is limited to dealing with fraud, not overextension, presumably on the theory that only the very biggest players, whose judgment can be trusted, can get into this game in the first place. Now that we know that's not the case, Congress should get busy and do something about it.