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27 March 2008updated 24 Sep 2015 11:16am

The borrowers

Over the past 15 years, individuals and businesses in both Britain and the United States have taken

By Philip Delves Broughton

In November last year, Louis Bacon, one of the cleverest American hedge-fund managers, paid $175m (£88m) for the Trinchera Ranch, which covers 250 square miles of Colorado. It was the US’s largest-ever private property transaction.

At the time, this was viewed as just another example of hedge-fund excess, like the bottles of Petrus blithely downed in Mayfair each night. But, in retrospect, it may have been one of Bacon’s smartest investments.

When the rest of the financial world goes to hell, good ranch land holds its value. You can see it, touch it and even live off it if you have to. That is more than can be said for a collateralised debt obligation, one of the gimcracks causing Wall Street’s current woes.

It has been a breathtaking few weeks to be in New York. Whether you work in financial services or not, Wall Street dominates the city, its economy and its culture. It was on Wall Street that the downfall of Eliot Spitzer, New York’s governor, was greeted with the greatest rapture. Spitzer had made his name punishing bankers for their actions during the 1990s boom, so for them his humiliation was delicious.

And then came the heart-stopping implosion of Bear Stearns, one of the Street’s biggest banks. Faced with a run by clients and creditors over the weekend of 15-16 March, Bear was forced to consider an offer from J P Morgan for $2 a share, (later increased to $10).

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A year earlier, Bear’s shares had traded for $150 each. Bear is a brass-knuckle firm which never cared to make friends. Its executives have a reputation for toughness.

Jimmy Cayne, Bear’s chairman, who stepped down as CEO in January, was reported to be playing bridge as the firm headed for the rocks. In the course of a year, his stake in Bear fell in value from over $1bn to less than $15m. To his enormous credit, though, he never sold his stock.

While the rest of the world may view Bear’s demise as just a financial story, or a tale of greed rightly punished, in New York it feels personal. Bear employs 13,000 people, mostly in Manhattan. Unlike some of its rivals, it is meritocratic to its core, employing people from every class and race in the city. The ripple effect of its collapse has been felt in all quarters of New York, not just along Park Avenue.

A crisis on Wall Street means a crisis for hundreds of thousands who never play bridge or golf or receive multimillion-dollar bonuses, but depend on the bankers for their living.

But the Federal Reserve did not orchestrate the bailout of Bear Stearns to save anyone’s job or personal fortune. It intervened because Bear Stearns is the counterparty to trillions of dollars of derivative transactions called “swaps”. Like it or not, this is a vital piece of the world’s financial circuitry. Had it burned out, the consequence might have been a complete seizing up of financial markets. So once we are all finished laughing at freshly impoverished bankers having to sell their houses in the Hamptons and pull their children from expensive nursery schools, it is worth asking where this crisis goes next.

The consensus is that we are still in the first act of a three-act drama. And the original sin of excessive borrowing has yet to be fully punished. Any country that borrowed more than it could afford over the past 15 years is in deep trouble. That means the United Kingdom as well as the United States. Because, at some point, you either have to stop borrowing, which for habitual borrowers means stopping spending, which means a recession; or you have to devalue your currency in order to slash the real value of your debt.

Either situation is ugly, but one or the other is necessary. America today is wrestling with both and the UK cannot be far behind. Over the past 15 years, individuals and companies in both countries have borrowed far too much. They were enabled by financial institutions that earned fees on loans. The more loans they could issue and the more derivatives based on those loans, the more revenue. And, for the borrowers, from first-home buyers to private equity firms, easier credit meant more stuff, more houses, more stocks, more companies, more flat-screen televisions, all on the never-never.

Sadly, the “never-never” has become the “now”, as many of those fee-driven derivatives have turned out to be hokum, loans upon loans upon loans far beyond the wit of the average banker to understand, let alone value correctly. Banks, it turns out, have been telling the world that those billions on their balance sheets were real money, when in fact they were nothing but paper. The truth is that getting out of debt is never pretty. The best position to be in would be to have cash to buy assets from people desperate to sell – or own a very large ranch in Colorado.

Philip Delves Broughton is a writer based in New York

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