3c hapter - Index of

Blue Skies, Pipe Dreams, and the Lure of Easy Money 27
Meanwhile, sophisticated investors have been piling back into
risky investments in search of higher return. Junk bonds, hedge
funds, and emerging markets have seen huge infl ows of capital.
Some sophisticated investors are even investing in lawsuits for
a piece of the potential winnings. 16 Helped along by the ability to
borrow money on the cheap, the “smart” money is once again taking
on dangerous levels of debt. Leveraged buyouts—where private
equity investors borrow massive amounts of money to take
over an undervalued company, squeeze costs out of it, saddle it
with debt, and pay themselves enormous fees for the favor—are
staging a comeback. And the potentially destabilizing highfrequency
trades fi red off by computer algorithms now make up
almost three quarters of trading volume.
Is it any wonder that prominent economists from Joseph Sitglitz
to Nouriel Roubini have warned that another fi nancial meltdown is
likely in the coming years?
How Wall Street Ate the Economy
Ordinary investors had little hand in creating the crisis, aside
from those who took out mortgages they didn’t understand or
couldn’t afford. Rather, the crisis was the product of the so- called
sophisticated investors and the anything- goes universe they operate
within, where synthetic securities ginned up by fi nancial engineers
allowed them to pile up speculative bets and risk and feed
the Wall Street profi t machine.
The rationale for exempting sophisticated investors from regulation
is that, being wealthy and fi nancially savvy, they can fend for themselves.
Further, since they are trading among themselves, it is argued,
their actions do not affect ordinary investors. Their risk taking was
even helped along by Congress and the SEC. In 2004, for example,
at the request of the biggest investment banks, the SEC lowered the
net capital requirement, or cash cushion, for Bear Stearns, Lehman
Brothers, Goldman Sachs, Merrill Lynch, and Morgan Stanley, allowing
them to leverage themselves to the hilt. For every dollar invested,
the banks borrowed about $30. It was Happy Hour in the VIP room,
the equivalent of 30-for-1 drink special. (It is little coincidence that