Telling Fortunes

A San Francisco firm rolls the dice in the multibillion-dollar game of global finance

In the words of economist John Kenneth Galbraith, "Recurrent speculative insanity and the associated financial deprivation and large devastation are, I am persuaded, inherent in the system."

In other words, the world survives only by the grace of a tribe of fools. This fact became apparent to me between 1993 and 1997, while I worked as a Mexico City-based staff writer for Dow Jones & Co.'s financial newswires. This period spanned the buildup to, and immediate aftermath of, the Mexican financial and economic collapse, a debacle famously described by International Monetary Fund Director Michel Camdessus as "the first financial crisis of the 21st century."

The speed with which investors fled the peso, and the devastating effects on other countries, had the appearance of an entirely new kind of event. It was the world's first such collapse triggered by vast international capital flows gushing into -- and out of -- an emerging economy ill-prepared to deal with them.

In Mexico, I saw the surreal euphoria Galbraith says has historically preceded financial collapse. I saw a trillion dollars' worth of U.S. pension-fund managers breakfast with Mexico's president, then leave with thoughts of weighting their retirement portfolios slightly southward. Four-hundred-dollar-a-night Mexico City hotels were jammed with Wall Street bankers seeking takers for their money.

When the collapse began with a devaluation of the Mexican peso just before Christmas 1994, the world's financiers were caught off guard -- despite a seemingly sophisticated system for analyzing the financial health of countries. Investors had based their risk-reward calculations -- that peso-denominated treasury bills, for example, were worth the 18 percent interest the bonds paid before the collapse -- on the absurd idea that Mexico had entered the First World. They had listened to the scores of Ivy League-educated Mexican government officials who traipsed through the conference rooms of Manhattan every day, repeating the words "modernization" and "free trade."

Wall Street bankers had sent fresh-out-of-college, $80,000-a-year "analysts" to Mexico City to write country-risk reports. They lunched with Mexico's MIT-trained finance minister, and its Harvard-trained president. They drank with Mexican officials at Latin America investment conferences in Cancun, Mexico City, Miami, and New York.

Then, they returned to their offices and placed huge bets. Later, banks and private investors lost billions when the currency collapsed, financiers adjusted their Mexico risk-return calculations, and the country's entire financial system, economy, and standard of living cratered.

And Mexico was only the first.
The 21st century's second international financial catastrophe came in Southeast Asia, in the summer of 1997. The field of risk analysis had advanced since the peso debacle, but it is difficult to find a financier who foretold Asia's demise.

"Timing a collapse is impossible to predict," says Mark Headley, manager of Matthews International Funds, which lost millions of dollars during the Asia collapse.

While it may be impossible to predict the timing, the basic shape of such disas-ters appears quite predictable when they do happen.

The scene before, during, and after the century's second financial disaster was just as surreal as its first. Euphoria was boundless. Korean companies had mammoth financial and business interests so convoluted as to hide billions of dollars in loan losses. Banks had loan portfolios growing at a rate of up to 60 percent a year. Asian skylines grew like bamboo.

Andrew Foster, a San Francisco investment research analyst, worked as a financial consultant in Thailand during 1996, and at a Malaysian bank when the collapse hit. Before the collapse, he remembers looking out of a Bangkok high-rise onto a forest of construction cranes.

"The crane was the national bird of Thailand, and I remember looking out over Bangkok seeing all these cranes. The country was growing so quickly, and banks were making so many loans that they ran out of loan officers, so they were actually using security guards as loan officers. We used to joke that this gave new meaning to the word loan 'officers.' "

The crisis officially began with the July 1997 collapse of the Thai baht. Within months, the shock waves were felt around the world. And by the end of last year, the International Finance Corp.'s emerging-market index had lost 45 percent in dollar terms during the year-and-a-half since the crisis began.

Nobody knows where, or when, the 21st century's third global financial crisis will begin. But some seers hint that it may occur in California. More precisely, in the San Francisco Financial District that funds much of America's miraculous technological economy.

While the possibility of economic troubles seems remote in the fabulously nouveau riche San Francisco Bay Area, here and there one hears murmurs of doom. The Association of Bay Area Governments plans a conference this month called "Will the Bubble Burst?" Financial columns have been warning of an inflated stock market for several years now. Internet fund executives talk of a coming "downdraft." Even U.S. Federal Reserve Chairman Alan Greenspan has warned of "excessive exuberance" in U.S. financial markets. Greenspan jiggled interest rates, the exuberance continued. This December, the prices of already stratospheric Internet stocks doubled. Some observers have gone from scared to terrified.

But inside the amazing universe of Internet stocks, people are much more sanguine.

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