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Finance is human nature, someone once said, which is why things never change. Each generation gets up to the same old tricks, makes the same old mistakes, and is always surprised when things don't turn out as planned.
So if you want to know what is likely to happen next, simply take a look at what happened last time round. The last UK example of huge leverage being used to push structured products to ludicrous highs, only to see them become worthless as the system unwound, was the split-capital investment trust crisis.
And the last throw of those in the thick of the split-capital problem was to try to get "friendly" rivals to take stock off their books at an inflated price just before they had to sign off on their annual accounts. There was, of course, an under-the-counter deal that the original owners would buy the toxic stuff back again after the year-end had passed and the auditors had signed off the books favourably.
Word on the street is that some of the investment banks are contemplating something similar. The collapse at the end of last week of Peloton, a wellregarded hedge fund, is particularly unfortunate for the investment banks because as well as wiping out a fair chunk of its investors' money, the losses have apparently also spread back up the chain to the prime brokers - who are, of course, the investment banks.
It is also worth noting the words of one of Peloton's founders on why his business has failed. It is apparently nothing to do with the management, taking on too much risk, gearing up too dangerously and thinking they were skilful when in fact their past success had just been luck. The disaster is apparently entirely down to external factors - namely the "unprecedented market movements" and the unfairness of lenders in taking no account of the firm's good credit history in deciding not to lend it so much in future.
Be that as it may, the story on Friday was that one investment bank - which libel laws will not allow me to name - was touting around a package of $3 billion (£1.5 billion) of loans and securities that it wants to trade on a bedand-breakfast deal - so they will not be on its books when the auditors come to call. It wants someone to buy them at an inflated price so the bank does not have to recognise a loss on its balance sheet. It will then repurchase the package at that price plus a suitable fee to the counter-party in a week or two.
It is no surprise if this is happening. It is the same kind of window dressing they tried to do with the splits crisis, and indeed in the fringe banking crisis of the 1970s. It happens because banks are still in denial about the disaster they have unleashed on their world.
Today's other big rumour is that another flagship investment bank will be forced into a profits warning towards the middle of this month. Again, we should not really be surprised - though the markets might not see it like that.
A straw poll of banking activity for the month just ended showed that European Equity capital markets activity was down 70% on 12 months ago, global equity capital markets is down 50%, and leveraged finance in its various forms is down about 25%. On top of that are the prime brokerage losses just mentioned, losses in-house from proprietary trading, and a loss of income from hedge funds as they retrench. Given that firms have barely begun to tackle their cost bases, the plunge in net income in some houses is said to be frightening.
Parallel with this are the lawsuits. Barclays Capital is suing Bear Sterns over the way it ran a hedge fund in New York and UBS, one of the banks most troubled by subprime, picked up an ugly-looking writ in Germany last week. There will be many more, and two things are likely to happen.
BACK in 1990 the London Borough of Hammersmith and Fulham escaped the consequences of multi-million pound losses in the derivatives markets when a London court ruled that these were ultra vires - meaning the authority had no legal right to be buying those kind of investments. This in effect means they had been mis-sold and the losses reverted to the investment banks which had done the selling. We must expect many variants on that theme in the coming months - given that many investors nursing horrendous losses were assured they were buying triple-A products.
The other big issue will be the attitude of the insurance companies and whether they will be willing to pay up when the banks lose in court. The banks would be unwise to take that for granted - for the again long-established reason that if the insurers feel a bank brought some of these losses on itself by the way it behaved, they will show a marked unwillingness to cough up.
Thus we move inexorably to the next stage of the great unravelling.
