Fisher on credit meltdown

The WSJ interviews Peter Fisher, the man who led the Fed intervention during the LTCM crisis. He's now an MD at Blackrock.

WSJ: What similarities or differences do you see to previous market crises?

Mr. Fisher: Big market events that pose systemic risks tend to reflect collective mistakes in which most market participants are offside in the same direction. In the summer of 1998 there was a collective misunderstanding about credit risk: Everyone underestimated sovereign risk and lived in the fantasyland were sovereigns did not default. Remember? "Russia won't default, they have missiles." It turned out not be about missiles but about cash flows. It turned out that credit mattered and then we had to revalue a lot of sovereign paper that was being used as collateral.

WSJ: So in 1998, there were problems with collateral. And this time, there are even more problems with collateral, right?

Mr. Fisher: Yes, indeed. Until the week before last, nobody seemed to be focused on the uncertainty surrounding the value of mortgage-related and structured-finance paper and, then, suddenly, everyone did. The late MIT Professor Rudi Dornbusch sagely observed that in financial markets things always take longer to happen than you expect but once they happen, events unfold much more quickly than you expect and this perfectly describes the events of mid-August.

WSJ: The conventional wisdom was that globalization would lead to a dispersion of risk. And yet, the market seems so spooked with announcements of problems from Australia to Germany as well as in the U.S. How do you see the costs and benefits of globalization in the financial markets?

Mr. Fisher: The benefit of course is risk diversification and dispersion but this comes with an offsetting cost. This is the cost of proxy or imperfect hedging, where market participants sell what they can rather than what they wish, which leads to higher linkages and less benefit of dispersion. In 1998, after Russia's default, there was selling pressure in Mexican bonds not because the market thought a Mexican default was likely but because the Mexican bonds were liquid.

WSJ: What else feels different this time?

Mr. Fisher: In September of 1998 there were a lot fewer people who thought they saw a buying opportunity -- famously, in the case of LTCM, only Warren Buffett and Hank Greenberg. It took until October and November of that year for more people to see a buying opportunity and for the markets to find a bottom.