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 “It doesn't feel like the game is going to come to an end just yet,” asserts today’s Wall Street Journal. But reading between the lines, we see many, many signs that the love affair with risk has run its course. One is the response U.K. Prime Minister, Tony Blair, got when he expressed concerns over the investment climate in Russia. Even though Moscow recently stepped up moves to tighten its control over the energy sector, “dozens of global chief executives paid homage to Russia’s growing economic might” and basically told Blair to shut up. Peter Hambro Mining, an Aim-listed company with extensive interests in Russia, said on Mr Blair’s comments “ran the risk of being damaging” for British business interests. Despite Russia’s belligerent attitude toward business “there are few dissenting voices from the denizens of global business” including the heads of Deutsche Bank, Citigroup, Chevron Corp, Royal Dutch Shell and BP who all attended a recent forum in Moscow. It’s understandable that they might not want to be the ones to sound a warning, but their alarm at Blair’s willingness to do so suggests that it is, in fact, time for the “financial fallout,” called for in recent issue of The Elliott Wave Financial Forecast. The chairman of Barclays Capital actually insists that “Russia’s transition to a market economy has been successful and cannot be undone.”

In a classic finishing touch, his firm just announced the opening of a 200-person Moscow office. Goldman Sachs, Lehman, Merrill Lynch and UBS are also expanding their investment banking businesses in Russia. In fact, $7 million to $10 million a year offers to managing directors in Moscow make it the best paying investment banking post in the world right now. Wall Street’s rush to establish satellites in a place where the leader garners 70% approval ratings despite an increasingly autocratic style and a very questionable commitment to the rule of law is sure sign that financiers have lost all respect for what can happen when asset prices retreat. As the EWFF demonstrated in May 2000, Wall Street has a special talent for committing resources to bull markets as they reach their final destination. As we suggested here on April 4, this may well have been demonstrated once again by the street’s recent commitment to giant new trading floors.

Wall Street’s seemingly unquenchable demand for risk is explained in a column in today’s Wall Street Journal:
Skewed Incentives Whet Appetites for Greater Risk

 Noting that “risk appetites are determined by the balance between greed and fear,” the article relates that while fear is increasing, “greed has been increasing even more rapidly.” “Hedge-fund managers, buyout barons, investment bankers and oligarchs are infected more by greed than by fear largely because they often have safety nets. Managers of hedge funds and private-equity firms -- the two dominant species in the modern financial jungle -- typically collect 20% of the profits when things go well. But they don't share in the losses when things go badly. This one-way bet accentuates greed and blunts fear.” As EWFF has also noted, bankers are similarly inclined because they “don't make loans the way they did in the past, keeping the risk of default in-house. Instead, they mainly originate loans, collecting fees. As long as bankers can play this game of pass the parcel, they don't face much risk.”

The loans are then doled out to syndicates which are taking increasingly exotic forms. “In many cases, the suppliers of debt (particularly for leveraged buyouts) are collateralized loan obligations (CLOs) and hedge funds that specialize in credit. These, too, earn fees by cranking out deals. Since they aren't principally playing with their own capital, their risk appetites also are skewed. This cat's cradle of one-way bets doesn't just anesthetize fear. It encourages a breathless accumulation of assets. If the public is willing to let you play ‘heads I win, tails you lose’ with $1 billion, that's pretty nice -- but how much better to play with $20 billion.” As the May issue of EWFF noted, however, there is an important catch that is starting to turn up in the subprime mortgage area where the decline is already well established. When the trend reverses, these well-dispersed risks become a huge burden because they make establishing and complying with workouts and bankruptcy terms hopelessly complicated. As EWFF noted in May, scattered syndicates mean “more parties must comply with the terms of each default,” which slows “down decision making enough to turn even a mild recession into ‘systemic disaster.’ In this way, the financial engineering that pushed debt levels, valuations and investor optimism through the roof on the way up reverses and will foster an atmosphere of rising caution, falling prices and ill will.”

It’s an almost impossible juggling act, but, as long as the stock market was rising, Wall Street could keep all the balls in the air. But the first return to earth is now very clear in deals like Bear Stearns’s High-Grade Structured Credit Strategies Enhanced Leverage Fund. The fund, which has a big exposure to low grade subprime mortgages, fell 23% from the start of the year through late April. According to an account in the Wall Street Journal, observers are convinced “the paper losses will have a limited impact on Bear” because it moved the funds into a separate corporate entity, Everquest Financial Ltd. But the Journal also reported, “Some market participants predict the fund's downturn could have a chilling effect on Bear's planned initial public offering of Everquest.” The paper adds, “Recently, the fund prevented some investors from pulling their cash [from the High Grade Structured Credit Fund].” The harder Wall Street asserts “everything is fine,” the quicker the conversion from liquidity boom to bust is likely to unfold.