Discussing What's Happening on Wall Street in Class

On September 18, Leon Metzger's class on hedge funds was supposed to focus on the broad metrics and trends in the industry, the differences in tax law between hedge and mutual funds, and the role of private equity and its convergence with hedge funds. Instead, Metzger, a lecturer in finance and longtime senior executive at Paloma Partners Management Company, essentially tore up the lesson plan to lead a discussion on the ongoing troubles on Wall Street. What made the session extraordinary wasn't that outside events had encroached on the class, but that it had happened for the second week in a row. "Never in my wildest imagination did I think we'd be talking about this topic again," Metzger said at the beginning of class. "I've been around a long time and I never thought I'd see anything as bad as the '87 crash - and this is worse."

Around SOM, students and faculty were diving into the rapidly evolving Wall Street crisis, whether debating the causes and possible solutions during class, or listening to guest speakers, such as Boon Sim '92, the head of Americas mergers and acquisitions for Credit Suisse, who provided his unique viewpoint of the unfolding events on September 23. The school also partnered with the Wall Street Journal and CNBC to convene a roundtable discussion in New York on September 23 that brought together business leaders and scholars from Yale, Wharton, NYU, and the Columbia and Harvard business schools to discuss the unfolding situation in the markets and the economy more broadly, as well as the proposed Treasury Department bail-out plan.

Metzger used the collapse of Lehman and the impending bailout of insurance giant AIG as a lens through which to view the world of hedge funds. He explained the similarities between hedge funds and the way the proprietary trading desks of investment banks operate and how the valuation issue hitting bank assets and liabilities could easily infect the funds. "Perhaps there's a fear that the assets of the banks exceed their liabilities," he said. "Just look at AIG. In one week, what it needed in additional funding went from $20 billion, to 40, to 60, to 80, to $85 billion and does anyone know if even that is enough?"

While talk in New York and Washington focused on an industry-wide Wall Street bailout, the hedge fund class, which covers critical managerial aspects and characteristics of hedge funds and the hedge fund industry, linked the discussion of the crisis to topics of interest to future hedge fund managers, such as the performance of chief players on the Street and in the government, the role of short selling in the sudden drop in stock prices, whether firms were too highly leveraged, and how even diversified companies or funds can be put at risk if one key division fails. At one point, Metzger asked the class why the Federal Reserve moved to assist Bear Stearns, Fannie Mae, Freddie Mac, and AIG, but not Lehman or Merrill.

"Bear happened so quickly that the Fed had to step in," said Jay Siembieda '09. "Lehman and Merrill had enough time after that to sort things out, but didn't or couldn't. And AIG was too big to fail."

"It seems as if the government believed the financial markets could survive the Lehman collapse, but couldn't survive if AIG went under," Metzger added. "Let me ask you this: Will the U.S. still be able to preach free markets to the rest of the world?"

"No," answered Yulee Newsome '09. "In a way, we're socialist now."

"At least we didn't do what Russia did yesterday and shut down the markets," said Drew Skelton '09. "But the ultimate question is whether this will even work. The reason this time is so terrible is that there is no end in sight. We won't know how bad this crisis really is until we can see the light at the end of the tunnel."

"So what's next?" Metzger asked, pointing out that the news about other financial-service industry companies was less than optimistic. "Hopefully this is a once-in-a-lifetime occurrence. But if any of the predictions are correct, we're going to have to take time for our next class, too."

For Metzger, current events are often part of the lesson plan. Hedge funds rely on a deep understanding of finance, something he said is served well by encouraging debate, requiring students to take a stand on issues, and telling stories that underline and emphasize the larger points. "Stories often help students remember the lessons better," he said. And with the financial turmoil continuing, chances are good Metzger will need to tear up his lesson plan at least one more time.