page_title: Long-Term Capital Management
section_title: 1998 bailout
hierarchical_section_title: Long-Term Capital Management / 1998 bailout
caption_attribution_description: Federal Reserve Bank of NY, 33 Liberty Street
context_page_description: Long-Term Capital Management L.P. was a hedge fund based in Greenwich, Connecticut that used absolute return trading strategies combined with high financial leverage. LTCM was founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Members of LTCM's board of directors included Myron S. Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a "new method to determine the value of derivatives".
  Initially successful with annualized return of over 21% in its first year, 43% in the second year and 41% in the third year, in 1998 it lost $4.6 billion in less than four months due to a combination of high leverage and exposure to the 1997 Asian financial crisis and 1998 Russian financial crisis.
context_section_description: Long-Term Capital Management did business with nearly every important person on Wall Street. Indeed, much of LTCM's capital was composed of funds from the same financial professionals with whom it traded. As LTCM teetered, Wall Street feared that Long-Term's failure could cause a chain reaction in numerous markets, causing catastrophic losses throughout the financial system.
  After LTCM failed to raise more money on its own, it became clear it was running out of options. On September 23, 1998, Goldman Sachs, AIG, and Berkshire Hathaway offered then to buy out the fund's partners for $250 million, to inject $3.75 billion and to operate LTCM within Goldman's own trading division. The offer of $250 million was stunningly low to LTCM's partners because at the start of the year their firm had been worth $4.7 billion. Warren Buffett gave Meriwether less than one hour to accept the deal; the time lapsed before a deal could be worked out.
  Seeing no options left, the Federal Reserve Bank of New York organized a bailout of $3.625 billion by the major creditors to avoid a wider collapse in the financial markets. The principal negotiator for LTCM was general counsel James G. Rickards. The contributions from the various institutions were as follows:
  $300 million: Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, J.P.Morgan, Morgan Stanley, Salomon Smith Barney, UBS
  $125 million: Société Générale
  $100 million: Paribas
  Bear Stearns, Lehman Brothers and Crédit Agricole declined to participate.
  In return, the participating banks got a 90% share in the fund and a promise that a supervisory board would be established. LTCM's partners received a 10% stake, still worth about $400 million, but this money was completely consumed by their debts. The partners once had $1.9 billion of their own money invested in LTCM, all of which was wiped out.
  The fear was that there would be a chain reaction as the company liquidated its securities to cover its debt, leading to a drop in prices, which would force other companies to liquidate their own debt in a vicious cycle.
  The total losses were found to be $4.6 billion. The losses in the major investment categories were (ordered by magnitude):
  $1.6 bn in swaps
  $1.3 bn in equity volatility
  $430 mn in Russia and other emerging markets
  $371 mn in directional trades in developed countries
  $286 mn in Dual-listed company pairs (such as VW, Shell)
  $215 mn in yield curve arbitrage
  $203 mn in S&P 500 stocks
  $100 mn in junk bond arbitrage
  no substantial losses in merger arbitrage
  Long-Term Capital was audited by Price Waterhouse LLP. After the bailout by the other investors, the panic abated, and the positions formerly held by LTCM were eventually liquidated at a small profit to the rescuers. Although termed a bailout, the transaction effectively amounted to an orderly liquidation of the positions held by LTCM with creditor involvement and supervision by the Federal Reserve Bank. No public money was injected or directly at risk, and the companies involved in providing support to LTCM were also those that stood to lose from its failure. The creditors themselves did not lose money from being involved in the transaction.
  Some industry officials said that Federal Reserve Bank of New York involvement in the rescue, however benign, would encourage large financial institutions to assume more risk, in the belief that the Federal Reserve would intervene on their behalf in the event of trouble. Federal Reserve Bank of New York actions raised concerns among some market observers that it could create moral hazard since even though the Fed had not directly injected capital, its use of moral suasion to encourage creditor involvement emphasized its interest in supporting the financial system .
  LTCM's strategies were compared (a contrast with the market efficiency aphorism that there are no $100 bills lying on the street, as someone else has already picked them up) to "picking up nickels in front of a bulldozer"—a likely small gain balanced against a small chance of a large loss,
caption: On September 23, 1998, the chiefs of some of the largest investment firms of Wall Street—Bankers Trust, Bear Stearns, Chase Manhattan, Goldman Sachs, J.P. Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley Dean Witter, and Salomon Smith Barney—met on the 10th floor conference room of the Federal Reserve Bank of New York (pictured) to rescue LTCM.
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