call to review the progress of the working groups. two of the working groups concluded that a “ lifting ” of the fixed income and equity positions was not feasible. the third group developed a consortium approach, which was deemed feasible. every one agreed that the consortium approach should be “ last ditch ”, and that parallel solutions should still be encouraged. the four firms met at the federal reserve at 7 : 00 p. m. a draft term sheet was reviewed which provided detail with respect to the consortium approach. the terms and conditions were debated, altered in some places, and ultimately refined so that the four firms could present it to a wider group. although federal reserve officials were present at the meeting, we did not participate in the discussion about terms and conditions. at about 8 : 30 p. m., a meeting of a wider group involving 13 firms began. meanwhile, some representatives of the core group called long - term capital to discuss the terms and conditions of the consortium approach. federal reserve officials did not participate in any conversations with long - term capital regarding the terms and conditions. in the meeting with the wider group, peter fisher explained the importance of avoiding a disorderly close - out of long - term capital ’ s positions. he also underscored the desirability of parallel efforts to resolve the problem. it was agreed that the group would reconvene at 10 : 00 a. m. the following morning. it was clear to everyone that time was of the essence. i returned to new york from london around midnight. during the early morning hours, i called various foreign central bank officials to inform them of the situation. at about 9 : 30 a. m. my colleagues and i met with the core group to review the status of the situation. a few minutes before the start of the scheduled 10 : 00 a. m. meeting, one of the core group firms told me that an investor group would make an offer to acquire the long - term portfolio. i called one of the representatives of the investor group to confirm this development. the offer was subsequently conveyed to long - term capital by that investor group and a response was requested by 12 : 30 p. m. after a brief consultation with the core group, i decided that the effort to proceed with the consortium approach needed to be suspended for a short time until the alternative offer could be considered. as noted earlier, the consortium approach was seen as a “ last resort ”. consequently, the meeting about the consortium approach was adjou

mr. mcdonough describes the role of the frbny in the events leading up to private - sector recapitalization of long - term capital management testimony by the president of the federal reserve bank of new york, mr. william j. mcdonough, before the committee on banking and financial services of the us house of representatives on 1 / 10 / 98. good morning mr. chairman and members of the committee. i am pleased to appear before you today to describe the federal reserve bank of new york ’ s role in the events leading up to the recent private - sector recapitalization of long - term capital management and its fund, long - term capital portfolio. i will cover four points. first, i will provide some background on long - term capital ’ s financial problems. second, i will explain our judgment that an abrupt and disorderly close - out of long - term capital ’ s positions would have posed unacceptable risks to the american economy. third, i will explain the limited role we played in facilitating the privatesector resolution to this private - sector problem. fourth, i will identify some of the issues that should concern us as we begin to understand the lessons of this experience. background long - term capital is an investment partnership that was started in 1994. it has many of the characteristics of a “ hedge fund ” in that it borrows money to leverage its capital and is only available to wealthy investors. the strategy of long - term capital was to use complex mathematical formulas to identify temporary price discrepancies between different interest rates. for example, the firm might notice that the yield on corporate bonds relative to treasury yields was higher than the range observed in recent years. if long - term capital believed the former relationship would reassert itself, it would buy corporate bonds and sell short treasury bonds. if the spread narrowed as expected, the firm would profit. if, however, the spread continued to widen, the firm would incur losses. this basic strategy and many complex variations was followed across many interest rate products in the us and many overseas markets as well. the firm was active both in traditional securities markets, and perhaps more importantly, in derivative product markets such as futures, swaps, and options. anticipating that some positions would move in their favor and some would move against them, the firm relied on diversification across a large number of product and geographic markets. long - term capital proved quite successful at this strategy, generating returns in excess of 40 percent in 1995