LTCMS

FAILURE
Group Members
Aditya Jha (15113)
Ankit Pokharel (15121)
Sajal Shrestha (15132)
Story

John Meriwether, reputed fixed income trader at

Solomon brothers, founded a hedge fund called
Long Term Capital Management in 1993.

Meriwether hired a group of expert traders and

mathematicians which included two Nobel
laureates- Robert Merton and Myron Scholes, and
former regulator David Mullins.
The banks provide Interest Rate Swaps to LTCM at
market rate with no initial margin.
Initial Strategy of LTCM
Borrow From a Bank

Buy Securities
using those fund

Borrow from
another Bank
Keeping the same
securities as
collateral
This theory could leverage to infinity
Trading Strategies

Convergence Strategy
Long Position in the cheap securities and short
positions in rich securities.

Relative Value Arbitrage Strategy

Computer based models to find arbitrage
opportunities in the international market.
Exploiting deviations in market value from fair
value.
Returns

1996
1995 41%
43%
1994
20%
Timeline
Meriwether, head of fixed income trading at Salomon
Brothers, founded LTCM after being let go by Salomon in
1993 1991.

LTCM returned $2.7 billion to the investors to reduce its

positions relative to the market.
1997

UBS put $800 million in the form of a loan $266 million in

straight Equity
Credit Suisse Financial Product put in $ 100 million loan and
1997
$33 million in equity

Salomon Brothers was selling all the thing that Long Term
July 17, owned making the fund fall down by 10%.
1998
 Russia Default on its debt. It is also called Ruble
August Crisis
17, 1998

LTCM portfolio lost $ 550 million in a single day.

August
21, 1998

Meriwether sent a letter to his investors saying

that the fund had lost $2.5 billion or 52% of its
Sept 2, value that year, $2.1 billion in August alone.
1998 Its capital base had shrunk to $2.3 billion.

Meriwether is looking for fresh $ 1.5 billion

Septemb investment to carry the fund through.
er, 1998
 US FED started having concern about the serious
Septemb effect the deteriorating situation of Long-Term could
er 18, have on world markets.
1998

It was found that LTCM had done swaps upon swaps

with 30 different counterparties.
Septemb LTCMs on balance sheet assets totaled around $
er 20, 125 million but its off balance sheet business was
1998 around $ 1 trillion.

Warren Buffett offered to buy the LTCM portfolio for

$ 250 million and recapitalize it with $ 3 billion from
Sept , Berkshire Hathaway, $700 million from AIG and
1998 $300 million form Goldman.

Finally, 11 Banks came in together to bail out LTCM

by putting $ 300 million each.
Sep, Banks - 90% share, LTCM partners 10% share
1998
Swap

Swap
Margin Money
Russian Sovereign
Default
Flight to Liquidity
All the fixed income portfolio managers began
to shift their assets to more liquid assets in this
case US Government Bonds
LTCM had to liquidate a number of positions
due to panic caused among investors by
Ruble Crisis.

Domino Effect
FED as protector
Micro level risk analysis
Reason for Failure

Overconfidence
Banks credit
US Federal Reserve System
Information Asymmetry (Transparency)
Unregulated Market (Sloppy Market)
 Major Losers
LTCM Partners - $ 1.1 billion
UBS - $ 690 million
Dresdner Bank - $ 145 million
Bank of Italy - $ 100 million
Sumitomo Bank - $ 100 million
Credit Suisse - $ 55 million
Liechtenstein Global Trust - $ 30 million
Merrill Lynch - $ 22 million (employees deferred payment)
Bear Sterns Executives - $ 20 million
McKinsey Executives - $ 10 million
Sandy Weill - $ 10 million (Co-ceo, Citigroup)
Donald Marron - $ 10 million (Chairman, PaineWebber)
Prudent Life Corp - $ 5.43 million
Lessons Learned

Market Values Matter

According to LTCM short term fluctuation in
the market values does not matter- they would
converge to fair value over time

Liquidity risk is itself a factor

Models must be Stress Tested