Editing Long-Term Capital Management (section)

== 1998 bailout ==
[[File:Federal-reserve-33-liberty.jpg|right|thumb|300px|The [[Federal Reserve Bank of New York]] (''pictured''), the site of a September 23, 1998, meeting to rescue LTCM; in attendance were representatives of [[Bankers Trust]], [[Bear Stearns]], [[Chase (bank)|Chase Manhattan]], [[Goldman Sachs]], [[J.P. Morgan & Co.|J.P. Morgan]], [[Lehman Brothers]], [[Merrill Lynch]], [[Morgan Stanley Dean Witter]], and [[Salomon Smith Barney]].]]
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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]], [[American International Group|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.<ref>{{Harvnb|Lowenstein|2000|pp=203–04}}</ref>

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.<ref>{{Cite book |last=Partnoy |first=Frank |title=Infectious Greed: How Deceit and Risk Corrupted the Financial Markets |publisher=Macmillan |year=2003 |isbn=978-0-8050-7510-6 |page=261 |author-link=Frank Partnoy}}</ref> The principal negotiator for LTCM was [[general counsel]] [[James G. Rickards]].<ref>Kathryn M. Welling, [http://www.docstoc.com/docs/27535620/Rickards-Interview "Threat Finance: Capital Markets Risk Complex and Supercritical, Says Jim Rickards"] {{Webarchive|url=https://web.archive.org/web/20161221225136/http://www.docstoc.com/docs/27535620/Rickards-Interview |date=2016-12-21 }} ''welling@weeden'' (February 25, 2010). Retrieved May 13, 2011</ref> The contributions from the various institutions were as follows:<ref>Wall Street Journal, 25 September 1998</ref><ref>{{Cite web |url=https://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=a2mbR8rPyzto |title=Bloomberg.com: Exclusive<!-- Bot generated title --> |website=[[Bloomberg News]] |access-date=2017-03-08 |archive-date=2007-09-30 |archive-url=https://web.archive.org/web/20070930012850/http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=a2mbR8rPyzto |url-status=live }}</ref>
* $300 million: [[Bankers Trust]], [[Barclays]], [[Chase Manhattan Bank|Chase]], [[Credit Suisse First Boston]], [[Deutsche Bank]], [[Goldman Sachs]], [[Merrill Lynch]], [[JPMorgan Chase|J.P.Morgan]], [[Morgan Stanley]], [[Salomon Smith Barney]], [[UBS AG|UBS]]
* $125 million: [[Société Générale]]
* $100 million: [[Paribas]] and [[Lehman Brothers]]<ref>{{Cite web|title=Lehman Says It's 'Solvent'|url=https://www.wsj.com/articles/SB907368542444447500|access-date=2020-10-31|website=Barron's|language=en-US}}</ref><ref>{{Harvnb|Lowenstein|2000}}</ref>
* [[Bear Stearns]] and [[Crédit Agricole]]<ref name="eml.berkeley.edu">http://eml.berkeley.edu/~webfac/craine/e137_f03/137lessons.pdf {{Webarchive|url=https://web.archive.org/web/20210304083802/https://eml.berkeley.edu/~webfac/craine/e137_f03/137lessons.pdf |date=2021-03-04 }} {{Bare URL PDF|date=March 2022}}</ref> 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.<ref>{{Harvnb|Lowenstein|2000|pp=207–08}}</ref>

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 [[virtuous circle and vicious circle|vicious cycle]].

The total losses were found to be $4.6 billion. The losses in the major investment categories were (ordered by magnitude):<ref name="Lowenstein 2000" />
* $1.6 bn in [[Swap (finance)|swaps]]
* $1.3 bn in equity [[Volatility (finance)|volatility]]
* $430 mn in Russia and other [[emerging markets]]
* $371 mn in directional trades in [[Developed country|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 [[High-yield debt|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 (see [[Greenspan put]]). 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.<ref>[http://www.gao.gov/archive/2000/gg00067r.pdf GAO/GGD-00-67R Questions Concerning LTCM and Our Responses] {{Webarchive|url=https://web.archive.org/web/20120419060858/http://www.gao.gov/archive/2000/gg00067r.pdf |date=2012-04-19 }} General Accounting Office, February 23, 2000</ref>

LTCM's strategies were compared to "picking up nickels in front of a bulldozer"<ref>{{Harvnb|Lowenstein|2000|p=102}}</ref> – a likely small gain balanced against a small chance of a large loss, like the payouts from selling an out-of-the-money naked call option. This contrasts with the market efficiency aphorism that there are no $100 bills lying on the street, as someone else has already picked them up.