John W. Meriwether,
the founder of Long-Term Capital Management,
shown in 1998.
New York Times
A FINANCIAL firm borrows billions of dollars to make big bets on esoteric securities. Markets turn and the bets go sour. Overnight, the firm loses most of its money, and Wall Street suddenly shuns it. Fearing that its collapse could set off a full-scale market meltdown, the government intervenes and encourages private interests to bail it out.
The firm isn’t Bear Stearns — it was Long-Term Capital Management, the hedge fund based in Greenwich, Conn., and the rescue occurred 10 years ago this month.
The Long-Term Capital fiasco momentarily shocked Wall Street out of its complacent trust in financial models, and was replete with lessons, for Washington as well as for Wall Street. But the lessons were ignored, and in this decade, the mistakes were repeated with far more harmful consequences. Instead of learning from the past, Wall Street has re-enacted it in larger form, in the mortgage debacle cum credit crisis....
....Regulators, too, have seemed to replay the past without gaining from the experience. What of the warning that obscure derivatives needed to be better regulated and understood? What of the evident risk that intervention from Washington would foster yet more speculative behavior — and possibly lead to a string of bailouts?
Indeed, through the lens of today’s more widespread failure, the Long-Term Capital collapse looks like a small dress rehearsal. But at the time, it sent tremors of fear through the corridors of Wall Street, along the electronic byways of finance and around the globe. Somehow, a geeky band of bond traders was able to throw the financial world off kilter.
In its first four years, Long-Term Capital achieved phenomenal profits with virtually no downside. Thanks to its seemingly flawless computer models, as well as its formidable arbitrageurs — including two Nobel laureates and a former vice chairman of the Federal Reserve — it quadrupled its capital without having a single losing quarter.
BUT in the summer of ’98, its fortunes took a frightful downturn. With terrifying suddenness, bond markets turned skittish and all the fund’s gambits ran into trouble.....
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Long-Term Capital Management’s offices in Greenwich, Conn., in 1998. A group of banks bailed out the fund after it lost billions...
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