It nearly collapsed in late If it had, that would have set off a global financial crisis. LTCM's success was thanks to the stellar reputation of its owners. The principal shareholders were Nobel Prize-winning economists Myron Scholes and Robert Merton.

These were all experts in investing in derivatives to make above-average returns and outperform the market. They were not allowed to take the money out for three years, or even ask about the types of investments LTCM used.

Despite these restrictions, investors clamored to invest. LTCM boasted spectacular annual returns of LTCM successfully hedged most of the risk from the Asian currency crisis. It gave its investors a But by September , the company's risky trades brought it close to bankruptcy. Its size meant it was too big to fail.

As a result, the Federal Reserve took steps to bail it out. Le Monde, LTCM, a Hedge Fund Above Suspicion , November Like many hedge funds , LTCM's investment strategies were based upon hedging against a predictable range of volatility in foreign currencies and bonds. When Russia declared it was devaluing its currency, it defaulted on its bonds.

That event was beyond the normal range that LTCM had estimated. Investors sought refuge in Treasury bonds , causing long-term interest rates to fall by more than a full point.

As a result, LTCM's highly leveraged investments started to crumble. In September, Bear Stearns dealt the final death blow. LTCM had been out of compliance with its banking agreements for three months.

The Independent, Bear Stearns Call Triggered LTCM Crisis , September 26, To save the U.

It reassured investors that the Fed would do whatever was needed to support the U. Without such direct intervention, the entire financial system was threatened with a collapse. IMF , World Economic Outlook, Interim Assessment, " Chapter III: Turbulence in Mature Financial Markets December ; IMF Report: International Contagion Effects from the Russian Crisis and the LTCM Near-Collapse , April A CATO Institute study says the Federal Reserve didn't need to rescue LTCM because it would not have failed.

Shareholders were not happy with the price. He would have replaced management.

But the Fed intervened and brokered a better deal for the LTCM shareholders and managers. That was the precedent for the Federal Reserve's bailout role during the financial crisis. Once financial firms realized that the Fed would bail them out, they became more willing to take risks. The Cleveland Federal Reserve countered by saying the Buffett deal was only for LTCM's assets, not its portfolio. That consisted of derivatives. Their failure would have damaged the global economy.

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Furthermore, the Fed technically didn't bail out LTCM. It used no federal funds. It merely brokered a better deal than the one Buffett was offering. Large banks throughout the world would have lost billions, forcing them to cut back on loans to save money to write down those losses. Small banks would have gone bankrupt. The Fed stepped in to soften the blow.

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The LTCM crisis was just an early warning symptom of the same disease that reoccurred with a vengeance in the global financial crisis. Federal Reserve of Cleveland, Some Lessons on the Rescue of Long-Term Capital Management, April Search the site GO.

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