This presentation is about the collapse of LTCM. We studied how the collapse happened , strategies used by LTCM, the counter parties involved and who suffered the most. The project also gives some important lessons we learnt from this collapse.

1. LTCM
BAILOUT = $3.6BLOANS
LOANS
INVESTMENTS
Merton
Meriwether
Scholes
Mullins
Black
PRESSURE
PRESSURE
Bond trading experience
$1.25 billion up to $7B
down to $555M
Up to 40%
returns
Up to $1 trillion in derivatives

2. Agenda
• Introduction
• Strategies
• LTCM’s Success
• When Genius failed
• Counterparties
• Bailout-Fed’s Intervention
• Lessons Learnt
• Conclusion

3. Background

4. Key Members
• John Meriwether who founded Long Term
Capital Management 1993.
• Fixed Income Trader at Salomon Brothers.
• Two Nobel Laureates: Robert Merton and
Myron Scholes.
• Former Regulator David Mullins.
• Had huge respect in Wall Street more than
Average Dealer or Broker.

5. Strategies
• Convergence trading Strategy
• Fixed Income Arbitrage
• Leverage/ UBS Investments
• Merger Arbitrage/Risk Arbitrage
Cash Merger
Stock Merger

6. It was a Game
• It was unregulated.
• Free to operate in any market.
• No capital charges.
• Only few reporting to US Securities &
Exchange Commission (SEC).
• Interest rate swaps on market rate with no
initial margin.

7. Borrow From a bank
Buy Securities with that Cash
Borrow From another bank keeping
securities as collateral
This theory could leverage to
infinity

8. Background

9. LTCM’s Success

10. Background
.
• The hedge fund incorporated a Delaware limited
partnership LTCM L P,but the Fund, LTC Portfolio L
P, was a Cayman Islands entity.
• By 1997, the equity had risen to $7 billion, but by the
beginning of 1998 this had fallen to $4.8 billion ($2.7
billion or 36 percent of its capital having been
returned to investors in 1997.

11. Borrowings
• LTCM borrowed a further $124.5 billion,
giving a leverage ratio of 25:1,and the asset
base was four times that of the next largest
hedge fund.
• At that time, most hedge funds did not
borrow more than their equity, and it was rare
for the leverage ratio to exceed 10:1

12. Returns
For a few years LTCM offered investors spectacular returns after
hefty fees of 2 percent for administration plus an incentive fee of
25 percent.

13. A filing with the SEC for June 30 1998 showed
that LTCM had equity stakes in 77 companies,
worth $541 million. It also got into emerging
markets , including Russia.
Russia was "8% of its book" which would come
to $10 billion. Meriwether applied a formula
which brought in new investment During 1997,
under this formula.

14. • UBS put in $800 mn in the form of a loan and $266
mn in straight equity.
• Credit Suisse Financial Products put in a $100 mn
loan and $33 mn in equity.
• Other loans may have been secured in this way,
but they haven’t been made public.
• Investors in LTCM were pledged to keep in their
money for at least two years.
• LTCM entered 1998 with its capital reduced to $4.8
bn.

15. When Genius Failed

16. • In1997the fund’s assets had grown to about $120
billion and its capital to about $7.3 billion despite
that high leverage—an assets-to-equity ratio of
over 16 to 1
• The management concluded that the capital base
was too high to earn the rate of return on capital
for which they were aiming.
• They returned $2.7 billion of capital to
shareholders, reducing the capital to $4.8 billion
and increasing its leverage ratio to around 25 to 1.

17. FACTORS AGAINST LTCM
• The time-frame within which rates would converge
again
• Counterparties had lost confidence in themselves and
LTCM.
• Many counterparties had put on the same convergence
trades, some of them as disciples of LTCM.
• Some counterparties saw an opportunity to trade
against LTCM’s known or imagined positions ( taking
the o ppo site po sitio n).
• Most of LTCM’s bets had been variations on the same
theme, convergence between liquid treasuries and
more complex instruments that commanded a credit or
liquidity premium. Unfo rtunate ly co nve rg e nce turned

18. THE BIG TROUBLE
•Big trouble for LTCM started on:-
•July171998whe n Salo m o n Sm ith Barne y
anno unce d it was liq uidating its do llar inte re st
arbitrag e po sitio ns.
That month, the fund dropped about
10% because Salomon Brothers was
se lling all the thing s that Lo ng -Te rm
o wne d.

19. RUSSIA DEFAULTS
•ON Aug17, 1998 theRussiangovernment devaluedtheruble
anddeclaredamoratoriumonfuturedebt repayments of
$13.5billion.
•This lead to the large increases in the spreads between the
prices of Western government and emerging market bonds
and the fund had bet massively on those spreads’ narrowing.
•This resulted the decline of LTCM’s capital down to $2.3
billionat the end of August 1997 and the fund had lost over
half of theequitycapital it had had at the start of the year.
The Assets got reducedto$107billion from $ 120 billion so its
leverage ratio had climbed to over 45: 1which is a very high
ratio that to in a volatileenvironment.

20. •As its losses mounted, meeting margin calls became difficult
for the fund and needed more collateral to ensure that it could
meet its obligations to counterparties.
•The fund was running short of high-quality assets for
collateral to maintain its positions, and it also had great
difficulty liquidating its positions: many of its positions were
relatively illiquid even in normal times and hence still more
difficult to sell in the declining markets.
•By September19thefund’s capital was downto only$600
million.
•The fund had an asset base of $80 billion, and its leverage
ratio was approaching stratospheric.

21. SWAPS
• LTCM had done swapuponswapwith 36 different
counterparties.
• In many cases it had put on a new swap to reverse
a position rather than unwind the first swap, which
would have required a mark-to-market cash
payment in one direction or the other. (include or
not to include??)
• LTCM’s on balance sheet assets totalled around
$125 billion, on a capital base of $4 billion, a
le ve rag e o f abo ut 30 tim e s .
• But that leverage was increased tenfold by LTCM’s
off balance sheet business whose notional principal

23. 3/1994 1/1995 1/1996 1/1997 1/1998
$4.50
4.00
3.00
2.00
1.00
0.00
Gross value of $1 invested March 1994 - October 1998 in LTCM
When Genius Failed pp. xiv
Fall down Graph
80% loss over 5 weeksRussia
defaults

24. • US Fed hearing LTCM problem from
Wall Street banks.
• Bear stearns (clear house) wanted
$500 mn collateral to continue trade.

25. Counterparties
• 20 Counterparties
• Probable Loss of $3 bn.
• Looking for single buyer of the portfolio.
• AIG was looking to buy.
• LTCM’s capital base dwelled $600 mn.
• UBS $800 mn credit and $266 mn sent team to
study portfolio.
• Vice president Peter Fischer, JP Morgan,
Merrill Lynch, Goldman sachs and UBS.

27. Was LTCM a bailout?

28. Counterparties & Bail-out
• LTCM borrowed $470 mn from Chase
Manhattan Bank.
• Fed planned to chip $250 mn from 16 banks to
total LTCM’s capital $4 bn.
• Warren Buffet offered to Buy portfolio $250 mn
& Recapitalize it from:
 $3 bn from Berkshire Hathaway group
 $700 mn from AIG
 $300 mn from Goldman Sachs
Condition: John Meriwether and team will have no Management.

29. Bail-out
• Fed cannot bail-out as LTCM was in
Caynes Island.
• JP Morgan did not reply.
• Bear Stearns denied as it already had
lost from it.
• Lehman Brothers also denied.
• 13 banks left to bail-out at last.
• Meriwether left with 10% stake.

30. Bail-out Funds
Bank Amount
Contributed
Bankers Trust $300M
Barclays 300M
Chase 300M
CSFB 300M
Deutsche Bank 300M
Goldman Sachs 300M
Merrill Lynch 300M
JP Morgan 300M
Morgan Stanley 300M
Salomon 300M
UBS 300M
Société Générale 125M
Lehman Bros 100M
Paribas 100M
Bear Stearns $0. (Karma)
Total: $3.625B

31. The Losers
• LTCM partners: $1.1 bn
• Liechtenstein Global Trust: $30 mn
• Bank of Italy: $100 mn
• Credit Suisse: $55 mn
• UBS: $690 mn (Biggest Loser)
• Merrill Lynch (deferred employees payment): $22 mn
• Donald Marron, chairman, Paine Webber: $10 mn
• Sandy Well, co-ceo, Citigroup: $10 mn
• McKinsey executives: $10 mn
• Bear Stearns executives: $10 mn
• Dresdner Bank: $145 mn
• Sumitomo Bank: $100 mn
• Prudential Life Corp: $5.43 mn

32. Was LTCM successful
(as a bailout)?

33. After Story
• Mid 1998, LTCM making again profit of $400
mn.
• June 1999, 14% up of net fees of members.
• Meriwether looking for $4.7 bn fund redeem.
• July 1999, LTCM paid $300 mn to original
investors who had 9% stake.
• $1 bn to 14 consortium members.

34. Relevance to Current Crisis
• Investment strategies
• Market dynamics
• Moral hazards

35. Lessons
The account of collapse of LTCM made
us analyze and think of things which were
essential to be considered to make sure
such type of mistakes doesn’t happen the
next time.
They are

36. Risk Factor
Risk is basically anything affecting the efficient performance.
Transparency
It is basically to deal with relationship management and openness.
Trading Credit
Taking leverage to multiply the profits. Good ? To a certain level.
Frequent Market Analysis
A hedge fund should make frequent analysis about market conditions so as to
anticipate the worst case scenario since there are lots of risk factor involved in
it.
Regulations
There must be proper regulations to hedge funds as well . Though it is not
confined to retail investors it is still public money and something should have a
strict enforcement in using the same.

37. Risk types
•Liquidity Risk
Operational efficiency to meet the margin requirements,
budgeted planning etc.
•Market Risk
Market perceptions, factors driving the market, psychological
aspects on making a instrument liquid and illiquid etc.
•Credit Risk
Efficient formulation of credit policies and ensuring lesser
deviations, in such formed policies.
•Governance Risk
Corporate governance, responsibility and regulatory measures.
•Operational Risk
Maintaining secrecy of operational information, trying to avoid
small mistakes as it could lead to bigger problems.
•Reputational Risk
Maintaining the so earned reputation with good transparency
with clients, employees,shareholders, investors etc.

38. Reference List
• Shirreff, D (n.d.) “Lessons from the Collapse of
Hedge Fund, Long-term Capital Management”.
• Butler et al (2007) “Long Term Capital Management
case study” Cornell University, New York.
• Halstead, J,M et al (2005) “Hedge Fund Crisis and
Financial Contagion: Evidence from Long Term
Capital Management” pp.65-67.
• The Trillion Dollar Bet (2000) [Accessed from
www.youtube.com on 6’ November’ 2015].

39. LTCM
BAILOUT = $3.6BLOANS
LOANS
INVESTMENTS
Merton
Meriwether
Scholes
Mullins
Black
PRESSURE
PRESSURE
Bond trading experience
$1.25 billion up to $7B
down to $555M
Up to 40%
returns
Up to $1 trillion in derivatives