1장
When Genius Falters: The Spectacular Rise and Fall of Long-Term Capital
In the late summer of 1998, the global financial system teetered on the brink of collapse due to the impending failure of a relatively obscure Connecticut hedge fund. Long-Term Capital Management, despite its modest public profile, had amassed positions worth over $1 trillion-a staggering sum that threatened to destabilize markets worldwide. What made this crisis particularly fascinating was the pedigree of those responsible: LTCM was run by John Meriwether, a legendary Wall Street trader, alongside two Nobel Prize-winning economists and a team of mathematical geniuses who believed they had conquered financial risk through sophisticated models. Warren Buffett reportedly called the fund "a bunch of very smart people working with other people's money." The book became an instant Wall Street classic, frequently cited in business schools and by financial professionals as the definitive case study on the dangers of excessive leverage and overconfidence. Even today, "When Genius Failed" remains required reading at top MBA programs and has influenced an entire generation of risk managers who learned from LTCM's catastrophic mistakes.
2장
The Arbitrage Visionary: John Meriwether's Trading Philosophy
John Meriwether's fundamental trading insight-ride your losses until they turn into gains-was forged during his time at Salomon Brothers. This philosophy crystallized in 1979 when securities dealer J.F. Eckstein approached Salomon on the verge of bankruptcy. Eckstein had been practicing classic arbitrage with Treasury bill futures: buying futures contracts trading at a discount to actual bills, then selling the bills and waiting for prices to converge. The beauty of this approach, which would later become LTCM's core strategy, was its theoretical market neutrality. It didn't matter whether prices rose or fell-all that mattered was how two related securities moved relative to each other.
When Eckstein's trades went catastrophically wrong, Meriwether convinced Salomon to take over his positions despite significant risk. Though initially losing money, the prices eventually converged exactly as Meriwether had predicted, earning Salomon substantial profits and cementing his arbitrage group's reputation for brilliance.
At Salomon, Meriwether cultivated an insular culture that bred both exceptional results and resentment from colleagues. His secretive team, particularly the brilliant but demanding Larry Hilibrand, increasingly threw their weight around, demanding special compensation arrangements and questioning other departments' value. Their clannishness created an "us-against-them" mentality that would later isolate Long-Term from potential allies on Wall Street when they needed them most.
The team's exceptional performance led Meriwether to secure a special compensation formula giving his arbitrageurs 15% of profits, resulting in Hilibrand earning an unprecedented $23 million in a single year. This arrangement infuriated other traders, particularly Paul Mozer, who later submitted false bids to the U.S. Treasury in a desperate attempt to boost his own performance. When Mozer confessed to Meriwether, J.M. reported it to CEO Gutfreund, but their delayed response ultimately forced both executives to resign in disgrace.
After the scandal, Meriwether rejected a diminished role at Salomon and instead began planning his own hedge fund, preparing to raid the very Arbitrage Group he had built-a decision that would set in motion one of the most spectacular rises and falls in financial history.
3장
The Birth of a Hedge Fund Colossus
By the early 1990s, hedge funds had become status symbols among the wealthy elite. For those who summered in the Hamptons and decorated with Warhols, investing in a hedge fund signified membership among Wall Street's smartest and savviest. Paradoxically, the princely fees enhanced their allure-who but the exceptionally talented could command such prices?
Meriwether designed Long-Term Capital Management to focus on "relative value" trades in bond markets-buying some bonds while selling others, betting on spreads between pairs to widen or contract. This approach was theoretically low-risk since related securities usually rise and fall together. The key difference was leverage: LTCM planned from the start to leverage its capital twenty to thirty times or more, multiplying both potential returns and risks.
In early 1993, Meriwether approached Merrill Lynch to raise an ambitious $2.5 billion-far beyond typical hedge fund launches. His terms were equally bold: 25% of profits plus 2% on assets annually (exceeding the standard 20% and 1%), with investors locked in for an unprecedented three years. Despite lacking a formal track record and carrying the taint of the Mozer affair, Meriwether began reassembling his Salomon team, starting with Eric Rosenfeld, followed by Victor Haghani and Greg Hawkins.
To add academic credibility, Meriwether recruited Harvard's Robert C. Merton, the leading scholar in finance who had revolutionized the field with his "continuous time finance" models, and Myron Scholes, co-creator of the Black-Scholes options pricing formula. With these two Nobel-caliber academics, LTCM gained extraordinary mystique. Merton saw LTCM not as a mere hedge fund but as a sophisticated financial intermediary providing liquidity to markets, similar to how banks operate.
The fund's capital-raising efforts began awkwardly. During a global roadshow spanning dozens of cities, the partners proved poor salespeople. Meriwether remained reserved, Rosenfeld seemed nearly comatose to one investor, and Hawkins lost audiences with academic jargon. Many potential investors balked at the high fees, secretive strategies, and planned leverage.
Scholes emerged as the fund's best salesman, using vivid metaphors about "vacuuming nickels" others couldn't see. The partners gradually gained momentum by touting their Salomon track record ($500 million annually during Meriwether's last five years) and promising 30% returns with diversified risk.
Their most stunning recruitment was David Mullins, Federal Reserve vice chairman and second only to Greenspan, giving them unparalleled credibility and access to international financial institutions. With Mullins aboard, they secured investments from central banks and government entities worldwide, including the Bank of Italy, Hong Kong Land & Development Authority, and Singapore Investment Corporation.
By February 1994, Long-Term Capital opened with $1.25 billion-short of Meriwether's goal but still the largest hedge fund launch ever. The timing proved perfect, as market turbulence would soon create the precise conditions they needed to thrive.
4장
Masters of Leverage: The LTCM Advantage
Long-Term's competitive edge came from their refusal to pay standard "haircuts"-the small margin requirements that normally limit leverage. From the start, they insisted they were so well-heeled they didn't need to post initial margin, and wouldn't trade with anyone who disagreed. Most banks acquiesced; those who balked, like PaineWebber, got virtually none of their business. "You had no choice if you were going to do business with them," admitted Goldman's Jon Corzine.
The fund secured longer-term financing than competitors received, giving them more patience in their trades. This was where Meriwether's marketing strategy paid dividends-banks saw not a credit-hungry startup but a luminous firm of celebrated scholars with supposedly fail-safe technology. They rationalized easy credit terms because Long-Term settled daily and appeared flush with capital. Only a scenario of sudden, catastrophic losses would threaten their collateral.
Long-Term divided its business among banks strategically, using Goldman for junk bonds, J.P. Morgan for government bonds and yen swaps, and Lehman for mortgages. While this matched expertise to trades, it prevented deeper relationships. J.P. Morgan was eager to develop a closer alliance but couldn't get past the fund's secrecy. The partners approached every interaction as a discrete transaction with tallied pluses and minuses-every relationship was just another "trade," revocable if someone offered better terms.
The partners themselves were a bred type-intellectual, introverted, detached, controlled. They operated with uncanny closeness, as if sharing one mind. A small inner circle-J.M., Hilibrand, Rosenfeld, and Haghani-dominated the firm, controlling votes and taking more than half the rewards. Lesser partners like Scholes constantly angled for more money and authority.
Larry Hilibrand embodied the firm's essence-cool, self-confident, and untroubled by doubt. He followed models religiously, seeing issues in black and white. Though trustworthy, he was blind to concerns outside his narrow sphere. Money meant less to him than the intellectual challenge of trading.
Meriwether maintained a mysterious hold over the group despite his bashful demeanor. He spoke in fragments, avoided eye contact, and fiercely protected his privacy from his $2.7 million Westchester estate. At meetings, he welcomed debate but rarely spoke until the end, if at all.
Long-Term specialized in finding tiny price discrepancies they could exploit with massive leverage. Their first major success came with on-the-run/off-the-run bond trades that netted $15 million without using capital. They preferred reaping sure nickels to gambling on uncertain dollars, multiplying small margins thousands of times through extraordinary leverage.
5장
The Mathematical Illusion: Risk Management at LTCM
In 1994, Long-Term's first year, the fund earned a phenomenal 28 percent (20 percent after fees) while most bond investors lost money. Though Meriwether warned investors not to expect a repeat and acknowledged potential losses, his letter went much further-it calculated precise mathematical odds of losses occurring. Merton and Scholes specified that Long-Term would lose at least 5 percent of its money in twelve of every hundred years, with additional precise probabilities for larger losses. This precision revealed Long-Term's philosophical approach: they viewed money management not as an art requiring judgment but as a quantifiable science.
Long-Term's approach to risk was fundamentally different from most investors'. Their portfolio resembled a hat full of thousands of pairs of numbers representing volatility and expected return for each trade, with the partners constantly "tuning the mix" based on correlations between different positions. Rather than targeting specific returns, they engineered their portfolio to fluctuate about as much as the stock market. If too quiet, they'd increase leverage; if too volatile, they'd reduce it.
The Black-Scholes formula, central to Long-Term's approach, treated market movements as random events following a bell curve distribution, similar to physical phenomena like molecules spreading through coffee. The formula made a critical assumption: that volatility was constant and predictable based on historical patterns. Merton extended this by assuming "continuous time" markets where prices would never jump but flow smoothly through every increment. This perfect-arbitrage assumption underpinned Long-Term's hedging strategies.
Several experts questioned the model's real-world application. Paul Samuelson, Merton's mentor, recognized that "continuous time" was merely ideal; in reality, traders took time to react and markets sometimes gapped. Eugene Fama, Scholes's thesis adviser, had discovered that stock prices showed far more extreme movements than a normal distribution would predict. While a five-standard-deviation event should occur once every 7,000 years in a normal distribution, Fama found they happened every three to four years. Financial assets displayed "fat tails"-higher probabilities of extreme events than models predicted.
Financial markets run to extremes more often than coin flips because they have memories. Unlike random events where each flip is independent, market trends can continue because traders expect them to. After three bad "flips," some traders may be forced to sell while others panic, creating momentum that defies randomness. The human element that causes these runs was entirely absent from Merton's idealized markets.
For all its attention to risk, Long-Term had a serious flaw: unlike banks where independent risk managers oversee traders, the partners monitored themselves. Though trades required approval from the risk-management committee, persistent traders like Hilibrand and Haghani usually prevailed through sheer persistence. Meriwether's cardinal weakness was his failure to insert himself into debates-there was no one to play the role of watchdog as Gutfreund had at Salomon. The partners were their own nannies.
6장
Hubris and Expansion: The Road to Ruin
Long-Term Capital Management continued its eerily consistent performance, defying what seemed like natural market laws. By spring 1996, the fund controlled $140 billion in assets-thirty times its underlying capital-making it 2.5 times larger than Fidelity Magellan and bigger than Lehman Brothers and Morgan Stanley. Despite having only a couple dozen traders, this two-year-old fund rivaled Wall Street's oldest institutions in size and influence, though its massive leverage remained hidden from most observers.
While Wall Street banks later claimed ignorance about LTCM's massive leverage, they actually had access to the fund's quarterly disclosures. LTCM reported derivative bets on $650 billion in securities by end of 1995, though these disclosures were deliberately opaque. Banks competed fiercely to finance LTCM, with up to 55 banks extending credit at remarkably favorable terms-often LIBOR plus just 0.5% instead of the appropriate 2%. The fund expertly played banks against each other, extracting maximum advantage while giving minimal profits in return.
Meriwether cultivated close personal relationships with Merrill Lynch executives, particularly chairman Daniel Tully. Their bond extended to golf outings at J.M.'s Waterville course in Ireland, where annual competitions became prestigious events. Despite providing $6.5 billion in financing (equal to Merrill's total equity), Merrill earned a paltry $25 million yearly from LTCM.
By 1996, the partners had collectively amassed a $1.4 billion stake in the fund-nine times their initial $150 million investment. They treated the fund like a personal checking account, redeeming portions when needed for spending. Though not generally ostentatious, each partner had indulgences: Meriwether with his Ferrari and golf club memberships, Rosenfeld with his ten-thousand-bottle wine cellar, and Hilibrand building a $4 million mansion on a $2.1 million Greenwich property.
Long-Term earned an astounding 57 percent in 1996 (41 percent after fees) through leveraged spread trades on Japanese convertibles, junk bonds, interest rate swaps, and Italian bonds. Their total profits reached $2.1 billion-more than McDonald's, Merrill Lynch, Disney, or American Express earned that year. The fund achieved this with remarkably low volatility, never suffering a monthly loss exceeding 1 percent.
As money flooded into arbitrage, compressing spreads, Long-Term asked investors to stagger their withdrawal dates, providing protection against mass redemptions. Meriwether remained cautious in his investor letter, noting that 1996's returns "substantially exceeded expectations" and predicting that 1997 would likely be "materially below" current results, with a "potential for loss." The firm was finding it increasingly difficult to locate new trades fast enough to keep pace with its growing capital.
7장
Venturing Beyond: New Markets, New Risks
By the late 1990s, Long-Term's success had attracted numerous imitators, with almost every Wall Street investment bank establishing arbitrage desks. This competition was eroding the very spreads that had made Long-Term profitable. As Rosenfeld complained, "Everyone else was catching up to us. We'd go to put on a trade, but when we started to nibble, the opportunity would vanish." With traditional opportunities dwindling, Meriwether encouraged the firm to explore new territory, moving beyond their established expertise.
The partners began diversifying beyond public markets, exploring ventures where their mathematical prowess could be applied without facing copycats. Merton worked on a joint venture with Banca Nazionale del Lavoro to sell mutual funds to Italian retail investors. Meanwhile, the partners quietly began exploring an insurance operation. With over $5 billion in equity to deploy, Long-Term dramatically expanded into commercial mortgage-backed securities, transforming that market from $30 billion to $60 billion in new issues almost overnight.
Equities represented a far larger and more tantalizing frontier for Long-Term, despite being traditionally avoided by mathematically-oriented traders. While bond pricing could be reduced to formulas, stock valuation remained subjective and emotional. Nevertheless, Long-Term boldly applied its models to equities, with Haghani researching European paired shares and Rosenfeld believing equity arbitrage would be uncorrelated with bond arbitrage, providing diversification.
Haghani's most dramatic position was in Royal Dutch/Shell, where he bet $2.3 billion-half long on Shell Transport (England) and half short on Royal Dutch Petroleum (Netherlands). Though both companies derived income from the same source, Shell historically traded at an 8% discount. Haghani believed this spread would contract as Europe integrated. The position's size was unprecedented-ten times larger than Goldman Sachs' similar trade-and practically illiquid, creating enormous risk for a leveraged fund that might need to exit quickly.
On the American side, Hilibrand moved aggressively into merger arbitrage, betting that announced acquisitions would close. Unlike traditional risk arbitrageurs who selectively chose deals based on deep industry knowledge, Long-Term simply bought virtually every deal stock it deemed safe. This approach sparked fierce internal debate, with Scholes and Merton arguing the firm had no expertise in this specialized field. Veterans quickly realized that an indiscriminate buyer had entered their market, as Long-Term's massive positions squeezed spreads across the board.
Long-Term circumvented the Federal Reserve's Regulation T, which limited stock margin loans to 50% of investment value, by using derivative contracts rather than buying actual securities. Through swap agreements with banks like Swiss Bank, Long-Term could make side bets on stock movements with no money down and without regulatory disclosures. This perfectly legal maneuver allowed Long-Term to build massive equity positions with extreme leverage, while the banks typically hedged by purchasing the underlying stocks themselves.
By mid-1997, Long-Term faced diminishing returns. At their Toronto airport annual meeting, the partners admitted concern about shrinking bond arbitrage spreads. Meanwhile, finance professors Shleifer and Vishny published a prescient paper warning that arbitrage firms like Long-Term could be overwhelmed if "noise traders" pushed prices from true value, forcing liquidations at market lows. Merton dismissed this possibility, convinced markets could never be overwhelmed.
8장
The Storm Gathers: Warning Signs Ignored
In early 1998, Long-Term Capital became known as the "Central Bank of Volatility" due to their massive short positions on equity volatility. The partners fundamentally believed markets would become more rational and less volatile over time-that investors would eventually behave more like themselves. This philosophy permeated all their trades, with Rosenfeld noting, "We've always had that belief." Their approach reflected the academic mindset that Andrew Hall, a former Salomon trader, described: "The MIT types always want to short volatility. Academics have embedded in their minds the Black-Scholes models that assume normal distributions. They think these models are the Holy Grail."
As pressure mounted to find profitable trades, Long-Term increasingly strayed into exotic markets like Brazilian and Russian bonds and Danish mortgages. They abandoned their cautious hedging strategy for more directional bets, despite Scholes' protests that they lacked "informational advantage" in markets like Norway. Victor Haghani dominated decision-making, pushing partners until he got his way, while Larry Hilibrand increasingly acted on impulse.
The weekly risk meetings became increasingly scripted, with predetermined outcomes despite heated debates. Scholes, Merton, Mullins and McEntee raised concerns about position sizes, especially after experiencing difficulty exiting large trades, but none threatened to quit-the one action that might have forced Meriwether and Rosenfeld to confront their top traders.
Wall Street remained oblivious to Long-Term's internal tensions, continuing to finance the fund on minimal margins. When Merrill Lynch's repo desk expressed concern about Long-Term's emerging market exposure, credit officer Robert McDonough dismissed them, saying, "We're in bed with these guys. If they go down, we go down!" This financial laxity pervaded Wall Street, with Russia touted as capitalism's next frontier.
The first hints of trouble appeared in spring 1998. As traders liquidated positions, volatility increased, forcing more liquidations in a dangerous cycle. By May, Russia became the speculators' next target despite central bank chairman Sergei Dubinin's insistence that "There will be no devaluation of the ruble." Interest rates tripled to halt capital flight. Meanwhile, in the U.S., the economy was slowing, causing Treasury yields to fall and spreads between Treasurys and other bonds to widen-the opposite of Long-Term's bet. The fund suffered its worst month ever, losing 6.7%.
By June, credit spreads widened in every market where Long-Term was active. This wasn't specific to any security but represented a general credit pullback-a pervasive sense that markets had been undercharging for risk. Investors fled to safety, paying premium prices for Treasury bonds.
Jim McEntee, the one partner who relied on intuition rather than computers, sensed the changing winds and repeatedly urged reducing risks, but was ignored as a "nonscientific, old-fashioned gambler." The partners' isolation in Connecticut had disconnected them from useful trading floor gossip.
Despite mounting losses, Long-Term maintained a facade of confidence. After a brief recovery in July, Meriwether told investors that "future expected returns are good." The fund continued hiring, adding eight new software developers and reaching a peak staff of 190.
9장
When Models Fail: The Collapse Begins
In just five weeks, Long-Term Capital would lose all of its $3.6 billion in capital, transforming from one of America's most esteemed investment funds into a financial catastrophe. The collapse began when Russia declared a debt moratorium on August 17, shattering investors' assumption that nuclear powers wouldn't default and that global financial authorities would always intervene. Without the expected IMF or G7 rescue, markets panicked as investors realized no emerging market was safe.
By Thursday after Russia's default, markets worldwide buckled-eastern European shares weakened, Venezuela's market plunged 9.5%, Brazil fell 6%, and even Germany dropped 2%. Investors fled all forms of risk, not just emerging markets. By Friday, August 21, Long-Term suffered catastrophic losses as swap spreads wildly oscillated over 20 points-an event their models considered practically impossible. Mortgage spreads, high-yield bonds, and even off-the-run Treasuries all moved dramatically against their positions.
Long-Term, which had calculated it was unlikely to lose more than $35 million on any single day, lost $553 million-15% of its capital-on that Friday in August alone. Since April, they'd lost over a third of their equity, dropping from $4.67 billion to $2.9 billion. The partners gathered on Sunday morning with legal counsel present, hearing from traders that there was simply no demand for Long-Term's positions despite their theoretical soundness. Their leverage had become dangerously high, but selling was nearly impossible without further moving markets against them.
Desperate for capital, the partners continued their frantic calls. With Bear Stearns pressuring them about clearing trades, they tried to pair offsetting positions at the same banks to reduce margin requirements. But with sixty thousand individual positions, this task was overwhelming. The partners' earlier secrecy had become a liability-they now had to plead with the very banks they had previously offended.
By August's end, Long-Term had lost $1.9 billion (45% of capital), leaving just $2.28 billion against $125 billion in assets-an untenable 55-to-1 leverage ratio. With markets effectively frozen, they couldn't reduce this exposure even as their positions continued deteriorating.
As September began, Long-Term's once-secret portfolio had become completely exposed. The "secrecy-obsessed hedge fund had become an open book," with rivals selling in anticipation of Long-Term's liquidation. Bear Stearns was increasingly uncomfortable clearing for the fund, especially as Shustak repeatedly underestimated losses due to rival banks marking down Long-Term's trades.
The partners desperately sought capital while hiding the severity of their situation from employees, who mockingly developed a "necktie index" to gauge the firm's troubles by how many partners wore ties. In early September, the partners made a dubious transaction, moving $38 million from the portfolio into LTCM to pay salaries through year-end.
By September 10, Long-Term's capital had fallen below $2 billion, and Bear Stearns threatened to stop clearing their trades unless they opened their books. Their last hope appeared to be Goldman Sachs and its chief Jon Corzine, whom Meriwether had long respected.
10장
The Federal Reserve Steps In: Preventing Systemic Collapse
Peter Fisher, who ran the Fed's trading desk overseeing a $450 billion government securities portfolio, had been monitoring hedge funds before Long-Term's crisis. When he visited Long-Term's offices that fateful Sunday, Hilibrand showed the officials Long-Term's secret "risk aggregator"-a document summarizing the fund's exposure across markets. Fisher studied it like a pathologist examining an X-ray, realizing the patient was critical.
The document revealed massive exposures across virtually every major market in the world. Fisher had an epiphany: Long-Term's seemingly diverse trades were actually correlated-"the same spread trade everywhere in the world." During crises, all correlations go to one. If Long-Term failed, its seventeen biggest counterparties would lose at least $2.8 billion, potentially $3-5 billion in the current frayed markets.
With Long-Term down to just $1.5 billion equity and only $470 million in free cash, the officials and partners devised a plan for banks to examine the portfolio Thursday and bid at an auction Sunday. But Long-Term was losing hundreds of millions daily and likely wouldn't survive until then.
By Monday, September 21, the situation deteriorated further. Swap spreads widened dramatically, Treasury spreads jumped to 19 points, and equity volatility spiked to an absurd 38%. Long-Term lost $553 million that day-a third of its remaining equity-leaving it with less than a billion dollars against $100+ billion in assets. Its leverage exceeded 100-to-1, meaning a mere 1% additional loss would wipe it out completely.
Fisher invited the chiefs of Merrill Lynch, Goldman Sachs, and J.P. Morgan to breakfast at the Fed Tuesday morning. The bankers arrived in grim moods-Merrill's stock had halved since July, Morgan was down 40%, and Goldman had suffered a $1.5 billion trading loss. By afternoon, Herb Allison of Merrill had drafted a consortium plan. Fisher agreed to convene an emergency meeting of Wall Street's top banks at the Fed that evening.
At 8:20 PM, an extraordinary gathering assembled-the cream of Wall Street's leadership, twenty-five middle-aged men from twelve banks squeezed into the Fed's boardroom under portraits of past governors. Fisher spoke briefly about avoiding a "chaotic liquidation" that would harm the system. Allison proposed each bank invest $250 million for a total of $4 billion.
Warren Buffett faxed an offer to buy Long-Term for just $250 million-a fund worth $4.7 billion at the start of the year. His terms were harsh: the partners would be wiped out and fired, with only an hour deadline to accept. For Meriwether, this was a bitter echo of his Salomon trauma-once again losing his company to Buffett. The partners studied the offer earnestly, but identified fatal flaws. Buffett's bid mistakenly targeted LTCM (the management company) rather than the portfolio, and failed to account for the complex Cayman Islands partnership structure.
The final terms: the banks would receive 90% of the fund's equity in exchange for their capital. Long-Term's existing investors would retain just 10%, worth about $400 million. The partners' share was completely wiped out by their debts-their $1.9 billion investment gone in just five weeks. The bankers had chosen a certain $300 million loss over an unknowable systemic risk, finally losing their appetite for gambling.
11장
Lessons Unlearned: The Legacy of Long-Term Capital
The consortium deal remained precarious through Sunday evening when Goldman threatened to quit unless Chase waived repayment of the $500 million bank syndicate loan. Despite further complications with holdout banks, by Monday evening the partners were ready to sign. Larry Hilibrand, in tears and initially refusing to sign what he saw as indentured servitude, finally relented after appeals from Meriwether and Allison, completing the takeover by fourteen banks.
The partners lost $1.9 billion personally, with Hilibrand losing nearly half a billion dollars and facing a $24 million debt. Most lost 90% of their wealth but remained far richer than ordinary Americans. The press showed no sympathy, dubbing them "The Brightest and the Brokest" while questioning the fairness of the Fed-assisted rescue.
Despite the rescue and the Fed's interest rate cuts, Long-Term continued plummeting, losing $750 million in the first two weeks after recapitalization. By mid-October, major Wall Street firms revealed their own large losses, having mimicked hedge fund strategies. Only after Greenspan cut rates a second time on October 15 did bond spreads narrow and Long-Term finally stop losing money after a devastating six-month period that had cost $5 billion.
The aftermath saw careers upended across Wall Street. Allison resigned from Merrill after learning he wouldn't succeed Komansky. Corzine continued pursuing Long-Term briefly before Goldman's IPO in May 1999, but was ousted in a boardroom coup. UBS was devastated by losses, forcing Cabiallavetta's resignation, while Bankers Trust sold to Deutsche Bank after catastrophic Russian losses.
Long-Term's investors had mixed fortunes. Those who invested at inception and were mostly cashed out in 1997 averaged 18% annual returns. Those who fully exited before 1998 did even better. However, "favored" investors allowed to keep more capital invested ultimately lost money. The fund's cumulative performance was devastating-a dollar invested had grown to $4.11 by April 1998, but shrank to 33 cents by the bailout.
Meriwether immediately planned a comeback, pestering the consortium to let them raise new money. In their narrative, they portrayed themselves as brilliant rationalists undone by an unreasoning market, denying their leverage or strategy were flawed. They blamed "liquidity shortages" and other traders' irrationality, comparing their situation to a "perfect storm" despite similar financial crises occurring regularly throughout history.
Ten years after LTCM's rescue, history repeated itself on a catastrophic scale: September 2008 saw the bailouts of Fannie Mae and Freddie Mac, Lehman's collapse, AIG's rescue by the Fed, emergency conversions of Goldman Sachs and Morgan Stanley to commercial banks, and government intervention in money markets and banks-all amid accelerating market panic. Once again, Wall Street CEOs gathered at the New York Fed to prevent systemic collapse.
The parallels between LTCM and the 2008 crisis are striking: excessive leverage, complex financial instruments beyond typical investor comprehension, and blind faith in computer models that looked backward rather than forward. Just as LTCM's models failed to predict they could lose $553 million in a single day (against a predicted maximum of $35 million), credit rating agencies never imagined housing prices could fall 30% when rating mortgage securities.
The 2008 crisis finally laid to rest the chimera of perfect markets and showed that risk models looking to past market behavior are fundamentally flawed. Markets remain inherently unstable due to their susceptibility to panic, particularly in credit markets where solvency can become a matter of whim. The lessons are clear: restrict casino-type credit markets and limit leverage, especially "hot money" funding, for systemically important institutions. Yet as history shows, these lessons seem destined to be learned and forgotten in an endless cycle of financial hubris and collapse.
