Here Is The Washington Post Full Article.
You were dead on Ole 49r!Guess they should get the " door prize " instead of the " Nobel Prize " eh?We/you have been questioning these strategies for some time here with apprehension and at times disgust.Let's see how this all unfolds now......................
Wall St. Struggles to Save Big Fund
By Steven Mufson and John M. Berry
Washington Post Staff Writers
Thursday, September 24, 1998; Page A1
A huge private investment fund run by Wall Street legend
John Meriwether and two Nobel Prize-winning economists
teetered on the verge of collapse yesterday as losses mounted
on more than $100 billion of bets it made in financial markets
around the world.
In an attempt to avoid a new bout of global market turmoil
that might be caused by a fire sale of the fund's assets, chief
executives and other top officials from two dozen of the
world's largest banks and brokerage firms spent six hours
hammering out a preliminary agreement yesterday at the New
York Federal Reserve Bank to provide a rescue plan of more
than $3.5 billion for the Greenwich, Conn.-based fund, called
Long-Term Capital Management L.P.
The money is not a bailout of the firm's investors but rather a
takeover of the firm by its creditors, who are attempting to
buy time so they can recover some of its losses.
The negotiations at the New York Fed underscored the
seriousness with which regulators regard the turmoil
surrounding Long-Term Capital. The fund, like many similar
"hedge funds" on Wall Street, used a complex,
computer-based strategy to invest in bonds and currencies
from around the globe - and officials fear that its demise
could reverberate well beyond the narrow confines of Wall
Street. Traders said banks already are tightening credit in
response to the crisis, a credit crunch that eventually could
affect loans to individuals and small businesses.
The high-level negotiations are likely to cast further attention
on the largely unregulated business of hedge funds, which use
borrowed money to wager on the direction of financial
markets. Their web of international transactions has played a
key role in linking financial crises in one part of the globe to
seemingly unrelated markets elsewhere.
A source close to the negotiations described hedge funds as
"the connectors of the global economy." The leaders of many
developing countries, such as Malaysia, have placed the
blame for a regional economic collapse at the feet of hedge
fund managers.
Long-Term Capital has trading contracts based on securities
worth nearly $1 trillion, an investment banker close to the
talks estimated, and its agreements involve institutions
scattered all over the world. The fund's arcane series of
transactions linked its fortunes to securities ranging from
Russian treasury bonds to Danish mortgages, from the British
pound's value against the U.S. dollar to the volatility of the
American stock exchanges.
In a statement last night, Long-Term Capital said it believed
the infusion of new funds would provide enough breathing
room for the company to manage its investments and if the
markets cooperate, recover some of its losses. The deal came
with a price, however. The consortium of banks lending the
money will now own 90 percent of the firm and appoint an
oversight committee that will direct its overall strategy and
make sure it reduces its exposure to markets.
The committee will consist of representatives from Goldman
Sachs & Co., Merrill Lynch & Co., Morgan Stanley Dean
Witter, Travelers Group Inc. and UBS Securities Inc. - firms
with some of the largest exposures to Long-Term Capital's
troubles.
Long-Term Capital had an enviable track record before this
year, but a series of miscalculations combined with unusual
international economic upheavals have hammered the fund's
performance. Earlier this month, Long-Term Capital said it
had lost $2.5 billion, or 52 percent of its net assets, in trading
so far this year, most of it in less than two months - and the
losses are said to have climbed even further this month.
The fund's swift decline was propelled in part by its strategy
of borrowing heavily to finance large market bets. The heavy
borrowing, or high leverage, meant that once the fund
suffered losses, it was forced to sell some of its other holdings
to meet margin calls from creditors concerned that the fund's
collateral was no longer sufficient to meet minimum loan
requirements. Being forced to sell while markets were in
turmoil only compounded the fund's losses - and added to
turmoil both in emerging markets and in the United States,
where it was easier to unload investments such as Treasury
bonds.
"When positions move away from them, the value of the
collateral shrinks and so they owe more collateral. To get the
collateral, they have to sell something else," said one source.
Long-Term Capital's troubles have been compounded by the
difficulty of untangling such large positions in a short time.
"Once the Street knows you're a wounded animal or cornered
bear, you're not going to get a good price," said Steven
Lonsdorf, president of Van Hedge Fund Advisors.
Hedge fund sources said that in late August, Long-Term
Capital asked the Quantum Fund, run by hedge fund titan
George Soros, for an injection of half a billion dollars in new
capital, but that Quantum declined.
But the investment firms and banks that did business with
Long-Term Capital had more at stake. "The alternative they
all have is if Long-Term goes bankrupt, a lot of banks can
lose," said an official of one major bank involved in the talks.
The financial institutions could be vulnerable because of
credit lines extended to Long-Term Capital, or because they
are on the other side of market bets the firm placed.
The major banks and investment houses do not want a forced
liquidation of Long-Term Capital's positions. Indeed, many
are willing to sit with the positions and wait for them to
recover. The banks are trying to avoid fire sales of assets that
could pull down prices in stock, bond and currency markets
worldwide, but one source said there may be sales that would
cause problems in particular markets - such as, say, Danish
mortgages - that are small and illiquid.
"It's easier to close out some positions than others," a source
said.
Prior to this year, Long-Term Capital had nearly tripled the
money of its investors. Meriwether, formerly the head of
bond trading at Salomon Brothers Inc., teamed up with Nobel
laureates Robert C. Merton of Harvard University and Myron
S. Scholes of Stanford University to use mathematical
formulas to arbitrage, or take advantage of differences in the
values of securities between different markets.
Long-Term Capital generally borrows money to buy
securities, pledging some or all of the value of the securities
as collateral for the loan. Then, Long-Term Capital creates
"derivatives" using those securities. Derivatives are financial
instruments whose value is tied to an underlying market
index, currency, stock, bond or commodity. As a hedge, they
can help companies protect themselves from unexpected
changes in such things as interest rates, foreign currency
fluctuations and swings in commodity prices.
But Long-Term Capital used them to place bets that went bad
when global markets started to lurch in directions, and
magnitudes, that defied the fund's statistical models.
Market sources said that some of the ways Long-Term
Capital lost money included: losses related to the Russian
bond market, the defaulting of ruble currency hedges by
Russian banks, an incorrect bet on Danish mortgages and
German bonds, a misguided bet that volatility in the American
markets would drop off, and a wrong bet on the value of the
British pound against the dollar. Stock and bond prices that
were supposed to converge, diverged instead and liquidity
dried up in many markets.
In a Sept. 3 letter to his shareholders, Meriwether said: "We
expected that sooner or later . . . we as a firm would be
tested. I did not anticipate, however, how severe the test
would be."
The losses struck a blow to the reputation of Meriwether,
who gained fame in the 1980s as a bold bond trader. In the
book "Liar's Poker," written by a former Salomon Brothers
bond trader, Meriwether was described as being dared by the
Salomon chairman to bet $1 million on a hand of poker using
serial numbers on a dollar bill. Meriwether reportedly offered
to make the bet $10 million, prompting the then-Salomon
chief to walk off in disbelief. |
