"Fear Of Wider Damage Fueled Long-Term Bailout"
Thursday September 24 6:19 PM EDT
Fear Of Wider Damage Fueled Long-Term Bailout
By Apu Sikri
NEW YORK (Reuters) - Long-Term Capital Management LP, plucked from the brink of collapse by a $3.5 billion
bailout, has a six-month reprieve, but with $80 billion in investments, its survival is not certain and the fallout from its
failure could be vast.
''This could start to have a domino effect on U.S. institutions and abroad. There is a real, systemic risk. The Federal
Reserve is clearly worried, that is why they got involved,'' Tanya Azarchs, a director at Standard & Poor's Ratings
Group, said.
At least 15 of the world's largest financial institutions put up capital to give breathing space to the 6-year-old Greenwich,
Conn.-based hedge fund at the behest of the Federal Reserve Bank of New York, which hosted the meeting of bankers.
The equity infusion gives banks a 90 percent stake in the fund, run by John Meriwether, former vice chairman and bond
trading chief at Salomon Brothers Inc.
''It is a watershed event. The Fed is pressuring commercial and investment banks to bail out a hedge fund because of
concern about a financial market meltdown,'' said Joan Solotar, securities analyst at Donaldson, Lufkin & Jenrette
Securities Corp.
Bankers said this will give other financial institutions time to examine their exposure to Long-Term Capital and work out
amicable arrangements to settle contracts.
Many of the investments held by the free-wheeling hedge fund are in derivatives, complex financial contracts that cannot
be easily bought or sold in the market.
''This will take quite some time to work out, at least six months to a year,'' a banker involved with the negotiations said. A
group of banks will oversee the sale and reorganization of the fund's investments.
Analysts said the impact of Long-Term Capital's problems will vary among banks. Union Bank of Switzerland , a unit of
UBS AG, said Thursday it has already recorded a loss of $685 million from its direct stake in Long-Term Capital.
Other banks could face losses from loans to the hedge fund, which are often secured by collateral, usually bonds or other
securities.
''Most exposure that securities firms have to hedge funds is secured, but the quality of collateral is going to vary from firm
to firm,'' said John Otis, a banking analyst at Bear Stearns & Co. ''Firms that have strict management of collateral
situations will come out okay. Those that are not diligent may have problems.''
As bankers rummage through the rubble, calls are growing for regulation of hedge funds, which have invested billions with
borrowed money.
''Maybe we need regulation of these institutions, otherwise we end up bailing them out,'' said Isaac Lustgarten, a partner
at the law firm of Schulte, Roth and Zabel LLP and a bank regulatory lawyer.
Hedge funds are exempt from regulatory requirements generally imposed on financial institutions by the Securities &
Exchange Commission, which regulates broker-dealers. They are also exempt from oversight of bank regulators such as
the New York Fed.
Top government officials downplayed the threat of a wider risk to the financial system from the near-collapse of
Long-Term Capital.
''I don't know if anything in that area that rises to the level of a systemic risk at this time,'' Treasury Secretary Robert
Rubin said.
U.S. banks and brokers that lined up to provide equity to Long-Term Capital included Merrill Lynch and Co. , Morgan
Stanley Dean Witter & Co. , Travelers Group Inc. , Goldman Sachs, J.P. Morgan & Co. Inc. , Bankers Trust Corp. and
Chase Manhattan Corp., each of which provided $300 million in capital.
Foreign banks included Deutsche Bank AG, CS Group , Union Bank of Switzerland and Barclays Plc .
Among banks that provided $100 million each were Lehman Bros. Holdings Inc. , Paribas and Societe Generale ,
according to sources.
Long-Term Capital, a hedge fund that boasts Nobel laureates Myron Scholes and Robert Merton among its partners,
suffered huge losses from bad bets on a variety of global markets that got hit during the recent flight to quality after Russia
defaulted on its domestic debt more than a month ago.
Bankers said the timing and pace of an orderly reworking of Long-Term Capital's investments will depend on how quickly
the financial environment improves.
The hedge fund's capital, nearly $5 billion at the start of the year, stood at a mere $600 million before the bailout by
banks, said people familiar with the situation.
''Right now, many countries and many markets are facing a liquidity crunch,'' S&P's Azarchs said.
Long-Term Capital chief Meriwether said the hedge fund he founded after leaving Salomon Brothers in 1991 ''greatly
appreciates the willingness of the consortium to provide capital which we are confident will stabilize our funds and enable
us to continue to be active in the market place.''
(http://dailynews.yahoo.com/headlines/bs/story.html?s=v/nm/19980924/bs/longterm_2.html) |
