LTCM & john meriwether
london financial times.
26.september98.
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LTCM had built up exposure of $200bn
By Richard Waters and Will Lewis in New York, Samer Iskandar in Paris and Tony Barber in Frankfurt
Long-Term Capital Management built a total market exposure earlier this year of approximately $200bn, prompting the bail-out of the US hedge fund this week by leading financial institutions to avoid the market chaos its liquidation might have caused.
According to people close to the hedge fund, it still has a total on and off balance sheet exposure of approximately $100bn.
While those on and off balance figures are described as "crude numbers" by people close to the firm, the extent of the hedge fund's previous and current leverage is far more than has previously been recognised.
Once the $3.5bn capital injection from leading financial institutions - expected this weekend - takes place, Long-Term Capital will have equity of approximately $4.5bn. This means it will still remain approximately 20 times leveraged.
Previous estimates of the extent of the hedge fund's exposure have varied between $40bn to $100bn.
On Friday in its first official statement, the consortium of financial institutions that has put together the rescue said that over the next three years it would aim "to reduce excessive risk exposures and leverage, return capital to the participants and to realise the potential value of the portfolio".
It added that "the consortium believes that this recapitalisation will help prevent disruption in global financial markets". The consortium will gain a 90 per cent ownership stake.
Yesterday another shock wave from the bail-out hit stock markets, as banks on both sides of the Atlantic registered the impact from the near-collapse.
The $3.5bn bail-out also threatened to create a political storm in Washington, with leading figures in Congress preparing to call hearings next week into how the stability of the entire New York financial system could have come to rest on a single, highly risky investment fund.
US and European banks that dealt with Long-Term Capital, as well as people close to the fund itself, said that the scale of its exposures overstated the potential losses from a collapse.
Fears about the potential damage to the banking industry from Long-Term Capital - and future hedge fund losses - affected stock markets in Europe.
In Paris, panic selling of French bank shares caused trading in Paribas to be suspended three times after hitting daily fluctuation limits. The sell-off in France was apparently prompted by reports that Paribas and Société Générale were contributing $100m and $125m respectively to the $3.5bn rescue.
Shares in Deutsche Bank, meanwhile, briefly touched their lowest point of the year yesterday at DM90.20 after the bank, Germany's biggest, had agreed to put up $300m for the bail-out.
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HEDGE FUNDS: Stormy weather
Tracy Corrigan profiles US investor John Meriwether, whose hedge fund's near-collapse became a moment of truth for Wall Street this week
John Meriwether, who has been a legend on Wall Street for more than a decade, stepped onto the world stage this week - though not, presumably, in a role he would have wanted for himself. When Long-Term Capital Management, his hedge fund, looked in danger of collapse, 15 big financial institutions corralled by the Federal Reserve Bank of New York came to its, and his, rescue. It was as if one of Wall Street's grandest companies was on the rocks.
That Long-Term Capital, with an original capital base of less than $5bn, was allowed to accumulate an estimated total exposure of $200bn, big enough to threaten the stability of the world's financial markets, is a measure - and perhaps an indictment - of Wall Street's reverence for Mr Meriwether's risk-taking reputation and ability. At least for a while, investment banks will now rein in lending to hedge funds, even those taking less risk than Long-Term Capital.
Raised on the South Side of Chicago, the Irish-American joined Salomon Brothers, the US investment bank, in 1974 after a stint as a local school teacher followed by an Master of Business Administration at the University of Chicago. As he rose to head bond trading operations at Salomon, the top bond house of the 1980s, he gathered around him a group of traders with PhDs in maths and physics who revolutionised trading on Wall Street with a highly technical approach to risk-taking in financial markets.
Their tactics sometimes lost money, but more often earned hundreds of millions of dollars of profit. But writes Michael Lewis in his 1989 book about Salomon Brothers, Liar's Poker, "once they got onto Meriwether's trading desk, they forgot they were supposed to be detached intellectuals. They became disciples."
"Everybody loved him," says one former Salomon staffer. Well, not quite everybody, as it turned out. In 1991 he found himself at the centre of a Treasury bond scandal, when he learned that Salomon had submitted a false bid and reported the transgression to his bosses, John Gutfreund and Tom Strauss. In the subsequent fall-out, Salomon was rescued by an infusion of capital from Warren Buffett, the investor known as the Sage of Omaha, and Meriwether's bosses were ousted. Meriwether himself was largely exonerated, and retained a loyal following. But hostile factions, who thought he should have taken tougher action, ultimately forced his resignation.
"I'm a fairly shy, introspective person," he said of the experience in 1994. But I became front-page news."
After that first brush with disaster, Mr Meriwether, went on to set up Long-Term Capital which for the first few years was hugely successful. He took some of the Salomon loyalists with him to the rich, leafy suburb of Greenwich, Connecticut, where he set up his new office, including Eric Rosenfeld, a former finance professor, and Larry Hilibrand, who was famous for the size of his bonus.
Even among hedge funds, which often employ top academics, Long-Term Capital was the cream of the cream. It charged higher than average fees. Its partners included David Mullins, the former vice chairman of the Federal Reserve Board and Nobel laureates, Myron Scholes and Robert Merton. Its trades were different too, relying on discrepancies between different securities and markets rather than big outright bets. The fund was characterised as a "market neutral" fund, and with the finest brains of Wall Street at the helm, investment banks extended greater credit - and at better terms - than to any other hedge fund, without, it seems, asking too many questions about the secretive fund's true exposure.
The saga is rich in irony. Unlike most hedge funds, which solicit investments from wealthy individuals, Mr Meriwether got the capital for his fund, set up in 1993, largely from financial institutions. The ties, both corporate and personal, between the fund and Wall Street's biggest institutions remained close.
The heads of Merrill Lynch and Paine Webber, David Komansky and Donald Marron, invested their own money in the fund. They were also among those who thrashed out the bail-out terms at the New York Federal Reserve on Wednesday. Messrs Scholes and Merton are two of the world's leading experts on risk management, yet the fund's risks had run out of control. And Mr Meriwether, viewed as the greatest trader and risk taker of his generation, ended up with a staggering total exposure of $200bn. All the complex formulae and computer models that the best brains had produced simply did not work when financial crisis spilt over from the emerging markets.
So is that it for Mr Meriwether. One person close to him says that although he is "concerned", in particular for investors, counterparties and employees, "I see no panic". In fact, he has continued to try to rally morale among the 180 staff in his offices. This, it seems, is characteristic of a man who has undoubted leadership abilities - and strong nerves. But people who have worked with him say that his personality is not that of the gung-ho "master of the universe" suggested by a famous anecdote about Liar's Poker.
"One hand, one million dollars, no tears," challenged John Gutfreund, then head of Salomon Brothers, one day in 1986. "No John," replied Mr Meriwether. "If we're going to play for those kind of numbers, I'd rather play for real money. Ten million dollars. No tears." Mr Gutfreund backed down.
Though some say that particular story is apocryphal, everyone agrees that as a trader Mr Meriwether was able to cover his emotions. "He wore the same blank, half-tense expression when he won as he did when he lost," wrote Mr Lewis in Liar's Poker. "He had, I think, a profound ability to control the two emotions that commonly destroy traders - fear and greed - and it made him as noble as a man who pursues his self-interest so fiercely can be."
But people close to Mr Meriwether say that his achievement at Salomon was partly to transform the macho culture. "That Liars Poker thing is really not his style at all. He is very analytical" and instead of macho bond traders brought in "really bright people who can analyse and look at risk. That was his leadership style." It is a view borne out by his ability to attracted Nobel prize-winning economists to his staff.
People who have worked with him believe that his personal strength will carry him through the current crisis. "He's going to be fine," said one former Salomon employee. "Poor, but fine." |
