The details starting to come out:
Monday September 28, 6:57 pm Eastern Time
Banks seen finalizing deal with LTCM within 2 days
By Apu Sikri
NEW YORK, Sept 28 (Reuters) - A bank consortium negotiating for oversight of ailing hedge fund Long-Term Capital Management L.P. will have a formal deal in place within the next couple of days, an official familiar with the talks said on Monday.
''It should be wrapped up over the next day or two,'' the official said.
Senior officials at 14 banks involved in the bailout of the Greenwich, Conn.-based hedge fund met over the weekend to hammer out details, the official said.
Some of the world's most powerful financial institutions, including Merrill Lynch & Co. Inc. (NYSE:MER - news), Goldman Sachs & Co., Chase Manhattan Corp. (NYSE:CMB - news) and Deutsche Bank AG (quote from Yahoo! UK & Ireland: DBKG.F), are signing on to a deal brokered by the Federal Reserve Bank of New York.
Under terms of the transaction, the banks are giving Long-Term Capital $3.5 billion in equity capital in return for essentially controlling and liquidating investments of the fund, currently estimated at about $90 billion.
The bailout became necessary after Long-Term Capital, run by John Meriwether, bond trading whiz and former vice chairman of Salomon Brothers Inc. (NYSE:TRV - news), lost nearly 90 percent of the capital it had at the beginning of the year.
One of the critical issues addressed by bankers is the number of people who will have complete access to Long-Term Capital's trading positions, officials said.
Bankers are trying to make sure that any information the oversight committee gathers on the fund's market exposure will remain hidden from traders who could exploit the fund's vulnerable position.
''Clearly, this is an issue that the oversight committee will focus on and establish set guidelines,'' said Richard Torrenzano, a spokesman for the consortium.
A bank official said ''there will be a 'Chinese wall' between those involved in the oversight and the trading desks.''
Portfolio managers and traders at banks not involved in the bailout of Long-Term have asked whether there will be ''front-running of Long-Term's positions,'' a portfolio manager said.
Such trades ''would benefit them (Wall Street dealers) individually but not as a group,'' said Richard Schwartz, portfolio manager at New York Life Asset Management who oversees $22 billion in bond investments.
Even as details of the deal were being worked out, some banks were already trading based on expectations of dumping Long-Term Capital's bonds and derivatives, traders said.
The most visible impact Monday was in the British sterling interest rate swaps market, traders said. The gap between the 10-year swap rate and British government bonds, or gilts, increased to 93 basis points from 85 basis points on Friday in the 10-year maturity, dealers said.
''It's not clear whether it was Long-Term liquidating its position or traders taking positions ahead of an anticipated liquidation,'' a swaps trader said.
Long-Term is believed to have a short position in British gilts and a long position in sterling swaps, traders said.
In Eurobond futures, Goldman Sachs sold a whopping 10,000 contracts between Friday and Monday which traders claimed was an unwinding of a transaction with Long-Term. Officials at Goldman did not return phone calls.
As traders try to second-guess the fund's positions, downsizing Long-Term Capital's investments will prove challenging at the least, bankers said.
Some of the fund's positions rest in relatively less liquid investments, such as bonds backed by commercial mortgage loans, equity derivatives and the riskier classes of bonds backed by receivables such as loan payments on automobiles, bankers said.
''There is a huge overhang in the market. People are just not willing to take on new positions,'' said Jim Shallcross, portfolio manager at JHM Capital Management.
Long-Term Capital counted the world's top banks among its lenders. It also included bankers among its shareholders. The fund required a minimum $10 million investment and gave out few details of its investment strategy.
Among Long-Term Capital's partners were Nobel laureates Myron Scholes and Robert Merton, pioneers in the theoretical framework for pricing options.
At a recent conference, Scholes said he had not been active in the fund, according to bankers who attended the gathering.
Essentially, Long-Term Capital bet that any type of bond with a credit risk would gain in price compared to U.S. Treasuries and government bonds of major powers such as Germany and Britain. The exact opposite has transpired over the last two months. As Russia got mired deeper in a financial crisis and Japan's woes refused to go away, prices of most bonds -- including corporate bonds, mortgage-backed securities and emerging market securities -- have dropped while prices of U.S. Treasuries and German bunds have escalated.
Bankers said that not only did Long-Term leverage its investments by about 20 to one, it also assigned a near-zero probability to the violent flight to quality assets that markets across the globe have witnessed this summer.
Other hedge funds are facing similar problems. The Financial Times reported Monday that Convergence Asset Management, a hedge fund also based in Greenwich, had suffered losses. Andrew Fisher, head of the fund and also a former Salomon Brothers trader, did not return phone calls seeking comment. |
