Hedge Funds and the Collapse of Long-Term Capital Management

Franklin R. Edwards

270 citations0/0 files storedThe Journal of Economic Perspectives

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Banking stability, regulation, efficiency Global Financial Crisis and Policies Global Financial Regulation and Crises

Abstract

The Fed-engineered rescue of Long-Term Capital Management (LTCM) in September 1998 set off alarms throughout financial markets about the activities of hedge funds and the stability of financial markets in general. With only $4.8 billion in equity, LTCM managed to leverage itself to the hilt by borrowing more than $125 billion from banks and securities firms and entering into derivatives contracts totaling more than $1 trillion (notional). When LTCM's speculations went sour in the summer of 1998, the impending liquidation of LTCM's portfolio threatened to destabilize financial markets throughout the world. Public policy response to LTCM should focus on risks of systemic fragility and ways in which bank regulation can be improved.

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References

1997On Persistence in Mutual Fund Performance 1997Risk Taking by Mutual Funds as a Response to Incentives 2024Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression 1995Risk Taking by Mutual Funds as a Response to Incentives 1991The Credit Crunch 1997Empirical Characteristics of Dynamic Trading Strategies: The Case of Hedge Funds 1990Asymmetric Information and Financial Crises: A Historical Perspective 1993International Value and Growth Stock Returns

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