The Lawlessness of Large Numbers

Pop Quiz - What was the value of the 1998 bailout of Long Term Capital Management?

I graduated college in 1998 and went to work on Wall Street. Amazingly, in just the last 10 years in the markets, I've seen several major financial events. The first was the collapse of LTCM in the wake of the Russian debt crisis. The second was the dotcom bubble and subsequent collapse. The third was the recent collapse of the housing bubble and structured products associated with it.

Before the most recent crisis, the collapse of Long Term Capital Management was probably the biggest systematic financial threat of my lifetime. The Federal Reserve had to orchestrate a cabal of big banks to provide capital to essentially fund the massively levered assets of LTCM, a private hedge fund. This was deemed necessary because otherwise losses from LTCM's positions, purchased (with huge leverage) with borrowed money, could threaten the entire financial system.

Why am I mentioning this today? John Meriwether, one of the principals at LTCM, just announced that he's shutting down his latest hedge fund, JWM partners.

"JWM Partners LLC is closing its main Relative Value Opportunity II fund after losing 44 percent from September 2007 to February 2009. Meriwether, credited with generating billions of dollars of revenue at the former Salomon Brothers in the 1980s through so-called relative value trades, returned an average of 1.46 percent a year with his new fund since opening in 1999, compared with 2.4 percent for the Credit Suisse/Tremont Hedge Fixed-Income Arbitrage Index.

Long-Term Capital, which assembled a team of top Salomon traders and Nobel laureates, lost more than 90 percent of its $4.8 billion of assets in the weeks following Russia’s currency devaluation and bond default. The Federal Reserve orchestrated a $3.6 billion bailout by the fund’s 14 banks to calm fears that the firm’s lenders and trading partners would be dragged down.

“For many investors, John Meriwether is by now just another hedge-fund manager,” said Tammer Kamel, president of Toronto-based Iluka Consulting Group Ltd., which advises clients on investments in the private pools of capital. “LTCM’s infamy was a big story in 1998, but the events of 2008 might finally relegate LTCM and 1998 to footnote status.”"

I was shocked to be reminded that the LTCM bailout - the mother of all financial interventions (previously!) was less than four billion dollars. Wow. Remember when money had meaning? Now BankofAmerica pays nearly $4B annually in INTEREST on the bailout funds they alone have received - and they're but a small piece of the pie. Indeed - the current bailout renders LTCM a footnote. The difference in size between the LTCM systematic threat and the 2008 housing/subprime/leverage crisis is striking, and an indication of the magnitude of notional expansion we created in the last 10 years. It should also serve as an indication that we likely have a very long way to go before we get back to the sorts of numbers we saw at the peak of the housing bubble.

If you haven't read Roger Lowenstein's account of the rise and fall of LTCM, "When Genius Failed," I strongly recommend it.

-KD