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Long-Term Capital Management. $4.50. 4.00. 3.00. 2.00. 1.00. 0.00. Gross value of $1 invested March 1994 - October 1998 in LTCM When Genius Failed pp. xiv. 3/1994 1/1995 1/1996 1/1997 1/1998. ***.

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slide1

Long-Term Capital Management

$4.50

4.00

3.00

2.00

1.00

0.00

Gross value of $1 invested March 1994 - October 1998 in LTCMWhen Genius Failed pp. xiv

3/1994 1/1995 1/1996 1/1997 1/1998

***

Bailouts Seminar Karen Bradshaw, Molly Grovak, Drew Navikas, Asha Spencer

agenda
Agenda
  • Background
  • Framework for analysis
  • Was LTCM a bailout?
  • Was LTCM successful (as a bailout)?
  • Relevance to Current Crisis
  • Conclusions
  • Questions
slide3

Bond trading experience

Black

LOANS

BAILOUT = $3.6B

PRESSURE

Up to 40% returns

Scholes

Meriwether

INVESTMENTS

Merton

Up to $1 trillion in derivatives

Mullins

LTCM

$1.25 billion up to $7B down to $555M

PRESSURE

LOANS

slide6

Background

Russia

defaults

80% loss over 5 weeks

$4.50

4.00

3.00

2.00

1.00

0.00

Gross value of $1 invested March 1994 - October 1998 in LTCMWhen Genius Failed pp. xiv

3/1994 1/1995 1/1996 1/1997 1/1998

slide12

Background

MISFIRE

Wall Street’s Rocket Scientists thought they had a surefire way

to bear the markets. Boy, were

they wrong!

-Business Week, Sept 21, 1998

framework for analysis
Framework for Analysis

Was LTCM a bailout?

ASK

Was LTCM successful (as a bailout)?

  • Use case studies from class to define the criteria for determining a bailout/success
  • Consider whether LTCM qualifies as a bailout/success against the criteria
  • Determine whether LTCM was a bailout/success and how LTCM might impact the criteria

FRAMEWORK

was ltcm a bailout15
Was LTCM a Bailout?

What makes something a bailout?

Input of

private parties

Government

intervention

More like a bailout

WHO

Principals

of the firm

Existing creditors

and stakeholders

Market Players

The Fed

Treasury

Congress

was ltcm a bailout16
Was LTCM a Bailout?

What makes something a bailout?

Input of

private parties

Government

intervention

More like a bailout

WHO

Principals

of the firm

Existing creditors

and stakeholders

Market Players

The Fed

Treasury

Congress

Market

facilitation

Government

intervention

More like a bailout

WHAT/

WHY

Emulating private market when dysfunctional

Jumpstart

private

negotiations

Stopping a

downward spiral

Propping up firms

during economic

turbulence

Gov’t intervention to pursue normative vision

was ltcm a bailout17
Was LTCM a Bailout?

What makes something a bailout?

Input of

private parties

Government

intervention

More like a bailout

WHO

Principals

of the firm

Existing creditors

and stakeholders

Market Players

The Fed

Treasury

Congress

Discount window

BOA & Merrill

TARP

HOLC

Chrysler 1979

GE Immelt bonus

Law firm partners

Chapter 11

Buffet & GS

Detroit Today

Market

facilitation

Government

intervention

More like a bailout

WHAT/

WHY

Emulating private market when dysfunctional

Jumpstart

private

negotiations

Stopping a

downward spiral

Propping up firms

during economic

turbulence

Gov’t intervention to pursue normative vision

S&L

Housing

Detroit Today

American Dream: F&F

TARP

Chrysler 1979

Detroit Today

Chrysler 1979

was ltcm a bailout18
Was LTCM a Bailout?

Yes yes yes! ~ NO

Input of

private parties

Government

intervention

More like a bailout

WHO

Principals

of the firm

Existing creditors

and stakeholders

Market Players

The Fed

Treasury

Congress

LTCM

LTCM

LTCM

Market

facilitation

Government

intervention

More like a bailout

WHAT/

WHY

Emulating private market when dysfunctional

Jumpstart

private

negotiations

Stopping a

downward spiral

Propping up firms

during economic

turbulence

Gov’t intervention to pursue normative vision

LTCM

LTCM

why does it matter
Why does it matter?
  • Distributes the perception of responsibility
    • Bailout = needed rescuing/failure by managers
    • Not a Bailout = this was a function of regulatory choices and global markets
  • Sets criteria by which we measure success
slide21

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Short-term impact on first parties

Long-term impact on first parties

first

party

t

short-term

long-term

slide22

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Autos, S&L, Banks

Saving Jobs

Chrysler, Detroit

Keeping Homes

HOLC, F&F, S&L

first

party

t

short-term

long-term

slide23

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Home Ownership

S&L, F&F

Public Policy

American Autos

Chrysler, Detroit

Economic Growth

Panic/Confidence

Easy Credit

TARP

TARP

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Autos, S&L, Banks

Saving Jobs

Chrysler, Detroit

Keeping Homes

HOLC, F&F, S&L

first

party

t

short-term

long-term

slide24

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Home Ownership

S&L, F&F

Public Policy

American Autos

Chrysler, Detroit

Economic Growth

Panic/Confidence

Easy Credit

TARP

TARP

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Preserving Jobs

Autos, S&L, Banks

Chrysler, Detroit

Saving Jobs

Chrysler, Detroit

Keeping Homes

HOLC, F&F, S&L

Moral Hazard

first

party

Autos, S&L, Banks

t

short-term

long-term

slide25

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Home Ownership

S&L, F&F

Barrier to Entry,

Alternative Investment

TARP, Chrysler, F&F

Public Policy

Opportunity Cost

American Autos

Chrysler, Detroit

Economic Growth

Panic/Confidence

Preserving Networks

Moral Hazard

Easy Credit

TARP

Market Learning

S&L, Chrysler

TARP

Chrysler, Detroit

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Preserving Jobs

Autos, S&L, Banks

Chrysler, Detroit

Saving Jobs

Chrysler, Detroit

Keeping Homes

HOLC, F&F, S&L

Moral Hazard

first

party

Autos, S&L, Banks

t

short-term

long-term

slide26

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Home Ownership

S&L, F&F

Barrier to Entry,

Alternative Investment

TARP, Chrysler, F&F

Public Policy

Opportunity Cost

American Autos

Chrysler, Detroit

Economic Growth

Panic/Confidence

Preserving Networks

Moral Hazard

Easy Credit

TARP

Market Learning

S&L, Chrysler

TARP

Chrysler, Detroit

Stopping Downward Spiral

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Preserving Jobs

Autos, S&L, Banks

Chrysler, Detroit

Saving Jobs

Chrysler, Detroit

Keeping Homes

HOLC, F&F, S&L

Moral Hazard

Muting Economic Turbulence

first

party

Autos, S&L, Banks

Chrysler, S&L

t

short-term

long-term

slide27

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Public Policy

Opportunity Cost

Economic Growth

Panic/Confidence

Preserving Networks

Moral Hazard

Stopping Downward Spiral

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Preserving Jobs

Moral Hazard

Muting Economic Turbulence

first

party

t

short-term

long-term

slide28

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

Public Policy

Opportunity Cost

Economic Growth

Panic/Confidence

Preserving Networks

Moral Hazard

+ prevented credit meltdown

+/- precedent for Fed involvement

+/- avoided regulation

Stopping Downward Spiral

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Preserving Jobs

+ no huge costs in human capital

+ unwound at a profit

+ internalized losses

+ investors who got out early

Moral Hazard

Muting Economic Turbulence

first

party

+ mitigated moral hazard

t

short-term

long-term

slide29

people

impacted

Short-term impact on third parties

Long-term impact on third parties

third

party

  • benefit financial gaming
  • made quantitative investment
  • less risky
  • “how to” rather than a
  • ghost story

Public Policy

Opportunity Cost

Economic Growth

Panic/Confidence

Preserving Networks

Moral Hazard

+ prevented credit meltdown

+/- precedent for Fed involvement

+/- avoided regulation

Stopping Downward Spiral

Short-term impact on first parties

Long-term impact on first parties

Shielding Stakeholders

Reputational Harm

Preserving Jobs

+ no huge costs in human capital

+ unwound at a profit

+ internalized losses

+ investors who got out early

Moral Hazard

Muting Economic Turbulence

first

party

+ mitigated moral hazard

- didn’t continue as a going concern

- reputational decline

t

short-term

long-term

relevance to current crisis
Relevance to Current Crisis
  • Investment strategies
  • Market dynamics
  • Moral hazards
conclusions
Conclusions
  • How do we put a stop to the learning gap without knee-jerk regulation?
  • What should LTCM have led the Fed and Treasury to ask about Bear and Lehman?
  • Why shotgun weddings without equity?
slide33

Bond trading experience

Black

LOANS

BAILOUT = $3.6B

PRESSURE

Up to 40% returns

Scholes

Meriwether

INVESTMENTS

Merton

Up to $1 trillion in derivatives

Mullins

LTCM

$1.25 billion up to $7B down to $555M

PRESSURE

LOANS