The collapse of hedge fund Long-Term Capital Market (LTCM) occurred during the final stage of the world financial crisis that began in Asia in 1997 and spread to Russia and Brazil in 1998.
LTCM was a hedge fund set up by Nobel Prize winners Myron Scholes and Robert Merton to trade bonds. The professors believed that in the long run, the interest rates on different government bonds would converge, and the hedge fund traded on the small differences in the rates.
But when Russia defaulted on its government bonds in August 1998, investors fled from other government paper to the safe haven of US Treasury bonds, and interest rate differences between bonds increased sharply.
LTCM, which had borrowed a lot of money from other companies, stood to lose billions of dollars – and in order to liquidate its positions it would have to sell Treasury bonds, plunging the US credit markets into turmoil and forcing up interest rates.
So the Fed decided that a rescue was needed. It called together the leading US banks, many of whom had invested in LTCM, and persuaded them to put in $3.65bn to save the firm from imminent collapse.
The Fed itself made an emergency rate cut in October 1998 and markets soon returned to stability. LTCM itself was liquidated in 2000.
By Steve Schifferes
Economics reporter, BBC News
