Too close to the hedge: the case of long term capital management LP: Part two: near-collapse and rescue

Part Two of this Case Study of the US hedge fund, Long Term Capital Management (LTCM), deals with the detail of the fund's September 1998 near-collapse and rescue after it had lost $2.1 billion of its investors' money (44 per cent of capital). Following a profile of LTCM, the Case looks at the fundamental reasons why LTCM fell into crisis, and the extent of actual and potential damage to the fund's investors and creditors is examined. Much of the blame for the rapid loss in value by LTCM lay at the door of extreme leverage, and a number of arbitrage and other trading operations are looked at in detail to see how LTCM's losses became magnified with leverage. LTCM's arbitrage operations are also examined to show how the fund made errors of judgement on the future direction of comparative bond yields. In September 1998, the Federal Reserve Bank of New York orchestrated a takeover of LTCM by 15 commercial and investment banks to the tune of $3.5 billion. The reasons why the US Government chose this course are considered, and lessons drawn for the future on how best to manage the proper operation of hedge funds for the benefit and protection of their investors, creditors and for the wider financial markets.