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Long-Term Capital Management collapse (1998)
Sept 1998· Crisis or event
Fact, law or dataA rule, statute, definition or measured number.
A star hedge fund lost about $4.6 billion in 1998, prompting a Fed-brokered rescue by banks to head off wider chaos.
See it on the Money & Finance map →How it works
Long-Term Capital Management, founded in 1994 by bond trader John Meriwether with Nobel laureates Myron Scholes and Robert Merton, bet that small price gaps between similar bonds would close. It earned about 40% a year in 1995–96 while running about 25 times leverage and over $1 trillion in derivatives. When Russia defaulted in August 1998, investors fled to safety and the gaps widened instead. On September 23, the New York Fed gathered 14 banks, which put in $3.6 billion and wound the fund down.
Why it matters
It showed that one lightly regulated, heavily borrowed fund could threaten big banks, a preview of 2008, and that models built on calm markets fail in panics.
Think of it like
Traders call it picking up nickels in front of a steamroller: small, steady gains until one bad move wipes everything out.
Facts, rules and data
The President's Working Group report on hedge funds (April 1999), Fed officials' congressional testimony, and Roger Lowenstein's history 'When Genius Failed' (2000).
Debates and risks
Whether the Fed's role, though no public money was used, taught Wall Street to expect rescues and encouraged later risk-taking is debated.
Connections (3)
▸Leverage: amplifying gains and losses with debt magnified losses at Long-Term Capital Management collapse (1998)Fact, law or data
The connection
LTCM's trades earned tiny margins, so it borrowed heavily to make them pay: about $125 billion of assets on under $5 billion of capital, plus over $1 trillion in derivatives. When spreads widened after Russia's default, a move of a few percent against it erased most of its equity.
When and why
Greenwich, Connecticut; losses of about $4.6 billion over roughly four months in 1998.
How we know
The President's Working Group report (1999) documented its leverage, and lenders' exposures came out during the rescue.
Debates and risks
Why lenders competing for its business asked so little collateral, and how much leverage hedge funds run today, remain open questions.
▸Long-Term Capital Management collapse (1998) was a famous blow-up among Hedge fundsFact, law or data
The connection
LTCM became the cautionary tale for the whole hedge-fund industry: brilliant models, extreme leverage and crowded trades that everyone exits at once. It showed a lightly regulated fund could matter to the banking system, a concern that, after 2008, helped push big managers into SEC registration and reporting.
When and why
Greenwich, Connecticut, 1994–1998; the fund was wound down by early 2000.
How we know
The 1999 President's Working Group report on hedge funds and leverage, prompted by LTCM; Dodd-Frank registration followed in 2010.
Debates and risks
Whether hedge funds pose less systemic risk now is debated, given limited disclosure and the stress in leveraged Treasury trades in March 2020.
▸Long-Term Capital Management collapse (1998) prompted a bank rescue organized by The Federal Reserve System (the Fed)Fact, law or data
The connection
LTCM, a hedge fund run by star bond traders and two Nobel-winning economists, had borrowed about 25 times its capital and held over $1 trillion in derivatives. Russia's August 1998 default triggered huge losses. Fearing a fire sale would hit markets broadly, the New York Fed gathered 14 banks, which put in $3.6 billion; no public money was used.
When and why
Federal Reserve Bank of New York, September 23, 1998, led by its president William McDonough; Greenspan's Fed then cut rates three times that fall.
How we know
Fed testimony to Congress in October 1998 and the President's Working Group report of April 1999 document the rescue.
Debates and risks
Did the rescue reduce systemic risk, or teach big players to expect Fed help, encouraging the leverage that blew up in 2008?