This September will see two important financial crisis anniversaries. Not only will it be ten years since Lehman Brothers filed for bankruptcy, but also twenty years since the near-collapse of the hedge fund Long-Term Capital Management. Amid all the reforms to the global banking system and trading infrastructure since 2008, it’s worth asking the question: could an outsized hedge fund threaten the financial system today in the same way that LTCM did in 1998?
The hedge fund industry is far bigger today, with about $3.2 trillion in capital or net asset value (NAV) according to industry data provider HFR, compared with $120 billion in 1998. With $4.7 billion in NAV at the start of that year, LTCM accounted for four per cent of total hedge fund capital before its near-collapse, equivalent to the likes of Bridgewater or AQR today.
But it was not LTCM’s equity that made it dangerous. It was the leverage. In 1998 LTCM’s gross assets were $129 billion and it had derivative notional of $1.25 trillion. That September, as its equity approached zero, the fear that a collapse could bring down dealer counterparties prompted the Federal Reserve to broker a bailout by a consortium of banks.