Hunting for the next LTCM

14 June 2018/No Comments
By Nick Dunbar

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.

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