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When industry-wide position liquidations become a distinct risk they will want to exit early, in order to mitigate losses.
Under these conditions, market runs arise from fear of runs, not necessarily because of fundamental risk shocks.
A broader group of thirteen firms was invited to the New York Fed that evening to discuss the approach.
The firms disagreed over how much each firm should contribute to a rescue package and could not commit to such an effort on such short notice (Siconolfi 1998).
In September 1998, a group of 14 banks and brokerage firms invested .6 billion in LTCM to prevent the hedge fund’s imminent collapse.
The arrangement was facilitated by the Federal Reserve, though the Fed did not lend any of its own funds. The capital infusion forestalled a fire sale of LTCM assets into already turbulent markets and instead allowed for an orderly liquidation of the hedge fund’s holdings.
While the Fed had been aware of LTCM’s situation through its usual market monitoring activities, the dangerous scale and scope of LTCM's positions became apparent only upon closer inspection.
By the nature of its strategy, LTCM earned low returns on each dollar invested.Hedge funds’ capital structure is vulnerable to market shocks because most of them offer high liquidity to loss-sensitive investors.Moreover, hedge fund managers form expectations about each other based on market prices and investor flows.LTCM had largely been betting on the spreads in its portfolios to converge, but in almost every case, they diverged (Lowenstein 2000).
The fund lost 44 percent of its value in August alone.
The effort thereby addressed the near-term concerns of a possible fire sale of LTCM assets, while mitigating long-term moral hazard concerns that might have arisen from the use of public funds.