Long Term Capital Management was a hedge fund that started in 1994 and was on the verge of bankruptcy in 1998. It was leveraged at 100:1 on risky bets and was hit by the Asian economic crisis. It was bailed out not by taxpayers but by banks and investment houses, which got a modest return before the company collapsed. Here are some important quotes.
Supporters of the bailout stressed that the Federal Reserve only facilitated the deal, and that the $3.5 billion in rescue capital came from 16 large banks and brokerages, rather than from taxpayers. Yet the critics pointed out that the rescuing banks are backed by taxpayers through federal deposit insurance. Moreover, they enjoyed that federal backing while throwing the money at Long Term Capital that enabled it to pursue its exotic–and, for three years, very profitable–speculations. “Why should the weight of the Federal Government be brought to bear to help out a private investor?” demanded former Fed Chairman Paul Volcker. “It’s not a bank.”
At the peak of its borrowing, the secretive fund reportedly carried a debt load 100 times as great as its net assets, or ownership capital. This would be like putting down $1,000 of your own money to buy a $100,000 house–in a flood plain on the San Andreas fault. “Most hedge-fund managers believe that a leverage ratio in excess of 50 to 1 is exceptionally large and very risky,” says Hunt Taylor, executive director of Tass Management, a hedge-fund consulting firm.
Now banks were only leveraged at 30:1.
Jon Corzine was a senior partner at Goldman Sachs that orchestrated the bailout, and as a result he was forced out of Sachs into public life as Senator and Governor of New Jersey. His predecessor, who forced him out because of the risky bailout of a risky fund? Henry Paulson.