Prologue: Summer 1998, New York
The air in Manhattan that August was thick and wet, the kind of heat that makes the city’s concrete seem to sweat. In the quiet, carpeted conference rooms of Wall Street’s most powerful banks, phones were ringing with a peculiar urgency.
Not about the next IPO, not about a sudden market rally — but about a single, private hedge fund most Americans had never heard of.
Long-Term Capital Management — LTCM for short — wasn’t supposed to be in trouble. It was supposed to be bulletproof. Staffed by the smartest people in finance, including two Nobel Prize winners, it had made fortunes so steadily that bankers spoke of it in hushed, admiring tones.
And yet, behind the fund’s closed doors, the math had stopped working.
By the end of that summer, the Federal Reserve would be calling emergency meetings, and the CEOs of America’s biggest banks would be summoned to a table they didn’t expect to share. The reason? LTCM’s trades were so big, so entangled with the global markets, that if it went under, it might drag everyone down with it.
Chapter 1: Birth of a Legend
In the early 1990s, a former Salomon Brothers bond trader named John Meriwether was quietly assembling a dream team.
Meriwether had made his name (and fortune) in the bond arbitrage game — finding tiny mispricings between similar securities and betting heavily that they would converge.
He wasn’t content to just hire good traders. He wanted the best minds in finance. That meant recruiting Myron Scholes and Robert Merton — two economists whose groundbreaking work on option pricing had earned them the Nobel Prize in Economics.
By 1994, Meriwether’s new creation, Long-Term Capital Management, was born in a nondescript office in Greenwich, Connecticut. No trading floor chaos, no flashing ticker screens. Just quiet rooms, whiteboards covered in equations, and a belief that the future could be calculated.
Chapter 2: The Magic Formula
The premise was simple — at least in theory.
If you could find a government bond yielding 6% and another, almost identical, yielding 6.1%, you could buy one, short the other, and pocket the spread when they converged.
Do this hundreds of times across markets, use models to hedge the risks, and — according to the math — you could generate steady, near-riskless profits.
The key word was leverage. LTCM started with about $4.5 billion in investor capital. But thanks to its sterling reputation, it could borrow tens of billions more from the biggest banks in the world at rock-bottom rates.
By 1998, the fund had positions worth over $125 billion on its balance sheet, and derivatives exposure estimated at $1.2 trillion.
It was leverage on an almost unimaginable scale. And for a while, it worked perfectly.
Chapter 3: The Years of Perfection
From 1994 to 1997, LTCM was a printing press for money.
- In its first year, it returned more than 20% after fees.
- The next few years were nearly as good.
- Investors — including banks, pension funds, and wealthy individuals — begged to get in.
But LTCM turned them away. Not because it didn’t want the money, but because exclusivity added to its mystique.
In 1997, the partners even returned capital to investors, claiming they simply had too much money to deploy effectively.
Inside LTCM, there was a sense of invincibility.
Chapter 4: The Storm on the Horizon
The trouble started in 1997 with the Asian Financial Crisis.
Currencies collapsed. Stock markets from Jakarta to Seoul plunged. Investors fled risky assets and piled into safe havens like U.S. Treasuries.
LTCM’s models hadn’t predicted that level of panic — the “once in a century” moves that, according to the math, weren’t supposed to happen more than once in a lifetime.
The fund absorbed the hit, but the real danger was yet to come.
In August 1998, Russia defaulted on its domestic debt and devalued the ruble. Overnight, a huge segment of the bond market that LTCM traded in froze.
The models said Russian debt was low-risk. Reality disagreed.
Chapter 5: When the Math Breaks
When Russia defaulted, the spreads LTCM was betting on didn’t just fail to converge — they blew wide apart.
It wasn’t just one trade. LTCM had similar positions across dozens of markets, all moving the wrong way at the same time.
Because the fund was leveraged 25-to-1, even small price movements had an outsized effect.
A 4% loss on assets meant nearly all the equity was wiped out.
By September 1998, LTCM’s capital had fallen from $4.5 billion to less than $600 million. Margin calls were flooding in from every bank that had lent to them.
Chapter 6: The Phone Calls No One Wanted
The nightmare wasn’t just LTCM’s problem.
The fund had trades with virtually every major financial institution: Goldman Sachs, Merrill Lynch, J.P. Morgan, Credit Suisse, UBS, and more.
If LTCM defaulted, those trades would have to be unwound in a fire sale, causing huge losses across the system.
The Federal Reserve feared a chain reaction. It wasn’t about saving LTCM’s partners — it was about saving the plumbing of the global financial system.
In late September, the New York Fed invited 14 top Wall Street executives to its offices. The message was clear: You’re going to fix this. Together.
Chapter 7: The Rescue
On September 23, 1998, a deal was struck.
Fourteen banks and securities firms agreed to inject $3.6 billion into LTCM in exchange for 90% ownership.
The fund’s original investors were wiped out. The partners lost nearly all of their personal wealth.
It was a private bailout — no taxpayer money changed hands.
But the precedent was troubling: the biggest banks, under Fed guidance, had just saved a private hedge fund because its collapse might take them all down.
Chapter 8: Lessons in Hubris
In the aftermath, the collapse of LTCM became a case study in hubris.
- The partners believed their models were airtight.
- They underestimated the risk of rare, catastrophic events.
- They assumed liquidity would always be there.
When the music stopped, there were no chairs left.
Epilogue: Echoes Through Time
LTCM’s blowup didn’t cause a 2008-style global meltdown, but it was a warning shot.
The same ingredients — overconfidence, extreme leverage, and complex, opaque trades — would reappear a decade later in the subprime mortgage crisis.
Even today, traders and risk managers invoke “LTCM” as shorthand for brilliant, but dead wrong.
It’s the reminder that no matter how sophisticated the math, markets have a way of humbling anyone who thinks they’ve solved them.