• Mon. May 20th, 2024

The Fall of Long-Term Capital Management (LTCM)


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What is the fall of long-term capital management LTCM?

In the year of 1998, there was closure in an investment company called Long Term Capital Management, which happened because of a catastrophic collapse. This closure was caused by the enormous amount of loss experienced by the investment company.

On August 28, 1998, it became clear that this particular company had lost 4.6 billion dollars and only remained with a hundred million dollars to pay for all its liabilities. In order to prevent more damage, the company was forced to liquidate all its assets and ceased to exist as an investment firm.

The fall of Long-Term Capital Management (LTCM) is considered one of the most significant financial crises that happened in the United States.

The roots of this debacle could be found in years before the company’s existence. The company was founded in the year 1994 by John Meriwether. John brought his huge amount of experience from the past experiences, where he led Salomon Brothers to become the most successful bond trading firm in the United States. Despite the experience and the formation of a talented group of traders, LTCM was faced with a hundred million dollars debt before its first day of operation. This was due to the high-risk strategies that the company had implemented in order to achieve higher returns.

The reason behind it

The main reason why LTCM collapsed was its over-dependence on a few traders who made wrong investment decisions. Those bad investment decisions caused an enormous amount of losses which the company couldn’t handle anymore. In the year 1997, the company had to pay twelve times its capital in order to support other companies. The fall of LTCM was not only happened because of investment mistakes but also because of irresponsible behavior from other parties such as banks which led this company to collapse.

Long Term Capital Management’s business model was very similar with other common hedge funds. The main difference was the company employed much more leverage in order to achieve higher returns. For instance, the company used fifty-five billion dollars of borrowed money to make two billion dollars in investments. This high degree of leverage increased the potential gain if everything went right but also magnified the losses when things went wrong. As we know, this is exactly what happened and led to the company’s closure.

Despite the huge amount of loss, there were still some people who gained from this debacle. For example, banks that had lent money to LTCM made a fortune when the company collapsed. This is because they received back all the money they had lent with high-interest rates.

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