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Friday, Sep. 25, 1998
Fed key player in rescue of floundering hedge fund
Preventing shocks to financial system was aim of consortium's bailout of Long-Term Capital
By ANDREW FRASER
Associated PressNEW YORK - The bailout of Long-Term Capital Management LP raised questions about the government's unprecedented role in rescuing a private investment fund for wealthy investors who can afford to lose millions without flinching.
But the decision by the Federal Reserve Bank of New York to orchestrate the $3.5 billion bailout by a consortium of banks and brokerage firms goes far beyond helping the fund's rich investors and focused on the broader repercussions if it had collapsed.
The New York Fed, which acted as a neutral observer and provided no taxpayer money for the rescue, was concerned that the failure of Long-Term Capital, a hedge fund run by some of the brightest minds on Wall Street, would jeopardize the nation's financial system.
The fund had more than $90 billion invested in complex bets in financial markets around the world - especially in bonds. Some of the money was borrowed from commercial banks and investment houses, which would have faced huge losses had the fund failed.
A failure also would have forced Long-Term Capital to unwind many of its positions, causing panic selling in the market and possible losses for other hedge funds and investment companies that had made bets on similar securities.
``Given the response of the Fed it is clear that there was risk of large and far-reaching consequences,'' said Cynthia Latta, principal U.S. economist, Standard & Poors/DRI in Lexington, Mass. ``They were trying to prevent the failure of this one big one from contaminating the rest of the financial system.''
A ripple of failures within the financial system would have severe consequences for the economy. ``If you had a big enough succession of failures, this would be followed by total credit crunch, job layoffs and recession,'' Latta said.
Asked about the matter on Thursday, Treasury Secretary Robert Rubin said, ``We always have to be watchful with respect to anything that could affect our system, but I don't know of anything in this area that rises to that level at this time.''
Long-Term Capital, a hedge fund based in Greenwich, Conn., is run by John Meriwether, a former bond arbitrage specialist at Salomon Brothers. Partners include Nobel prize-winning economists Robert Merton and Myron Scholes.
Hedge funds are largely unregulated investment funds. While the Federal Reserve has no jurisdiction over hedge funds, it does have a responsibility for the nation's banks. The effect on the commercial banks, which had made loans to Long-Term, was one of the reasons the Fed stepped up to help.
Some industry observers said it would be wrong for the debacle to prompt government regulation of hedge funds. What's needed, some suggested, is more scrutiny on commercial banks to ensure that they don't make loans to risky ventures that could end up hurting them.
``Loans to hedge funds should be carefully examined,'' said Steven Feinstein, a professor of finance at Babson College in Massachusetts. ``We shouldn't find ourselves in these situations. This story should have been `Yeah, Long-Term Capital went broke and brought down some investors.' ''
In Washington, the Senate Banking Committee ``is monitoring the situation and has been in touch with the Federal Reserve,'' said Richard Mills, a spokesman for the panel's chairman, Sen. Alfonse D'Amato, R-N.Y.
Rep. Jim Leach, R-Iowa, head of the House Banking Committee, said in a statement: ``It would appear that Long-Term Capital Management was deemed by the Federal Reserve to be too leveraged and too intertwined to fail.
``The question that remains for the economy is what other risk exists in the hedge fund and derivatives industries.''
Sixteen of the world's largest banks and brokerage firms, including Goldman Sachs & Co., Merrill Lynch & Co., Morgan Stanley Dean Witter, Travelers Group and UBS Securities Inc. agreed to put up at least $250 million each in return for equity in the fund, a source said.
``We greatly appreciate the willingness of the consortium to provide capital which we are confident will stabilize our fund and enable us to continue to be active in the marketplace,'' Meriwether said in a statement.
Negotiations among Long-Term Capital's lenders, dealers and the Fed began last weekend as it became increasingly apparent that the hedge fund was in danger of foundering. Global speculator George Soros was reportedly approached for assistance but declined.
The consortium of institutions lending the money will now own 90 percent of equity in Long-Term Capital. They also will form an oversight committee to direct the fund's overall strategy and limit its exposure to certain markets, the fund's statement said.
Earlier this month, Long-Term Capital said it had lost $2.5 billion or 52 percent of its net assets, in trading so far this year. As of Sept. 2, Long-Term Capital was said to have $2.3 billion in assets with about $90 billion in trading positions.
Some of the losses were related to the Russian bond market and the defaulting of ruble currency hedges by Russian banks.Post your comments about local news eventsFront Page || Main Index || News || Business || Texas || South Texas Outdoors || Birdwatching || Sports || Entertainment || Selena || Education || South Texas Attractions || World Wide Web