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[Time] 20:39
LTCM, 1998. They were a hedge fund; podcast with William Cohan. They were not a bank, not FDIC or SIPC insured--just a hedge fund that was highly leveraged, meaning they had borrowed a lot of the money they had used to make their bets with. No government money was explicitly put in. Federal Reserve Bank of New York convened a lot of large Wall Street counterparties and persuaded them to put in enough funds so that LTCM's positions could be unwound in an orderly way. They did have exposures around the world to lots of counterparties so had they been unable to honor their commitments, they would have had global implications. Also concerns about fire sales of assets--similar concern. If LTCM had to liquidate its positions in short order it would put a lot of downward pressure on asset prices which would impair the conditions of those other firms. That argument used a lot; used now to talk about why mark-to-market is part of the problem. The argument is that if they sell quickly, firms that hold similar assets will have to re-price them on their books; their capital cushion will no longer meet capital requirements, so they will have to start unwinding their positions. Cascade. Gets too much mileage out of the "quickly" part. Suppose they had to sell them slowly. The problem isn't the speed--it's that the assets aren't worth very much. Step back; ask the reaction of creditors to LTCM, reinforcing--even though no government money, when they called that meeting it wasn't so voluntary. What is next event important in reputational effects? Between early 1990s and recent crisis was mostly a period of tranquility in financial markets. Two other episodes: 1991 when Drexel Burnham went out of business--government let them go; wound them down in an orderly way. "Tequila crisis" in the early 1990s--a lot of banks had lent them money--U.S. government anxious not to see those bills--the Mexican obligations to the U.S. banks--go unpaid. Forbearance: some of those international exposures was part of the reason it was practiced. Forbearance is when you look at a financial institution, value its assets relative to its liabilities; if you are rigorous you might find the institution is insolvent; forbearance is when you are more generous in how you do the evaluations, which gives institution more time. Subtle: creditors, when they saw the government not enforcing those standards as rigorously as they normally would, saw that the government was trying to help them avoid bankruptcy. Creditors very sophisticated; some were even counting on it when they initiated their exposure to these organizations.
Gary Stern on Too Big to Fail | EconTalk | Library of Economics and Liberty
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