Long-Term Capital Management

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Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether, the famed Salomon Brothers bond trader. Meriwether assembled an all-star team of traders and academics in an attempt to create a fund that would profit from the combination of the academics' quantitative models and the traders' market judgement and execution capabilities. Also on board were the Nobel-prize winning economists Myron Scholes and Robert Merton, and David Mullins, a former vice-chairman of the Federal Reserve Board who quit his job to become a partner at LTCM. 80 founding investors put up $10 million apiece, including Bear Stearns and Merrill Lynch.

LTCM's main strategy was convergence trades. These trades involved finding securities that were mispriced relative to one another, and going long in the cheap ones and selling short the expensive ones.

LTCM attracted sophisticated investors, including many large investment banks, who invested $1.3 billion at its inception. Four years later, however, at the end of September 1998, the fund had lost substantial amounts of the investors' equity capital and was on the brink of default. To avoid the threat of a systemic crisis in the world financial system, the Federal Reserve orchestrated a $3.5 billion rescue package from leading U.S. investment and commercial banks. In exchange the participants received 90% of LTCM's equity.^[1]

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