Long Term Management's: $3.5 Billion Tranquilizer

Why the Fed took a hand in crafting an LTCM bailout plan

The turmoil in global markets rolled into the New York Federal Reserve on Sept. 23. In an emergency meeting at the stone fortress in the heart of the financial district, two dozen bankers from the world's leading financial firms convened to prevent the failure of hedge fund giant Long Term Capital Management--and head off a possible market panic, say market sources. As a measure of the gravity of the meeting, Goldman, Sachs & Co.'s co-chief executive Jon S. Corzine and J.P. Morgan & Co. Chairman Douglas A. Warner III were there.

LTCM, founded by former Salomon Inc. traders including John Meriwether, had already lost $2 billion of its $4 billion in the first eight months of 1998, and was facing liquidation due to huge losses in fixed-income markets around the world. The plan, which was reached on the evening of the 23rd, called for a consortium of major banks and investment firms to put up more than $3.5 billion in new equity for LTCM. In return, LTCM will give up control to an oversight committee that will run the firm. Members will include representatives of Goldman Sachs, Merrill Lynch, Morgan Stanley Dean Witter, Travelers Group, and UBS. "We greatly appreciate the willingness of the consortium to provide capital," Meriwether said in a statement.

The hedge fund's crisis began around Sept. 18. Bear Stearns & Co., an LTCM lender, had asked the fund to reduce trading positions because the value of bonds LTCM had pledged as collateral had fallen, sources say. That forced LTCM to find new financing. The firm turned to a $500 million committed credit facility that LTCM had lined up for just this situation, say market sources.

But some of the banks in the syndicate balked at letting LTCM draw down their credit, say market sources, because LTCM was close to defaulting on some loan covenants.

That's when LTCM, whose partners include former Federal Reserve Vice-Chairman David W. Mullins Jr., called the Fed. One source says LTCM first asked the New York Fed to force its banks to honor their commitments. In any event, the prospect of an LTCM failure brought swift attention from the Fed. "This could spook the market if this thing went down and nobody did anything," says Roy C. Smith, a finance professor at New York University.

On the evening of Monday, Sept. 21, a meeting was held at LTCM's Greenwich (Conn.) headquarters with its banks. The initial proposal was for the banks to cough up $250 million each to buy LTCM for $4 billion, say market sources. Some balked, but others pressed for a quick resolution.

Few traders missed the irony: Even as news of the bailout plan emerged on CNBC on the 23rd, Fed Chairman Alan Greenspan was warning Congress that the worsening global crisis required action by the U.S. Both in public and behind closed doors.

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