F i liquidating trust
P., collapsed in the late 1990s, leading to an agreement on September 23, 1998, among 16 financial institutions—which included Bankers Trust, Barclays, Bear Stearns, Chase Manhattan Bank, Crédit Agricole, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, JP Morgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, Paribas, Salomon Smith Barney, Société Générale, and UBS—for a .6 billion recapitalization (bailout) under the supervision of the Federal Reserve. Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers.
Members of LTCM's board of directors included Myron S. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a "new method to determine the value of derivatives".
It would therefore tend to create losses by making the 30-year bond that LTCM was short more expensive (and the 29.75-year bond they owned cheaper) even if there had been no change in the true relative valuation of the securities.
This exposure to the shape of the yield curve could be managed at a portfolio level, and hedged out by entering a smaller steepener in other similar securities.
For example, the most recently issued treasury bond in the US – known as the benchmark – will be more liquid than bonds of similar but slightly shorter maturity that were issued previously.
Trading is concentrated in the benchmark bond, and transaction costs are lower for buying or selling it.
The fund's operation was designed to have extremely low overhead; trades were conducted through a partnership with Bear Stearns and client relations were handled by Merrill Lynch.
The earnings for partners in a hedge fund was taxed at the higher rate applying to income, and LTCM applied its financial engineering expertise to legally transform income into capital gains.
It did so by engaging in a transaction with UBS (Union Bank of Switzerland) that would defer foreign interest income for seven years, thereby being able to earn the more favourable capital gains treatment.
With the help of Merrill Lynch, LTCM secured hundreds of millions of dollars from business owners, celebrities and even private university endowments and later the Italian central bank.
The bulk of the money, however, came from companies and individuals connected to the financial industry.