Hedge Fund Transparency is no Silver Bullet!

Abstract

In September 1998, a consortium of sixteen banks and US broker-dealers restructured the ownership of the hedge fund, Long Term Capital Management (LTCM). Among the biggest, best-known and most respected hedge funds, LTCM held positions that had fallen so far in value that calls for collateral had virtually exhausted the firm’s capital. LTCM was not alone. Other hedge funds were also printing double-digit red ink. The consensus holds that a global widening of credit spreads did this damage and that the Russian government’s moratorium on debt payments (announced on August 17th) was a catalytic event. As the magnitude of hedge fund exposures to global credits became clear, the funds’ bankers sharply increased collateral calls. Throughout September and October some funds were pushed into bankruptcy and many more were pushed to the brink. Trading desks at money center banks and their counterparts in the broker-dealer community held positions that mirrored those of their hedge fund clients. They suffered equivalent mark to market losses as well. Credit in the interbank market became so tight that the U.S. Federal Reserve Bank injected substantial new reserves into the banking system and abandoned its tightening bias in monetary policy. These actions were designed to bring order to the credit markets and to avert a global credit crunch. By November, order had returned to the markets and a process of evaluation began. The post morterm is now nearing completion.