Peak shape: the sharp peak — flat trough pattern

Abstract

In the autumn of 1998 the American Federal Reserve set up a consortium of banks and financial institutions in order to bail out a large hedge fund called Long-Term Capital Management. The clientele of this mutual fund comprised a small number of wealthy individuals for whom it tried to secure high rates of return through intricate transactions mainly in the derivatives market for interest rates. In a statement delivered on October 1, 1998 before a committee of the House of Representatives, A. Greenspan, the chairman of the Federal Reserve justified his policy by pointing out that LTCM’s portfolio was so entangled that it was virtually impossible to avoid what in the financial jargon is called a fire sale i.e. a sale at a considerable discount. Given the fragility of the markets, he added, such a liquidation could have triggered other failures and eventually lead to a severe drying up of market liquidity. At the same time the Federal Reserve cut interest rates three times to prop up stock markets. Subsequently, in December 1999, the Fed flooded the banking system with money to deal with the so-called Y2K (i.e. transition to year 2000) problem, an action that has been credited with fueling the December and January 2000 spurt of the NASDAQ index (Commercial Appeal, 23 January 2000). No doubt that by taking such moves the Fed has supported and prolonged the bull market. Later on in this chapter we will see that there are indeed good reasons to think that without such measures the end of 1998 would have marked a turning point.