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Bailouts Seminar Karen Bradshaw, Molly Grovak, Drew Navikas, Asha
Spencer
Long-Term Capital Management
Gross value of $1 invested March 1994 - October 1998 in LTCMWhen Genius Failed pp. xiv
3/1994 1/1995 1/1996 1/1997 1/1998
$4.50
4.00
3.00
2.00
1.00
0.00
***
Agenda
• Background• Framework for analysis• Was LTCM a bailout?• Was LTCM successful (as a bailout)?
• Relevance to Current Crisis• Conclusions• Questions
LTCM
BAILOUT = $3.6BLOANS
LOANS
INVESTMENTSMerton
Meriwether
Scholes
Mullins
Black
PRESSURE
PRES
SURE
Bond trading experience
$1.25 billion up to $7B down to $555M
Up to 40%
returns
Up to $1 trillion in derivatives
Background
Background
3/1994 1/1995 1/1996 1/1997 1/1998
$4.50
4.00
3.00
2.00
1.00
0.00
Gross value of $1 invested March 1994 - October 1998 in LTCMWhen Genius Failed pp. xiv
Background
80% loss over 5 weeksRussia defaults
BackgroundBank Amount
ContributedBankers Trust $300MBarclays 300MChase 300MCSFB 300MDeutsche Bank 300MGoldman Sachs 300MMerrill Lynch 300MJP Morgan 300MMorgan Stanley 300MSalomon 300MUBS 300MSociété Générale 125MLehman Bros 100MParibas 100MBear Stearns $0. (Karma)
Total: $3.625B
Background
Wall Street’s Rocket Scientists thought they had a surefire way to bear the markets. Boy, were they wrong!
-Business Week, Sept 21, 1998
MISFIRE
Framework for Analysis
1. Use case studies from class to define the criteria for determining a bailout/success
2. Consider whether LTCM qualifies as a bailout/success against the criteria
3. Determine whether LTCM was a bailout/success and how LTCM might impact the criteria
Was LTCM a bailout?
Was LTCM successful (as a bailout)?
FRAMEWORK
ASK
Was LTCM a bailout?
Was LTCM a Bailout?What makes something a bailout?Input of private parties
Government interventionMore like a bailout
WHOPrincipals of the firm
Existing creditors and stakeholders
Market Players The Fed Treasury Congress
Was LTCM a Bailout?What makes something a bailout?
WHAT/WHY
Marketfacilitation
Government interventionMore like a bailout
Input of private parties
Government interventionMore like a bailout
WHOPrincipals of the firm
Existing creditors and stakeholders
Market Players The Fed Treasury Congress
Jumpstart private
negotiations
Stopping a downward spiral
Propping up firmsduring economicturbulence
Emulating private market
when dysfunctional
Gov’t intervention to pursue normative vision
Was LTCM a Bailout?
WHAT/WHY
Marketfacilitation
Government interventionMore like a bailout
Input of private parties
Government interventionMore like a bailout
WHOPrincipals of the firm
Existing creditors and stakeholders
Chapter 11GE Immelt bonusLaw firm partners
Market Players
Buffet & GS
The Fed Treasury
Detroit Today
Congress
TARPHOLC
Chrysler 1979
Jumpstart private
negotiations
Chrysler 1979
Stopping a downward spiral
S&LHousing
Propping up firmsduring economicturbulence Detroit TodayChrysler 1979
Emulating private market
when dysfunctional
TARP
Gov’t intervention to pursue normative vision
Detroit TodayAmerican Dream:
F&F
What makes something a bailout?
Discount windowBOA & Merrill
Was LTCM a Bailout?Yes yes yes! ~ NO
WHAT/WHY
Marketfacilitation
Government interventionMore like a bailout
Input of private parties
Government interventionMore like a bailout
WHOPrincipals of the firm
Existing creditors and stakeholders
Market Players The Fed Treasury Congress
Jumpstart private
negotiations
Stopping a downward spiral
Propping up firmsduring economicturbulence
Emulating private market
when dysfunctional
Gov’t intervention to pursue normative vision
LTCM LTCM LTCM
LTCMLTCM
Why does it matter?
• Distributes the perception of responsibility– Bailout = needed rescuing/failure by managers
– Not a Bailout = this was a function of regulatory choices and global markets
• Sets criteria by which we measure success
Was LTCM successful
(as a bailout)?
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Reputational Harm
Shielding Stakeholder
s Autos, S&L, Banks
Saving JobsChrysler, Detroit
Keeping HomesHOLC, F&F, S&L
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Reputational Harm
Shielding Stakeholder
s
Home OwnershipS&L, F&F
American AutosChrysler, Detroit
Easy CreditTARP
TARP
Autos, S&L, Banks
Saving JobsChrysler, Detroit
Keeping HomesHOLC, F&F, S&L
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Preserving Jobs
Moral Hazard
Reputational Harm
Shielding Stakeholder
s
Home OwnershipS&L, F&F
American AutosChrysler, Detroit
Easy CreditTARP
TARP
Autos, S&L, Banks
Saving JobsChrysler, Detroit
Keeping HomesHOLC, F&F, S&L
Chrysler, Detroit
Autos, S&L, Banks
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Opportunity Cost
Preserving Networks
Moral Hazard
Preserving Jobs
Moral Hazard
Reputational Harm
Shielding Stakeholder
s
Home OwnershipS&L, F&F
American AutosChrysler, Detroit
Easy CreditTARP
TARPChrysler, Detroit
Market LearningS&L, Chrysler
Barrier to Entry, Alternative Investment
TARP, Chrysler, F&F
Autos, S&L, Banks
Saving JobsChrysler, Detroit
Keeping HomesHOLC, F&F, S&L
Chrysler, Detroit
Autos, S&L, Banks
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Opportunity Cost
Preserving Networks
Moral Hazard
Preserving Jobs
Muting Economic Turbulence
Moral Hazard
Stopping Downward Spiral
Reputational Harm
Shielding Stakeholder
s
Home OwnershipS&L, F&F
American AutosChrysler, Detroit
Easy CreditTARP
TARPChrysler, Detroit
Market LearningS&L, Chrysler
Barrier to Entry, Alternative Investment
TARP, Chrysler, F&F
Autos, S&L, Banks
Saving JobsChrysler, Detroit
Keeping HomesHOLC, F&F, S&L
Chrysler, S&L
Chrysler, Detroit
Autos, S&L, Banks
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Opportunity Cost
Preserving Networks
Moral Hazard
Preserving Jobs
Muting Economic Turbulence
Moral Hazard
Stopping Downward Spiral
Reputational Harm
Shielding Stakeholder
s
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Opportunity Cost
Preserving Networks
Moral Hazard
Preserving Jobs
Muting Economic Turbulence
Moral Hazard
Stopping Downward Spiral
Reputational Harm
Shielding Stakeholder
s
+ no huge costs in human capital+ unwound at a profit+ internalized losses+ investors who got out early
+ prevented credit meltdown+/- precedent for Fed involvement+/- avoided regulation
+ mitigated moral hazard
t
people impacted
short-term long-term
first party
third party
Short-term impact on third parties
Short-term impact on first parties
Long-term impact on third parties
Long-term impact on first parties
Public Policy
Economic Growth Panic/
Confidence
Opportunity Cost
Preserving Networks
Moral Hazard
Preserving Jobs
Muting Economic Turbulence
Moral Hazard
Stopping Downward Spiral
Reputational Harm
Shielding Stakeholder
s
- benefit financial gaming- made quantitative investment less risky- “how to” rather than a ghost story
+ no huge costs in human capital+ unwound at a profit+ internalized losses+ investors who got out early- reputational decline
+ prevented credit meltdown+/- precedent for Fed involvement+/- avoided regulation
+ mitigated moral hazard- didn’t continue as a going concern
Relevance to Current Crisis
• Investment strategies
• Market dynamics
• Moral hazards
Conclusions
• How do we put a stop to the learning gap without knee-jerk regulation?
• What should LTCM have led the Fed and Treasury to ask about Bear and Lehman?
• Why shotgun weddings without equity?
Questions?
LTCM
BAILOUT = $3.6BLOANS
LOANS
INVESTMENTSMerton
Meriwether
Scholes
Mullins
Black
PRESSURE
PRES
SURE
Bond trading experience
$1.25 billion up to $7B down to $555M
Up to 40%
returns
Up to $1 trillion in derivatives