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News > Companies
LTC bailout reassures
September 24, 1998: 2:48 p.m. ET

But the $3.5B hedge fund rescue is seen as stop-gap measure; volatility persists
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NEW YORK (CNNfn) - Less than 24 hours after a consortium of Wall Street's leading banks agreed to pony up $3.5 billion to bail out a foundering U.S. hedge fund, investors were still trying to gauge the fallout from Long Term Capital's problems.
     "There's obviously been a variety of issues swirling around the banks and the big broker dealers, and this is yet one more straw," said Diane Glossman, a banking analyst with Lehman Brothers, referring to the eleventh-hour rescue package for Long-Term Capital Management.
     Adding to the disarray, UBS AG, Europe's biggest bank, cited global market turmoil Wednesday for an expected skid in its third quarter net income. UBS said it anticipated an after-tax loss in the third quarter of $360 million to $716 million.
     The bank also warned it would take a nearly $700 million charge to write down the value of its investment in LTCM.
     The UBS warning sparked a downturn in major banking issues - including several of the big-name financial institutions that participated in the LTCM bailout.
     Shares of Morgan Stanley Dean Witter (MWD) slid 4-11/16 to 52-9/16 on active trading volume of more than 3 million shares. Travelers Group (TRV) stock eased 2-7/16 to 40-1/2, while Merrill Lynch (MER) gave up 4-1/4 points to 53-3/4.
    
Easing some of the strain

     Yet even as investors fumbled for a new comfort zone, many analysts gave a sigh of relief that LTC's salvation - though little more than a stop-gap solution to a larger problem - would help ease some of the strain on hard-pressed hedge funds across the industry.
     In recent weeks, as the Asian contagion infected Russia's bumbling economy - leading to a wholesale freeze on repayments of ruble-denominated debt - many investment firms had been scrambling to "deleverage" their holdings.
     LTC's cash infusion, said people familiar with the mechanics of the deal, may help reassure some of the more overextended funds that the sky isn't falling.
     "It will reinforce what's happened recently in the debt markets, (the idea) that there's been a sharp underperformance in high-risk assets," said Anthony Crescenzi, a bond analyst with Miller Tabak Hirsch.
     "But the resolution of the issue may begin to alleviate fears about systemic risk…Today we should all be looking at our financial system and saying these risks are very low, very few, and that we have a financial system that is sound," Crescenzi added.
     Crescenzi noted that a positive earnings report from investment banking firm Lehman Brothers Holdings - which on Wednesday posted third-quarter profits of $151 million, in line with Wall Street estimates - may help shore up market confidence as well. (Nonetheless, Lehman's results reflected a $60 million reduction due to a drop-off in global business.)
     America's economic custodians echoed these sentiments Thursday at the highest levels.
     U.S. Treasury Secretary Robert Rubin said the threatened collapse of LTC was not a systemic danger to the U.S. economy, despite heightened risks to domestic markets from the global economic tumult.
    
Rubin: No systemic danger

     "We always have to be watchful with respect to anything that can affect our system," Rubin said after a Treasury Department ceremony marking the launch of a new $20 bill. "But I don't know of anything in that area that rises to the level of a systemic risk to our economy at this time."
     LTC's blockbuster bailout, brokered Wednesday by the Federal Reserve Bank of New York in a rare conclave with top executives at 16 leading banks, brought the hedge fund back from the brink of imminent collapse.
     But on a broader level the rescue package served as a poignant reminder of the pitfalls awaiting highly-exposed financial firms in a global economy run amok.
     Long-Term, a brainchild of trading superstar John Meriwether, built its highflying portfolio on multi-million-dollar arbitrage-trading strategies sprinkled liberally across the globe, analysts said.
     Its strategy hinged on a pervasive practice in the hedge-fund world known as "shorting", in which highly leveraged, borrowed securities were sold in hopes of a future buyback at lower prices.
     LTC's bailout, to be fair, represents just a fraction of the hedge-fund industry's estimated $300 billion. But because the funds tend to be highly leveraged, their exposure to financial markets can be far greater, analysts say.
     The funds rely on a nexus of close relationships to the banks that serve as their primary creditors. The impresarios of the leading funds, like Meriwether at LTC, have wowed Wall Street's elite with their bravura flair in building great fortunes on aggressive, multibillion dollar bets eschewed by more conservative funds such as pensions or mutual funds.
    
Stripped of invulnerable aura

     Lately, however, that reverence has turned to remorse - and regret - as a fraying global financial system has stripped many of the funds of their aura of invulnerability.
     In times of economic turmoil, banks will often demand more collateral from the funds, a practice that is known as calling in a margin. When LTC found itself so squeezed at the margins that it was unable to cover its exposure, a bailout became the only alternative to liquidation.
     Even as bond traders in the United States braced for the possibility of new market shocks in the wake of the bailout, international efforts to stem fallout from LTC's troubles intensified.
     In London, Britain's Financial Services Authority, or FSA, said it has asked 55 financial firms to provide details of their exposure to hedge funds, Reuters reported Thursday.
     The FSA reportedly singled out for scrutiny so-called "complex groups" - or firms whose businesses encompass a wide array of activities in the financial services industry.
     At the same time, British bank Barclays PLC confirmed that it had taken part in the LTC bailout but insisted its participation would have no effect on profits or losses at the bank.
     Some analysts said Thursday that the rescue of LTC would make the deleveraging of other exposed hedge funds more orderly. "But we'll still continue to see deleveraging up through year-end," said one analyst, who requested anonymity since his firm participated in the bailout.
     The same analyst suggested that Federal reserve Chairman Alan Greenspan's "friendly speech" Wednesday, in which he hinted at an imminent interest rate cut, would cheer markets.
     "That also takes a little bit of the pressure off," he said.Back to top
     --By staff writer Douglas Herbert, with additional material from wire reports

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.