LongTerm Capital Management 4 50 4 00 3

Long-Term Capital Management $4. 50 4. 00 3. 00 2. 00 1. 00 0. 00 3/1994 1/1995 1/1996 1/1997 1/1998 Gross value of $1 invested March 1994 - October 1998 in LTCM When Genius Failed pp. xiv *** Bailouts Seminar Karen Bradshaw, Molly Grovak, Drew Navikas, Asha Spencer

Agenda • • Background Framework for analysis Was LTCM a bailout? Was LTCM successful (as a bailout)? Relevance to Current Crisis Conclusions Questions

LOANS ES S PR BA U O IL $ = T B 6. 3 E Black UR Bond ce perien g ex tradin Scholes ther % o 40 t p U rns retu iwe Merton Mullins INVESTMENTS Up to $1 trillion in derivatives LTCM $1. 25 billion up to $7 B down to $555 M PRES SURE LOANS

Background

Background

Background Russia defaults 80% loss over 5 weeks $4. 50 4. 00 3. 00 2. 00 1. 00 0. 00 3/1994 1/1995 1/1996 1/1997 1/1998 Gross value of $1 invested March 1994 - October 1998 in LTCM When Genius Failed pp. xiv

Background

Background MISFIRE Wall Street’s Rocket Scientists thought they had a surefire way to bear the markets. Boy, were they wrong! -Business Week, Sept 21, 1998

FRAMEWORK ASK Framework for Analysis Was LTCM a bailout? Was LTCM successful (as a bailout)? 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 a Bailout? What makes something a bailout? Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders Market Players The Fed Treasury Congress

Was LTCM a Bailout? What makes something a bailout? Input of private parties Government intervention More like a bailout WHO Principals of the firm WHAT/ WHY Existing creditors and stakeholders Market facilitation Jumpstart private negotiations Market Players The Fed Treasury Government intervention More like a bailout Stopping a downward spiral Propping up firms during economic turbulence Congress Emulating private market when dysfunctional Gov’t intervention to pursue normative vision

Was LTCM a Bailout? What makes something a bailout? Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders Market Players GE Immelt bonus Law firm partners Chapter 11 Buffet & GS WHAT/ WHY Market facilitation Jumpstart private negotiations Chrysler 1979 The Fed Discount window BOA & Merrill Treasury Congress Detroit Today TARP HOLC Chrysler 1979 Government intervention More like a bailout Stopping a downward spiral Propping up firms during economic turbulence S&L Housing Detroit Today Chrysler 1979 Emulating private market when dysfunctional TARP Gov’t intervention to pursue normative vision Detroit Today American Dream: F&F

Was LTCM a Bailout? Yes yes! ~ NO Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders LTCM WHAT/ WHY Market Players LTCM Market facilitation The Fed Treasury LTCM Government intervention More like a bailout Jumpstart private negotiations Stopping a downward spiral LTCM Congress Propping up firms during economic turbulence Emulating private market when dysfunctional Gov’t intervention to pursue normative vision

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)?

people impacted 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 first party short-term long-term t

people impacted third party Short-term impact on third parties Short-term impact on first parties Shielding Stakeholders Long-term impact on third parties Long-term impact on first parties Reputational Harm Autos, S&L, Banks first party Saving Jobs Keeping Homes Chrysler, Detroit HOLC, F&F, S&L short-term long-term t

people impacted third party Short-term impact on third parties Long-term impact on third parties Home Ownership Public Policy S&L, F&F American Autos Chrysler, Detroit Economic Growth Panic/Confidence Easy Credit TARP Short-term impact on first parties Shielding Stakeholders Long-term impact on first parties Reputational Harm Autos, S&L, Banks first party Saving Jobs Keeping Homes Chrysler, Detroit HOLC, F&F, S&L short-term long-term t

people impacted third party Short-term impact on third parties Long-term impact on third parties Home Ownership Public Policy S&L, F&F American Autos Chrysler, Detroit Economic Growth Panic/Confidence Easy Credit TARP Short-term impact on first parties Shielding Stakeholders first party Long-term impact on first parties Reputational Harm Preserving Jobs Autos, S&L, Banks Chrysler, Detroit Saving Jobs Keeping Homes Chrysler, Detroit HOLC, F&F, S&L Moral Hazard Autos, S&L, Banks short-term long-term t

people impacted third party Short-term impact on third parties Home Ownership Public Policy S&L, F&F American Autos Chrysler, Detroit Economic Growth Panic/Confidence Easy Credit TARP Short-term impact on first parties Shielding Stakeholders first party Long-term impact on third parties Opportunity Cost Preserving Networks Chrysler, Detroit Preserving Jobs Autos, S&L, Banks Chrysler, Detroit Keeping Homes Chrysler, Detroit HOLC, F&F, S&L TARP, Chrysler, F&F Moral Hazard Market Learning S&L, Chrysler Long-term impact on first parties Reputational Harm Saving Jobs Barrier to Entry, Alternative Investment Moral Hazard Autos, S&L, Banks short-term long-term t

people impacted third party Short-term impact on third parties Long-term impact on third parties Home Ownership Public Policy S&L, F&F Opportunity Cost American Autos Chrysler, Detroit Economic Growth Panic/Confidence Easy Credit TARP Stopping Downward Short-term impact on first parties Spiral Shielding Stakeholders first party Preserving Networks Chrysler, Detroit Preserving Jobs Autos, S&L, Banks Chrysler, Detroit Keeping Homes Chrysler, Detroit HOLC, F&F, S&L Muting Economic Turbulence TARP, Chrysler, F&F Moral Hazard Market Learning S&L, Chrysler Long-term impact on first parties Reputational Harm Saving Jobs Barrier to Entry, Alternative Investment Moral Hazard Autos, S&L, Banks Chrysler, S&L short-term long-term t

people impacted third party Short-term impact on third parties Long-term impact on third parties Public Policy Economic Growth Opportunity Cost Panic/Confidence Stopping Downward Short-term impact on first parties Spiral Shielding Stakeholders Reputational Harm short-term Moral Hazard Long-term impact on first parties Preserving Jobs Muting Economic Turbulence first party Preserving Networks Moral Hazard long-term t

people impacted third party Short-term impact on third parties Long-term impact on third parties Public Policy Economic Growth Opportunity Cost Panic/Confidence + prevented credit meltdown Stopping Downward Short-term impact on first parties Spiral Shielding Stakeholders first party Reputational Harm + no huge costs in human capital + unwound at a profit + internalized losses + investors who got out early short-term Preserving Networks Moral Hazard +/- precedent for Fed involvement +/- avoided regulation Long-term impact on first parties Preserving Jobs Muting Economic Turbulence Moral Hazard + mitigated moral hazard long-term t

people impacted third party Short-term impact on third parties Long-term impact on third parties Public Policy Economic Growth Opportunity Cost Panic/Confidence + prevented credit meltdown Stopping Downward Short-term impact on first parties Spiral Shielding Stakeholders first party Reputational Harm + no huge costs in human capital + unwound at a profit + internalized losses + investors who got out early - reputational decline short-term Preserving Networks - benefit financial gaming - made quantitative investment less risky - “how to” rather than a ghost story Moral Hazard +/- precedent for Fed involvement +/- avoided regulation Long-term impact on first parties Preserving Jobs Muting Economic Turbulence Moral Hazard + mitigated moral hazard - didn’t continue as a going concern long-term t

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?

LOANS ES S PR BA U O IL $ = T B 6. 3 E Black UR Bond ce perien g ex tradin Scholes ther % o 40 t p U rns retu iwe Merton Mullins INVESTMENTS Up to $1 trillion in derivatives LTCM $1. 25 billion up to $7 B down to $555 M PRES SURE LOANS