central punters

Brad De Long delong at econ.Berkeley.EDU
Sun Oct 4 20:56:05 PDT 1998

>Doug wrote:
>>But people are losing big money on LTCM--less than they would have
>>without the bailout for sure, but the banks, investors, and partners are
>>all taking big hits. Not that they're worth a tear, but you can't say no
>>one's losing anything.
>Public info is sketchy to say the least but it looks like LTCM only got
>into trouble because corporate-bond rates increased while the yields of
>Govts have fallen. The bet is that this is a temporary divergence.
>Apparently the bailout simply converts margin calls for cash into equity
>positions for new investors on this bet. If corporate-bond rates begin to
>fall (easier monetary policy anyone?) then the bet will still payoff, for
>the new equity investors as well as for Meriwether and Co. In other
>words, it
>seems a bit immature to say who's going to emerge from this thing
>fabulously rich. We basically have the Fed helping LTCM to continue to
>ante up until an easing of monetary policy can win the pot for Meriwether
>and Co..After all, it is reasonable to bet that interest rates move in
>Edwin Dickens

But not that they will converge--which is what LTCM has bet on.

It may be that LTCM's strategy was fundamentally sound, but undercapitalized given the amount of "noise" in the market these days (that's what Robert Merton argued was the case when Metallgesellschaft got into trouble, and I presume that's what he's arguing now). And to the extent that LTCM's new owners buy this argument, expect them to continue the strategy rather than to try to unwind the positions.

I'm interested to figure out what the new owners think: it is their money at stake now, after all...

Brad DeLong

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