<<
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.
My understanding is that a plurality of the meltdown in LTCM's value came from the divergence between US and overseas bonds (e.g. Russian vs US) not US corporates vs. Treasuries. In fact, the spreads between Corps and Treas have been widening for several months.
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.
To the extent that UBS et. al. are now in even deeper (albeit as "owners"), I'm not sure this is really an improvement. It is also quite possible that many banks haven't even recognized that a margin call is needed at this time. I suspect the opaqueness of valuing a lot of these exotic instruments is preventing a "marking to market." By the way, I do agree with Tom that the situation may have an upside (e.g. GEICO was underwater in 1974 because its bond portfoilio had lost so much value, and yet they have benefitted from a secular bull bond market) however, it is very unclear at this time wether LTCM has the internal capital structure to wait this out.
If corporate-bond rates begin to
fall (easier monetary policy anyone?)
Not necessarily - default risk premium may rear its head and offset the deflation premium.
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
tandum. >>
I'm not sure that interest rates move in tandem - especially given the weird shape of the current yield curve. The expectation from the y-curve is a SHORT recession and then a return to the "nirvana" economy. I think this is optimistic, the NASDAQ is down some +25% and there doesn't seem to be a lot of support. A lot os risk is becoming "systematic" which to me "smells like Keynes' spirit."
Jason