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LONG-TERM CAPITAL MANAGEMENT REVISITED: ACCOMMODATIONS FOR INTERNATIONAL MARKETS

Jill L. Wetmore

Saginaw Valley State University, USA.

 

ABSTRACT

The Long-Term Capital Management (LTCM) debacle of 1998 created serious problems for a number of major financial institutions worldwide. The fund was run by some of the most illustrious scholars in economics and finance. Before 1998, stellar returns kept the investors happy and not questioning the lack of transparency in accounting statements and inability to withdraw funds. The fund refunded capital to the shareholders in 1997. This among other actions involving misreading of risk left LTCM in a precarious position. By September 1998, losses were reported and a bailout occurred by the end of the month.

Thirteen of the fourteen banks participating in the bailout are included in this study. Since non U.S. banks are included for the first time, methodology is adjusted for changes in time, foreign exchange, and financial markets. The purpose is to determine the effects of non U.S. bank stock returns on the results and how non U.S banks fared in the bailout. Results are similar for U.S. financial institutions indication a global robustness of methodology.

In this study, stock prices of financial institutions participating in the bailout dropped by over 21% from the time of LTCM’s announcement of losses through the bailout period. This represents an abnormal decline when compared with banks that did not participate in the bailout nor had no loan exposure in the case of lending to LTCM. As a comparison, prices of commercial bank stocks without exposure to LTCM and two market indices show increases of 10.97%, 5.47%, and 2.53% respectively.

Of the bailout participants, U.S. banks perform somewhat better than investment banks and non U.S. banks suggesting a small insurance effect. Non U.S. banks appear not to have benefited by the announcement of the FED takeover of the bailout on September 18.

Evidence of contagion is revealed by significant negative abnormal returns during the loss announcement and bailout period by banks with no investment or loans to LTCM showing a significant negative return. The announcement on September 2, 1998 is a surprise despite earlier hints of problems with the investments of LTCM. Results are similar to those of earlier studies despite the inclusion of non U.S. banks and alternative methodology.

Key words: commercial banking, Long-term Capital Management, event study, financial institutions, abnormal returns

JEL codes: G21, G14