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Quote of the Day
“…long term thinking is a luxury not always available to the highly leveraged; they may not survive that long.”-Roger Lowenstein, from his book, When Genius Failed: The Rise and Fall of Long Term Capital Management.
This day in history marks an event that would be one of the primary reasons for LTCM’s collapse.
August 17th – This Day in Stock Market History
August 17th, 1987 – The Dow Jones Industrial Average closes above 2,700 for the first time.
The milestone came just 1 week after the Dow eclipsed the 2,600 barrier for the first time. It would be the fastest 100 point climb in the Dow’s history.
The market was on a tear in 1987, but it would not last much longer. On August 26th, 1987 the Dow would close at 2,722.42, which would be its high before “Black Monday – October 19th, 1987“. It would take the market until August 24th, 1989 to set a new all time high.
August 17th, 1998 – Russia effectively defaults on its foreign debt as it declares a “debt moratorium”.
U.S. stock markets do not panic initially, but by Friday August 21st worldwide stock markets plunge, as the Dow falls 280 points (about 3%) intra-day, the stock market in Caracas fell 9.5%, Brazil fell 6% and Germany fell 2%.
The panic caused by Russia was hurting one hedge fund in particular – Long Term Capital Management, who had $3.6 billion in assets leveraged at 25 to 1, much of which was used to bet heavily on Russian bonds. Within 5 weeks of Russia’s default, all equity of the fund would be lost.
Source: When Genius Failed
Best August 17th in Dow Jones Industrial Average History
1933 – Up 5.33%, 4.86 points.
Worst August 17th in Dow Jones Industrial Average History
1931 – Down 3.31%, 4.82 points.
Read of the Day
Warren Buffett talked about the fall of Long Term Capital Management in his 2002 letter to shareholders:
“Indeed, in 1998, the leveraged and derivatives-heavy activities of a single hedge fund, long-term capital management, caused the Federal Reserve anxieties so severe that it hastily orchestrated a rescue effort. In later congressional testimony, Fed officials acknowledged that, had they not intervened, that outstanding trades of LTCM – a firm unknown to the general public and employing only a few hundred people – could well have posed a serious threat to the stability of American markets. In other words, the Fed acted because its leaders were fearful of what might have happened to other financial institutions had the LTCM and Domino toppled. And this affair, though it paralyzed many parts of the fixed income market for weeks, was far from a worst-case scenario.
One of the derivatives instruments that LTCM used was total return swaps, contracts that facilitate 100% leverage in various markets, including stocks. For example, party a to a contract, usually a bank, puts up all the money for the purchase of the stock will party be, without putting up any capital, agrees that at a future date it will receive any gain or pay any loss that the bank realizes.”
Alice Schroeder also gives a very detailed account of Warren Buffett’s near rescue of Long Term Capital in Buffett’s biography, The Snowball