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READING 6: FINANCIAL DISASTERS #5

Open Grefer opened 5 years ago

Grefer commented 5 years ago

https://www.melonsblog.cn/2019/09/reading-6-financial-disasters.html#more

Grefer commented 4 years ago

A major contributing factor to the collapse of LTCM is that it did not account properly for the illiquidity of its largest positions in its risk calculations. LTCM received valuation reports from dealers who only knew a small portion of LTCM’s total position in particular securities, therefore understating LTCM’s true liquidity risk. When the markets became unsettled due to the Russian debt crisis in August 1998 and a separate firm decided to liquidate large positions which were similar to many at LTCM, the illiquidity of LTCM’s positions forced it into a situation where it was reluctant to sell and create an even more dramatic adverse market impact even as its equity was rapidly deteriorating. To avert a full collapse, LTCM’s creditors finally stepped in to provide USD 3.65 billion in additional liquidity to allow LTCM to continue holding its positions through the turbulent market conditions in the fall of 1998. However, as a result, investors and managers in LTCM other than the creditors themselves lost almost all their investment in the fund.

Grefer commented 4 years ago

Orange County imploded when Robert Citron made a large bet on inverse floating swaps, which was not fully understood by the county’s board of directors, and blew up when interest rates rose. Citron later admitted that he did not understand either the position that he took or the risk exposure of the fund.

Grefer commented 4 years ago

Poor correlation modeling was more a central theme of the subprime crisis or Long Term Capital Management (although the LTCM incident did not occur during a crisis.) The London Whale case took place in 2012, well after the end of the crisis, and its main themes were poor corporate governance with respect to risk concentration limits, position limits and VaR models.

Grefer commented 4 years ago

The Northern Rock case was a run on the bank which occurred partly due to an overreliance on repurchase agreements and liquidity risk when repo financing dried up.

Grefer commented 4 years ago

The LTCM case was a case of incorrect correlation modeling and inadequate stress testing. As a hedge fund, LTCM was not covered by regulatory capital requirements at the time.