Lessons of the Fall: LTCM's Meriwether May Rise Again

Halfway out of LTCM's $3.6 billion hole, John Meriwether looks for his next frontier. Talk about it on our message boards.
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It's been 366 days since a group of major banks rescued

Long Term Capital Management

, and one imagines its founder

John Meriwether

scratching off each day on the walls of his mind the way a prisoner would mark the passing of a jail sentence.

The past year must've seemed like hard time for Meriwether, a former

Salomon Brothers

vice chairman and the mastermind behind the hedge fund that at its zenith managed $7.5 billion and at its nadir was considered a threat to the stability of global financial markets.

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Yet last year's baggage hasn't stopped Meriwether from sending out feelers for a new fund. He may, however, have some obstacles in getting started.

There are the debts: In addition to all original investors, who were redeemed in June, the fund must still repay some $1.8 billion to the 14 banks that anted up $3.6 billion last September. Roughly half of the rescue package has already been repaid, says Peter Rosenthal, a spokesman for LTCM and the bank consortium that now oversees the fund.

But without the leverage that allowed LTCM to generate 45% returns some years, it's as if the

Ferrari

has become an

Oldsmobile

. In the past 12 months, the fund is up just 15%, trailing the return of the

S&P 500

by half.

Then there's the brain drain.

Nobel Prize

-winning economists Myron Scholes and Robert Merton have left the firm and returned to the safe havens of academia. Former

Federal Reserve

Vice Chairman David Mullins has also left, along with other partners William Krasker and James McEntee.

Add to that the frustration of being ostracized by the very firms that fed off LTCM's gravy train for years.

"Everyone used to love doing business with Long Term," says an institutional salesman at a major Wall Street firm. "But now they're in the penalty box."

Some investors, however, seem willing to brush aside the $4.4 billion that LTCM lost during a bizarre period last August, when Russia defaulted on its debt and investors, looking for safety, piled into U.S. Treasury bonds, sending the prices of those securities soaring.

Tough luck that LTCM had been short Treasuries, and that its bet that the spreads on certain bonds would converge turned out to be dead wrong.

Jonathan Bren says he passed up the opportunity to invest with Meriwether in 1994, because the fund of funds he was managing at the time eschewed the three-year lockup that LTCM required. But today as the manager of family money, he says he'd jump at the chance to invest with the man who fostered scientific finance.

Although Meriwether must repay 90% of the banks' outlay before he can accept money for a new venture, rumors have him talking with everyone from ex-

Goldman Sachs

Chairman Jon Corzine to former

Citigroup

President Jamie Dimon.

One thing is clear: "John Meriwether isn't raising any new money for Long Term Capital," says Rosenthal, the spokesman, although he declined to comment further on Meriwether's future plans.

And so, after all the fuss, Long Term Capital Management, the hedge fund that almost brought down the world, will simply close its doors and disappear like some fly-by-night bucket shop.

Hedge funds, which for a time last year had been considered the black sheep of investment vehicles, have largely weathered the crisis unscathed. Sweeping legislation that many hedgies feared would shackle the funds has not come to pass. Instead, most of the changes have been voluntary or the result of new market forces.

Despite initial talk of tougher disclosure rules, adds Sandra Mansky, a partner with consulting firm

Tremont Advisers

, "once people obtained some disclosure, they didn't know what to do with it."

And while global hedge fund assets under management fell by 15% to a low of $276.25 billion in January, assets have since regained their peak of $325 billion last seen July 1998 -- a month before LTCM began unraveling.

For that reason, David Bailin, executive vice president of

Ellington Management Group

, a fund that specializes in mortgage-backed securities and faced margin calls during last summer's panic, says, "You spend much more time educating your clients today."

Ellington has voluntarily halved its leverage to a maximum of 3 times assets. The fund now has an internal repo desk, which acts as a cash cushion so that a sudden change in terms by any lender would have little impact on the fund's ability to maintain financing. And it has expanded its network of financing partners.

Meanwhile, banks, many of which lost hundreds of millions from their own proprietary trading that mimicked LTCM's or from lending to hedge funds, have seen their appetite for risk reduced. As a result, proprietary trading (bets made with a bank's money as opposed to its clients') has been scaled back at several major firms, including Goldman Sachs and

Deutsche Bank

, consultants say. Neither bank returned phone calls seeking comment.

Salomon Smith Barney

had decided to limit its exposure to bond arbitrage in July, before Long Term Capital Management's near-collapse, notes a spokesman for that firm.

What that means is banks are relying more on institutional salesmen to convince clients to put up their own money. "That's much more

en vogue

now than the big trader," notes the institutional salesman.

Several banks are also limiting risk by imposing higher margin requirements when they lend to hedge funds.

Speaking at a conference, David Shaw, founder of the quantitative firm

D.E. Shaw

, said last year's mistakes are "something the market just won't allow to happen anymore."

There have been major changes in the way banks lend to hedge funds. Last summer, he recalled, margin rates shot from 1% to 5% "literally overnight," making the cost of running a highly leveraged fund prohibitive. The problem is that leverage is necessary to make money in the bond market, since prices move fractionally. That's one reason, he says, D.E. Shaw no longer trades in fixed-income.

It will be into this not-so-brave new world that Meriwether's next venture will launch. The man who survived a bond scandal at the former Salomon Brothers and the near-collapse of Long Term Capital Management is ready for parole.

The question now is whether the financial markets are ready for him.