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Bailouts Seminar Karen Bradshaw, Molly Grovak, Drew Navikas, Asha Spencer

Long-Term Capital Management. $4.50. 4.00. 3.00. 2.00. 1.00. 0.00. Gross value of $1 invested March 1994 - October 1998 in LTCM When Genius Failed pp. xiv. 3/1994 1/1995 1/1996 1/1997 1/1998. ***.

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Bailouts Seminar Karen Bradshaw, Molly Grovak, Drew Navikas, Asha Spencer

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  1. Long-Term Capital Management $4.50 4.00 3.00 2.00 1.00 0.00 Gross value of $1 invested March 1994 - October 1998 in LTCMWhen Genius Failed pp. xiv 3/1994 1/1995 1/1996 1/1997 1/1998 *** Bailouts Seminar Karen Bradshaw, Molly Grovak, Drew Navikas, Asha Spencer

  2. Agenda • Background • Framework for analysis • Was LTCM a bailout? • Was LTCM successful (as a bailout)? • Relevance to Current Crisis • Conclusions • Questions

  3. Bond trading experience Black LOANS BAILOUT = $3.6B PRESSURE Up to 40% returns Scholes Meriwether INVESTMENTS Merton Up to $1 trillion in derivatives Mullins LTCM $1.25 billion up to $7B down to $555M PRESSURE LOANS

  4. Background

  5. Background

  6. Background Russia defaults 80% loss over 5 weeks $4.50 4.00 3.00 2.00 1.00 0.00 Gross value of $1 invested March 1994 - October 1998 in LTCMWhen Genius Failed pp. xiv 3/1994 1/1995 1/1996 1/1997 1/1998

  7. Background

  8. Background MISFIRE Wall Street’s Rocket Scientists thought they had a surefire way to bear the markets. Boy, were they wrong! -Business Week, Sept 21, 1998

  9. Framework for Analysis Was LTCM a bailout? ASK Was LTCM successful (as a bailout)? • Use case studies from class to define the criteria for determining a bailout/success • Consider whether LTCM qualifies as a bailout/success against the criteria • Determine whether LTCM was a bailout/success and how LTCM might impact the criteria FRAMEWORK

  10. Was LTCM a bailout?

  11. Was LTCM a Bailout? What makes something a bailout? Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders Market Players The Fed Treasury Congress

  12. Was LTCM a Bailout? What makes something a bailout? Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders Market Players The Fed Treasury Congress Market facilitation Government intervention More like a bailout WHAT/ WHY Emulating private market when dysfunctional Jumpstart private negotiations Stopping a downward spiral Propping up firms during economic turbulence Gov’t intervention to pursue normative vision

  13. Was LTCM a Bailout? What makes something a bailout? Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders Market Players The Fed Treasury Congress Discount window BOA & Merrill TARP HOLC Chrysler 1979 GE Immelt bonus Law firm partners Chapter 11 Buffet & GS Detroit Today Market facilitation Government intervention More like a bailout WHAT/ WHY Emulating private market when dysfunctional Jumpstart private negotiations Stopping a downward spiral Propping up firms during economic turbulence Gov’t intervention to pursue normative vision S&L Housing Detroit Today American Dream: F&F TARP Chrysler 1979 Detroit Today Chrysler 1979

  14. Was LTCM a Bailout? Yes yes yes! ~ NO Input of private parties Government intervention More like a bailout WHO Principals of the firm Existing creditors and stakeholders Market Players The Fed Treasury Congress LTCM LTCM LTCM Market facilitation Government intervention More like a bailout WHAT/ WHY Emulating private market when dysfunctional Jumpstart private negotiations Stopping a downward spiral Propping up firms during economic turbulence Gov’t intervention to pursue normative vision LTCM LTCM

  15. Why does it matter? • Distributes the perception of responsibility • Bailout = needed rescuing/failure by managers • Not a Bailout = this was a function of regulatory choices and global markets • Sets criteria by which we measure success

  16. Was LTCM successful (as a bailout)?

  17. people impacted Short-term impact on third parties Long-term impact on third parties third party Short-term impact on first parties Long-term impact on first parties first party t short-term long-term

  18. people impacted Short-term impact on third parties Long-term impact on third parties third party Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Autos, S&L, Banks Saving Jobs Chrysler, Detroit Keeping Homes HOLC, F&F, S&L first party t short-term long-term

  19. people impacted Short-term impact on third parties Long-term impact on third parties third party Home Ownership S&L, F&F Public Policy American Autos Chrysler, Detroit Economic Growth Panic/Confidence Easy Credit TARP TARP Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Autos, S&L, Banks Saving Jobs Chrysler, Detroit Keeping Homes HOLC, F&F, S&L first party t short-term long-term

  20. people impacted Short-term impact on third parties Long-term impact on third parties third party Home Ownership S&L, F&F Public Policy American Autos Chrysler, Detroit Economic Growth Panic/Confidence Easy Credit TARP TARP Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Preserving Jobs Autos, S&L, Banks Chrysler, Detroit Saving Jobs Chrysler, Detroit Keeping Homes HOLC, F&F, S&L Moral Hazard first party Autos, S&L, Banks t short-term long-term

  21. people impacted Short-term impact on third parties Long-term impact on third parties third party Home Ownership S&L, F&F Barrier to Entry, Alternative Investment TARP, Chrysler, F&F Public Policy Opportunity Cost American Autos Chrysler, Detroit Economic Growth Panic/Confidence Preserving Networks Moral Hazard Easy Credit TARP Market Learning S&L, Chrysler TARP Chrysler, Detroit Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Preserving Jobs Autos, S&L, Banks Chrysler, Detroit Saving Jobs Chrysler, Detroit Keeping Homes HOLC, F&F, S&L Moral Hazard first party Autos, S&L, Banks t short-term long-term

  22. people impacted Short-term impact on third parties Long-term impact on third parties third party Home Ownership S&L, F&F Barrier to Entry, Alternative Investment TARP, Chrysler, F&F Public Policy Opportunity Cost American Autos Chrysler, Detroit Economic Growth Panic/Confidence Preserving Networks Moral Hazard Easy Credit TARP Market Learning S&L, Chrysler TARP Chrysler, Detroit Stopping Downward Spiral Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Preserving Jobs Autos, S&L, Banks Chrysler, Detroit Saving Jobs Chrysler, Detroit Keeping Homes HOLC, F&F, S&L Moral Hazard Muting Economic Turbulence first party Autos, S&L, Banks Chrysler, S&L t short-term long-term

  23. people impacted Short-term impact on third parties Long-term impact on third parties third party Public Policy Opportunity Cost Economic Growth Panic/Confidence Preserving Networks Moral Hazard Stopping Downward Spiral Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Preserving Jobs Moral Hazard Muting Economic Turbulence first party t short-term long-term

  24. people impacted Short-term impact on third parties Long-term impact on third parties third party Public Policy Opportunity Cost Economic Growth Panic/Confidence Preserving Networks Moral Hazard + prevented credit meltdown +/- precedent for Fed involvement +/- avoided regulation Stopping Downward Spiral Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Preserving Jobs + no huge costs in human capital + unwound at a profit + internalized losses + investors who got out early Moral Hazard Muting Economic Turbulence first party + mitigated moral hazard t short-term long-term

  25. people impacted Short-term impact on third parties Long-term impact on third parties third party • benefit financial gaming • made quantitative investment • less risky • “how to” rather than a • ghost story Public Policy Opportunity Cost Economic Growth Panic/Confidence Preserving Networks Moral Hazard + prevented credit meltdown +/- precedent for Fed involvement +/- avoided regulation Stopping Downward Spiral Short-term impact on first parties Long-term impact on first parties Shielding Stakeholders Reputational Harm Preserving Jobs + no huge costs in human capital + unwound at a profit + internalized losses + investors who got out early Moral Hazard Muting Economic Turbulence first party + mitigated moral hazard - didn’t continue as a going concern - reputational decline t short-term long-term

  26. Relevance to Current Crisis • Investment strategies • Market dynamics • Moral hazards

  27. Conclusions • How do we put a stop to the learning gap without knee-jerk regulation? • What should LTCM have led the Fed and Treasury to ask about Bear and Lehman? • Why shotgun weddings without equity?

  28. Questions?

  29. Bond trading experience Black LOANS BAILOUT = $3.6B PRESSURE Up to 40% returns Scholes Meriwether INVESTMENTS Merton Up to $1 trillion in derivatives Mullins LTCM $1.25 billion up to $7B down to $555M PRESSURE LOANS

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