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Chapter 12. The Eggheads Crack > The Beginning of the End

The Beginning of the End

LTCM began 1998 with $4.8 billion in equity capital. The first signs of trouble occurred in May and June of 1998. In those months, investors in the mortgage-backed security market actually demanded a substantially increased premium for taking risk. This was a move in prices that went against the hedged bet taken by LTCM. This caused a 16% decline in LTCM's equity capital.[7] At the end of June, they had $4 billion of equity.

Then came the announcement that rocked the financial world on August 17—Russia defaulted on its debt. Investors no longer wanted to take risk. Investors started selling emerging market bonds, asset-backed securities, and other higher risk bonds. Instead, these investors bought safe bonds like U.S. Treasury Bonds. This caused the price of safer bonds to increase and the price of riskier bonds to plummet. LTCM had bet on the spread between these bonds decreasing, not increasing. For example, emerging market bonds lost over $400 relative to U.S. Treasury Bonds. U.S. junk bonds lost over $200 in price relative to the highest grade corporate bonds. On August 21 alone, LTCM lost $550 million. By the end of August, its equity capital had fallen to $2.8 billion.


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