LTCM Revisited – A Forensic Account

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Published : April 20th, 2009
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LTCM was a hedge fund based in Greenwich, Connecticut, USA. The fund was formed in 1994 by a group of ex-Salomon Brothers traders led by John Meriwether. The key principals (in addition to Meriwether) included Eric Rosenfield, Lawrence Hilibrand, William Krasker, Victor Haghani, Greg Hawkins and David Modest. LTCM principals included Nobel price winners Robert Merton and Myron Scholes and former regulators including former Federal Reserve Board Vice Chairman David Mullins.

It’s been written that, 

the presence of Merton, Scholes and Mullins was puzzling. Merton and Scholes were at heart academics engrossed in research. Despite consulting gigs, they were unworldly when it came to the trading wars. Mullins was a career central banker [former vice-chairman of the Federal Reserve]. But they were names.” 

Or were they simply names? 

As Adam Hamilton reported back in the year 2000:

Persistent rumors exist that LTCM was short 400 tonnes of gold when it went belly up. The US government arranged for someone to supply this gold owed to counterparties very quietly, and forbade any LTCM principals to ever discuss the gold position and disposition in the future. Although the whole LTCM and gold scenario is incredibly intriguing, it is topic for a future essay.

It is a fact that one of LTCM’s investors was none other than the Bank of Italy. There have been books penned on this topic and here is a snippet of a review from one of them - "Inventing Money" is published in London by John Wiley & Sons Ltd


Published in December 1999, Nicholas Dunbar's book on the fall of Long-term Capital Management has more to offer than the usual tale of intellectual arrogance and economic hubris. Amidst the stories of Wall Street "rocket scientists" creating money-making machines of fiendish complexity, there are some nuggets concerning the run up to EMU, and the hedge funds relationship with the Banca d'Italia, in a nutshell:

"According to some observers who prefer to remain anonymous, the Bank provided LTCM with market access and privileged information denied to Italian banks - which would yield it a massive profit. In return, LTCM - and a handful of others - would engineer the convergence of Italian debt and get Italy into Emu. The Bank also invested in LTCM, effectively front-running the population of Italy."

In October 1994, the Italian Foreign Exchange Office, separate but closely related to the Bank, invested $100 million in the hedge fund. Alberto Giovannini, chairman of the "Council of Experts" advising the Italian Treasury at the time later found a job at none other than LTCM, under Victor Haghani, the man who allegedly engineered the deal. 

[The initially reported 100 million investment in LTCM by the Bank of Italy was later reported to be a more robust 250 million – RK]

In case ANYONE forgets – GOLD is an OFFICIAL RESERVE ASSET. I used to MISTAKENLY BELIEVE that the Bank of Italy had GOLD on its books at 35 bucks an ounce. 

I was wrong.

The Bank of Italy actually revalues [marks to market if you will] its gold bullion every three months and has done so for a VERY long time. While there are European countries [or were at the time] that carried “cheap” gold on their books [like Germany and Switzerland] – Italy was not one of them.

So What Was Really Up With The Bank of Italy and a Gold Loan to LTCM?

In 1997 – in the drive to meet conditions set down under the Maastricht Treaty to join the European Monetary Union [EMU] – Italy’s national finances were a mess. 

Folks would do well to understand that – unique among the EU member states - the Italian central bank consists of two institutions – of which the central government has no equity holdings in either:

            *           The Banca d’Italia [BI]

            *           Ufficio Italiano dei Cambi [UIC]

The government DOES receive approximately 60% of profits generated by the BI and roughly 25% of profit generated by the UIC. Now, appreciate that way back in 1996 – the UIC purchased 540 tonnes of gold from the BI to “secure” a 2 billion dollar loan from the German Bundesbank. The following year, the UIC resold the gold bullion back to the BI for 10,500 billion lire – generating a capital gain [profit] for the BI of 7,600 billion lire. 

The government’s “TAKE” on this transaction was some 3,400 billion lire – a number that amounted to .2 % of GDP. This is all explained in greater detail at this link, pages 124 – 127].

This was nothing less than financial chicanery being practiced at the penultimate.

The coup-de-grace, so to speak, was the GOLD LOAN to LTCM.

Journalist John Brimelow ‘lays out’ the intimate nitty-gritty details of exactly how the personnel of LTCM and the Italian central bank were intertwined:

Dunbar directly asserts, and supports with a detailed discussion, what can only be inferred from Lowenstein: that the Italian authorities in effect hired LTCM to groom or manipulate the Italian bond market, in order to accelerate convergence with the other European Monetary System bond markets and to reduce the Italian government interest burden. This permitted the achievement of the Maastrich criteria and allowed Italy to adopt the Euro.

"According to some observers...the Bank of Italy provided LTCM with market access and privileged information denied to Italian Banks - which would yield a massive profit. In return, LTCM - and a handful of others - would engineer the convergence of Italian debt..." 

Dunbar lays out in considerable detail how this was done. One element was the overlooking by the Italians of LTCM's repeated cornering of Italian bond auctions, greatly to the dismay of small local players. Of course, the U.S. Treasury had, since 1989, capped the proportion available to a single buyer at the American auctions at 35%. (It was a subordinate's flouting of this regulation which caused Merriwether's fall at Salomon.) The Italians were not so scrupulous.

How many other such cozy arrangements were there? As mentioned in my discussion of Lowenstein’s book, the credit department of UBS took comfort in the fact that about 31% of LTCM was owned by "generally government-owned banks in major markets" who could supply LTCM with market intelligence. Dunbar seems to imply that other ECU markets received LTCM’s ministrations. And he directly says of LTCM that by the end of 1997

“Governments treated it as a valued partner, to be used whenever markets weren't efficient enough to achieve macroeconomic goals."

(In this context, of course, "efficient" means "obedient" and "macroeconomic" means "political.”)

This leads directly to the question of gold. Dunbar, like Lowenstein makes no reference at all to gold, not even to repudiate the rumors of a large LTCM short position. And indeed such a position must have either been eliminated or else been very well hidden by the time LTCM was invaded by hordes of Goldman and J.P. Morgan investigators in late September '98. 

By “lending” gold to LTCM – the Italian government was ONCE AGAIN resorting to nothing more than GREED motivated financial trickery. By loaning bullion to LTCM – the Italian government was counting – heck banking - on LTCM’s MAGNIFICENT returns to generate a nice fat profit for the BI – of which they would be entitled to 60 % of the spoils – which would ‘undoubtedly’ help them over the hump in meeting their financial obligations in conforming to EMU guidelines.

The Russian Bond Default that unexpectedly “buried” LTCM put an end to those plans – didn’t it?

With the Italians no-doubt ‘still licking their wounds’ over this golden fleecing of some 400 tonnes of sovereign gold – it’s no wonder they have NOT BEEN a seller of gold bullion [to date] under ANY of the Washington Agreements – to which they are a signatory.

What I’m saying here is that LTCM was bailed out – categorically – because they were “short borrowed Central Bank gold”. A very public failure of LTCM would have undeniably exposed this fact to the whole world. 

Interestingly, it was the Federal Reserve in cahoots with the U.S. Treasury who would not allow this to happen.

Understanding this is very key to understanding what course of action[s] may or may not be forthcoming by monetary officials now that other celebrated Hedge Funds are seemingly ‘blowing up all over the place’.

Invest at your own risk.


Rob Kirby



All articles by Rob Kirby

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