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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:
LTCM-BANK OF ITALY
PLOT
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
KirbyAnalytics.com
All
articles by Rob Kirby
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