Long-Term Capital Management (LTCM) was a highly leveraged hedge fund founded by top financial minds, including Nobel laureates and former Salomon Brothers traders.
Through the mid-1990s, it delivered exceptional returns by using quantitative models to exploit small pricing discrepancies in global bond markets.
In 1998, after the Asian Financial Crisis and Russia’s sovereign default, markets behaved in ways the models had never anticipated.
Spreads widened instead of converging, liquidity vanished, and LTCM’s enormous leveraged positions produced massive losses.
The fund’s near-collapse threatened global financial stability due to its interconnected positions.
The Federal Reserve organized a private-sector rescue by major banks, and LTCM was unwound — becoming a landmark case study in modern financial risk.

What Drove the Collapse

Excessive leverage: LTCM used leverage of 25-to-1 and, in some trades, over 100-to-1. Small market moves erased equity instantly when spreads blew out.
Crowded trades and correlated risk: Many institutions were using similar convergence strategies. In stress, everyone rushed to exit the same positions, amplifying volatility.
Dependence on historical models: Strategies assumed normal market relationships and underestimated tail risk; models assumed liquidity that disappeared during crisis.
Liquidity crunch: Russia’s default caused a global flight from risk. Liquidity evaporated in fixed-income markets, making LTCM’s positions impossible to unwind without heavy losses.
Systemic interconnectedness: LTCM had derivatives exposure with every major Wall Street bank. Forced liquidation threatened broader Treasury and credit markets.

Investor Lessons

Leverage turns small pricing errors into existential threats, especially in strategies reliant on stable relationships and liquid markets.
Historical models fail in regime shifts or tail events; assumptions matter more than equations.
Liquidity risk can destroy even the most sophisticated strategies — liquidity is abundant in booms and nonexistent in crises.
When many participants crowd into similar trades, diversification becomes an illusion and exits become bottlenecks.
The core insight: “low-risk” strategies can be the most dangerous when they rely on leverage, narrow spreads, and the assumption that markets will behave like the past.

Long-Term Capital Management (1998)