# The Collapse of LTCM

> Long Term Capital Management, run by star traders and Nobel laureates, lost $4.6 billion in 1998 and needed a Fed organised rescue. Learn what went wrong and why.

Source: https://learn.tradelabsai.com/history/the-collapse-of-ltcm/  
Track: Market History · Level: Beginner · Updated: 2026-10-03  
Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice.  
Cite as: TradeLabs Learn, "The Collapse of LTCM", https://learn.tradelabsai.com/history/the-collapse-of-ltcm/

Long Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether, a former bond trading star at Salomon Brothers, with partners including Myron Scholes and Robert Merton, who shared the 1997 Nobel Prize in economics. Using sophisticated models and enormous leverage, it earned very high returns in its first years. Then, in 1998, after Russia defaulted on its debt, markets moved against its positions all at once. LTCM lost about $4.6 billion in less than four months, and the Federal Reserve Bank of New York organised a rescue by major banks to prevent wider damage.

## The strategy

LTCM specialised in relative value or convergence trades: buying securities that looked cheap and selling similar securities that looked expensive, betting the price gap would narrow. Examples included:

| Trade | Idea |
|---|---|
| On the run versus off the run Treasuries | Older Treasury bonds traded slightly cheaper than newly issued ones; the gap should close |
| Swap spreads | Bets on the difference between swap rates and government yields |
| European bond convergence | Yields of Italian and other bonds should converge toward German yields ahead of the euro |
| Merger arbitrage and equity pairs | Price relationships between related stocks. See [Pairs Trading](https://learn.tradelabsai.com/strategies/pairs-trading/) |

Each trade had a small expected profit, so LTCM used leverage to make returns meaningful. See [Arbitrage Strategies](https://learn.tradelabsai.com/strategies/arbitrage-strategies/).

## The leverage

At the start of 1998, LTCM had roughly $4.7 billion of equity supporting a balance sheet of over $100 billion, leverage of about 25 to 1, plus derivatives positions with a notional value of over $1 trillion. Small price moves against it produced large percentage losses on its capital. See [Leverage](https://learn.tradelabsai.com/markets/leverage/).

**Example: How a small spread move becomes a big loss**
Suppose a fund holds $25 of convergence positions for every $1 of capital. If the spreads it bets on move against it by enough to cost 1% of position value, the fund loses 25% of its capital. A 4% adverse move wipes it out entirely. In normal times, LTCM's models showed such moves were extremely unlikely. In 1998, many of its spreads widened together, the opposite of convergence, as investors everywhere fled to the safest, most liquid assets. See [Fat Tails](https://learn.tradelabsai.com/math/fat-tails/).

## What went wrong in 1998

| Factor | Explanation |
|---|---|
| Russian default (17 August 1998) | Triggered a global flight to quality and liquidity |
| Correlated positions | Trades that seemed unrelated all depended on markets calming; they lost together. See [Correlation Management](https://learn.tradelabsai.com/portfolio/correlation-management/) |
| Crowding | Other firms held similar trades and sold at the same time. See [Factor Timing, Crowding and Crashes](https://learn.tradelabsai.com/research/factor-crowding/) |
| Illiquidity | LTCM's positions were so large it could not exit without moving prices. See [Liquidity Risk](https://learn.tradelabsai.com/portfolio/liquidity-risk/) |
| Model assumptions | Historical correlations and volatilities underestimated stress. See [Operational and Model Risk](https://learn.tradelabsai.com/portfolio/operational-and-model-risk/) |
| Leverage | Left no room to wait for spreads to converge |

## The rescue

By September 1998, LTCM's capital had collapsed. Fearing that a disorderly liquidation would hit its many bank counterparties and destabilise markets, the New York Fed brought together major financial institutions. On 23 September, 14 firms agreed to inject about $3.6 billion in exchange for control of the fund, which was wound down over the following years. No public money was used, but the Fed's role was controversial. The Fed also cut interest rates three times in the autumn of 1998. See [Systemic Risk](https://learn.tradelabsai.com/portfolio/systemic-risk/).

## Lessons

1. **Being right eventually is not enough:** markets can stay irrational longer than a leveraged fund can stay solvent.
2. **Correlations rise in crises,** so diversification across trades can vanish. See [Diversification](https://learn.tradelabsai.com/portfolio/diversification/).
3. **Size creates liquidity risk** when you are a large share of a market.
4. **Models built on calm history underestimate extremes.** See [Stress Testing and Scenario Analysis](https://learn.tradelabsai.com/portfolio/stress-testing/).
5. **Leverage and counterparty links** can turn one fund's failure into a system wide threat. See [Market, Credit and Counterparty Risk](https://learn.tradelabsai.com/portfolio/counterparty-risk/).

## Sources

- Federal Reserve History, "Near Failure of Long Term Capital Management": https://www.federalreservehistory.org/essays/ltcm-near-failure

## Frequently asked questions

### What was LTCM?

A hedge fund founded in 1994 by John Meriwether with Nobel laureates Myron Scholes and Robert Merton, specialising in leveraged convergence trades.

### Why did LTCM fail?

Its highly leveraged, correlated positions lost heavily when the 1998 Russian default triggered a global flight to liquidity, and it could not exit its large positions.

### Was LTCM bailed out by the government?

The New York Fed organised a rescue in which 14 private financial institutions injected about $3.6 billion; no public funds were used.

Next, learn how one trader destroyed a historic bank in [The Fall of Barings Bank](https://learn.tradelabsai.com/history/the-fall-of-barings-bank/).

## Continue learning

- Next lesson: [The Fall of Barings Bank](https://learn.tradelabsai.com/history/the-fall-of-barings-bank/)
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- Related: [Liquidity Risk](https://learn.tradelabsai.com/portfolio/liquidity-risk/): Liquidity risk is the danger of being unable to trade quickly at a fair price, or running short of cash. Learn its two types, how to measure it and controls.
- Related: [Systemic Risk](https://learn.tradelabsai.com/portfolio/systemic-risk/): Systemic risk is the danger that problems at one firm or market spread through the whole financial system. Learn its channels, past examples and what traders can do.
- Related: [Arbitrage Strategies](https://learn.tradelabsai.com/strategies/arbitrage-strategies/): Arbitrage strategies try to profit from price gaps between the same or linked assets. Learn the main types, worked examples and why arbitrage is rarely riskless.
- Related: [Hedge Funds](https://learn.tradelabsai.com/industry/hedge-funds/): Hedge funds are private investment pools using flexible strategies, leverage and short selling. Learn the main strategies, fee structures, regulation and risks.