The rise -
Hedge funds became (in)famous in 1992 with George Soros’s Quantum Funds. At that time, UK was a part of the European Union, because of which it was following the highly conservative monetary policy of the German Central Bank - Deutsche Bundesbank. The British economy was suffering from a recession despite of which, it had to keep its interest rates high, making the pound sterling very strong. Because of this conflict faced by UK, it was widely believed that the country would soon let the pound go. This is where Quantum Funds stepped in. George Soros borrowed 15 billion pounds and short sold the currency intensifying the pressure on the pound and what would have happened over 4-5 months, was made to happen immediately. UK pulled out of the EU, lowered its interest rates and let the sterling fall (it depreciated by 15%). Soros made a quick profit of 2 billion pounds. For a common man, he became a villain overnight, who twisted the market conditions to make a quick profit. However it must be noted that Quantum Funds did not lead to UK pulling out the EU. It just hastened the whole process.
& the fall -
In August 97, Russia devalued ruble and defaulted on Sovereign debt. There was an Increase in spreads between emerging-market and Western government bond. Though few believe that LTCM never owned any russian debt & that they simply owned spread products, which cracked out in the wake of Russian default. But it was their excess leverage & use of derevative products that saw rapid decline in their investments. Finally Federal Reserve of New York bailed out LTCM with $3.65 billion purchase of of 90% of its equity.
Effects of the Collapse of LTCM: Banks and security firms are demanding more information from highly leveraged clients and Increased credit terms:- Increase collateralization; Increase diligence in credit analysis of counterparties.
