Research Handbooks in Financial Law series
Edited by Phoebus Athanassiou
Chapter 11: Lessons of Long-Term Capital Management and Amaranth Advisors
Mark Jickling* 49 INTRODUCTION For two decades, hedge funds have been under intense (if intermittent) scrutiny as the most visible agents of financial speculation. Two episodes best illustrate the relevant policy concerns: the near collapse of LongTerm Capital Management (LTCM) in 1998, which was revealing of how a single hedge fund could build up counterparty exposures large enough to threaten markets with system-wide disruptions; and the failure of Amaranth Advisors in 2006, which raised fears of large-scale manipulation in commodity prices. Neither instance led to a strong regulatory response, in part because there were no visible aftershocks – LTCM was quickly recapitalized, while Amaranth’s liquidation had little effect on natural gas prices. But both episodes prefigured greater financial disruptions to come. The regulators’ worst-case scenario if LTCM had been allowed to fail – a spiral of forced deleveraging and plunging asset values – closely resembles the actual course of events in 2008, while the price volatility that some attributed to Amaranth’s strategies was similar to but far milder relative to what was observed in energy and other market segments in 2008–2009. The Dodd-Frank Act passed by the United States (US) Congress in 2010 addressed the ‘too-interconnected-to-fail’ issue (by requiring large hedge funds to register and disclose trading information) and fears of excessive speculation (by increasing regulation and transparency in over-the-counter derivatives markets). Ironically, both major policy concerns about hedge funds were dealt with legislatively in response to a crisis in which hedge funds themselves played an insignificant role. * Mark Jickling covers financial...
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