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Jickling, Mark --- "Lessons of Long-Term Capital Management and Amaranth Advisors" [2012] ELECD 246; in Athanassiou, Phoebus (ed), "Research Handbook on Hedge Funds, Private Equity and Alternative Investments" (Edward Elgar Publishing, 2012)

Book Title: Research Handbook on Hedge Funds, Private Equity and Alternative Investments

Editor(s): Athanassiou, Phoebus

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781849802789

Section: Chapter 11

Section Title: Lessons of Long-Term Capital Management and Amaranth Advisors

Author(s): Jickling, Mark

Number of pages: 16

Extract:

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 Long-
Term 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 manipula-
tion 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 disrup-
tions 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 2008­2009. 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 ...