Responses to Questions Concerning Long-Term Capital Management and Related Events

Pursuant to a congressional request, GAO provided information concerning Long-Term Capital Management (LTCM), its near failure, and its subsequent recapitalization in September 1998.

GAO noted that: (1) upon discovering the potential systemic implications LTCM's problems posed, the Federal Bank of New York (FRBNY) officials--acting as promoters of financial stability--brought together several LTCM creditors and counterparties to discuss LTCM's problems and possible solutions; (2) according to FRBNY and industry officials familiar with the discussions, FRBNY's role was consistent with that of a central banker; (3) they said it acted as an "honest broker" in facilitating a private-sector resolution of a market event with potential systemic implications; (4) the group of LTCM creditors and counterparties considered various alternatives to avoid a rapid and potentially disruptive liquidation of LTCM and ultimately agreed to form a consortium and infuse $3.6 billion into LTCM; (5) FRBNY testified that although FRBNY officials were present at the meeting, they did not participate in discussions about the terms and conditions of the Consortium agreement; and (6) although no federal money was committed to the recapitalization, FRBNY's intervention raised concerns among some market observers that it could create moral hazard by encouraging other large institutions to assume greater risks, in the belief that the Federal Reserve would intervene to avoid potential future market disruptions.