Sic Semper Tyrannis

What happens to one of the principals of the most notorious hedge fund in history (as of yet), eight years later?

Nope, not jail time.

Nope, not damages.

Nope, not being banned from the finance industry.

Try getting a lifetime achievement award from it, instead:

John Meriwether, who has dedicated over 30 years to alternative investment strategies and is currently at the helm of JWM Partners, is the recipient of Alternative Investment News' 2006 Lifetime Achievement Award. Meriwether will be honored during an awards ceremony June 28 in New York, where the other winners of AIN's 4th Annual Hedge Fund Industry Awards will be announced.

...

Meriwether, of course, is probably most famous for his role in the failed Long-Term Capital Management hedge fund. In 1998 the fund, which Meriwether had started in 1994, nearly collapsed. A syndicate of international banks and brokerage firms agreed to bail-out Long-Term Capital with $3.6 billion, at the prompting of the Federal Reserve.

Of course, there is no "nearly" about it. LTCM did collapse.

So, this is the example that is being set for all the other John Meriwether-wanna-be, gambling-with-other-people's-money hedge fund manager clones out there. This certainly makes Steve Waldman's "leverage optionality" remarks all the more real.

Oh, but that's not all. There's an epilogue to this story that hasn't been written yet. Note the justification for the award to Meriwether, despite the LTCM travesty:

... neither LTCM nor Meriwether broke any securities laws, and the Fed bail-out did not directly involve taxpayer money, instead relying on a consortium of investment banks to buy out the fund and unwind its positions. And while the fund's meltdown in the summer of 1998 was indeed disastrous in terms of performance, the prior year it had returned most of its capital to investors--at annualized gains of over 40%.

No taxpayer money, you say? That's interesting, because Turk and others found something rather incriminating on LTCM's books at the time of the collapse:

... everyone is still focusing on LTCM's assets, not its liabilities. The 400 tonne [gold] liability at the end of August was $3.6 billion in Dollar terms, with the Gold price at $274. Relative to $90 billion of liabilities, this $3.6 billion was hardly on the radar screen of the people overseeing LTCM.

Even more important, the magnitude of this problem is underestimated because few people realize that it is probably impossible to buy 400 tonnes of Gold anywhere near present prices.

Turk wrote this in 1999. Today that liability in gold--almost certainly borrowed from your treasury and funneled through the Fed--comes to upwards of $8 billion, and it is even more impossible to pick up that much of the heavy yellow stuff. This debt appears to have quietly been forgiven by the Fed, and was never paid back.

Why would LTCM and other parties do this?

Hedge funds like LTCM borrowed Gold because the volatility was low and because of the perceived central bank overhang, namely, that central banks were going to dishoard their Gold, a process which would take next to forever to complete. Borrowing Gold to fund assets was seen as a low risk play, which it has been for the past 2-1/2 years as Gold declined. Also, option volatility on Gold had been dropping for years, confirming LTCM's mathematically derived perception of low risk. So borrowing Gold seemed like a low risk funding technique, which I guess it was until Gold hit $274 at the end of August, at which point LTCM started to unravel.

Great timing there, boys. And nice models. Think fundamentals still don't matter now? Since then, gold has recovered to more of a historically-sane level of $600/oz plus. But rather than being in the US treasury where it belongs, the LTCM gold is likely being worn on necks and ring fingers of India's women, and sitting in Iran's and Syria's vaults.

LTCM. Your gold. Your Federal Reserve.

UPDATE:

There seems to be some confusion surrounding LTCM's obligation to the government, and how/whether it was actually repaid, and what this would constitute. It's possible that the bank consortium paid the Federal Reserve $3.6 billion, ostensibly for the gold obligation, but I'm not sure this is a correct reading. But let's assume this was the case. Then, was LTCM's obligation to the government really repaid? The answer is no. The obligation was for the gold itself; it was not a sale of gold, but a lease. The Fed was never authorized to sell gold. That is the first problem. The second problem is that $3.6 billion was likely not enough to cover the gold's true value on the market. If the gold had to be re-purchased on the open market, the cost would have been much higher, due to scarcity. The third problem is much more subtle. That is: what are dollars really worth to the government? The answer is that the dollars are worth nothing, because the government can (and does) routinely create as many dollars as it needs. The effect of the banks paying the Fed the $3.6 billion would simply be to drain a tiny amount of liquidity out of the system, which is the only real reason the Fed ever engages in monetary transactions. This is a far cry from replenishing the missing gold from the vaults.

Still don't see anything wrong? Then imagine that the Fed decides to unwind the $3.6 billion payoff, because it actually wants the gold. So it returns $3.6 billion to the banks. Then, it requires the banks come up with 400 tonnes of gold. My guess is a lot more than $3.6 billion would have to be spent by the banks to achieve this; in fact, probably a lot more than even the current $8 billion+ spot value. Possibly something more like $20-$50 billion would have to be spent to return the original public gold inventory, due to the effects of a short squeeze.

To conclude, my point is that LTCM had an obligation to the people forgiven; it was an obligation that was more severe than a monetary obligation, and this was done surreptitiously, possibly without legal justification, and certainly without the consent of the owners of the asset (you and I). All to benefit a bunch of irresponsible gamblers. And the ringleader was awarded.