We can’t believe that this is the first time we’ve ever heard this story. The basics are known to everyone. Long Term Capital Management, the now infamous hedge fund started by the real-life characters from Michael Lewis’s Liar’s Poker, collapsed dramatically in a very short period of time when bond spreads moved in an unlikely way against their positions. LTCM was so levered up that its collapse provoked fears that it might “bring down the financial system.” Then-Fed chief Alan Greenspan stepped in to organize a Wall Street bailout of LTCM. It was a scary spectacle for those involved and those merely watching.
Now comes the story that all of this might have been unnecessary. Or at least the meltdown might not have been quite as scary as it was because apparently Warren Buffett was ready to ride to the rescue, scoop up LTCM’s bond positions and save them from the margin call squeeze. Except that Bill Gates had invited him to go on vacation, so the whole thing never got done.
Here's Jeremy Siegel telling the story:
The LTCM crisis was a ready-made example of Warren’s philosophy of buying firms when the economics was right, yet fear ruled the markets. He noted that “off-the-run” (non-benchmark) government bonds were selling to yield 30 basis points more than the “on-the-run” (benchmark) bonds that were maturing just six months later. He rightly claimed that this made no sense economically.
LTCM had taken a huge leveraged position in these bonds when the spreads were much smaller, but didn’t have the collateral to hold on to it when the spread widened. Buffett quoted John Maynard Keynes, who wrote in 1931 that “The market can stay irrational longer than you can stay solvent.” As the spread widened, Keynes’ dictum became devastatingly relevant for LTCM. But Berkshire, with its huge cash hoard, could withstand the pressure of even more market irrationality before the spread eventually returned to normal.
Unfortunately, Warren was never able to consummate the deal. He had been invited by Bill Gates to vacation in Alaska when the crisis broke and it was hard to negotiate such a deal on a cell phone... “Bill Gates cost me about $3 billion,” he shrugged.
Uhm. Wow. Imagine what would have happened if Citadel's Ken Griffin had an art museum date when Amaranth faced a similar margin-call, collateral squeeze following Brian Hunter’s misadventures in the natty-gas futures markets. Citadel reportedly lead the charge to buy up Amaranth's energy trading positions in a move that many credit with helping prevent the "contagion" from the Amaranth meltdown from spreading. I guess we should be glad that gerbils don’t need vacations.
Buffett Wisdom [Yahoo Finance via Marginal Revolution]