Federal Reserve Orchestrates $3.6 Billion Bailout of Long-Term Capital Management to Prevent Systemic Collapse

On September 23, 1998, Federal Reserve Bank of New York President William McDonough orchestrated a $3.6 billion bailout of hedge fund Long-Term Capital Management (LTCM) by convincing 14 major banks and brokerage firms to inject capital in exchange for 90% ownership of the failing fund. Founded by former Salomon Brothers Vice Chairman John Meriwether and featuring two Nobel Prize laureates, LTCM had leveraged $4.7 billion in equity into $124.5 billion in debt and $1.25 trillion in notional derivative positions—a debt-to-equity ratio exceeding 25:1. The fund collapsed after Russia’s August 1998 currency devaluation, losing 44% of its value in a single month. Federal Reserve officials feared LTCM’s disorderly liquidation would trigger a domino effect across the financial system due to counterparty risk. While the Fed facilitated the rescue without committing public funds, Federal Reserve Chairman Alan Greenspan stated that LTCM’s failure could have ‘potentially impaired the economies of many nations.’ The bailout established a dangerous precedent of moral hazard, teaching financial institutions that regulators would rescue them from catastrophic losses. This lesson contributed directly to the excessive risk-taking that caused the 2008 financial crisis. The LTCM collapse exposed critical regulatory failures: the lack of oversight of hedge fund leverage, the systemic dangers of derivatives, and regulators’ inability to monitor interconnected risks across the financial system. No significant regulatory reforms followed the crisis, allowing the same forces to intensify over the next decade.