[H8crilA]

To be honest there were countries that defaulted on their sovereign bonds in their home fully controlled currency. Russia did this in the late 90s and took down LTCM, which was collecting premiums for insuring something that they thought is too illogical to ever occur. Well, it did occur.

The reason why this is illogical is that there is very little distinction between "the dollar" and US sovereign debt. It applies to all countries in a similar situation, for example "the Yen" and Japanese Government Bonds. It doesn't quite apply to odd cases like, IDK, Spanish sovereign debt in EUR and "the Euro" since the Spanish government does not control all forms of the issuance of the currency of the bond.

[btilly]

I don't believe that LTCM was insuring anything.

What they were doing is identifying pairs of securities whose values had diverged and they believed would eventually converge. They would short the more expensive one and buy the cheap one. When they converged they would sell the no longer cheap one, use the money to close out the no longer expensive one, and collect a profit.

However usually the reason why one was more expensive is that it had a more liquid market. So people could safely invest in it with money that they might need back quickly. This shouldn't matter if you planned to buy and hold though..at least in theory.

But in the wake of the Russian default, liquidity became more valued. So people sought to get rid of illiquid securities and buy liquid ones. This meant that LTCM had shorted things that were rising in value, and bought things that were falling in value. So they had a loss. And as the shorts got higher, they wound up having to sell assets at a loss to cover their shorts. And now the temporary losses became very real ones, and drove them bankrupt.

However, infamously, their investments made money in the end. They just weren't able to last long enough to benefit from it.

[Scoundreller]

> I don't believe that LTCM was insuring anything.

While most of their strategy was convergence arbitrage, if I recall from the book, they thought of selling short equity options as a form of selling insurance.

People buy these options to insure against some event and they expected more buyers than sellers, so LTCM figured they would profitably be the provider of it. Well-structured insurance is always a loss to the buyer (they take in more than they pay out).

[wjnc]

Insurance works because people, companies, shareholders etc are risk-averse and thus value paying a little for reducing variance a lot. That’s not a loss to the buyer. NPV isn’t the only measure of value.

[edmundsauto]

Been a while since I read the book as well, but wasn’t part of the narrative that their backstop as insurance enabled traders to take bigger and bigger bets, because they were hedged with LTCM?

[seanhunter]

I don't think any trader at a broker/dealer would think that, but it's possible people on the buyside thought that. There are plenty of funds who have a strat of just allocating say 95% of their holdings to the Russell or something and then putting the remaining 5% into some high-vol bets (like putting them into LTCM or whatever). They don't see it as a hedge exactly, but it means that they hardly need to work at all and when these pay off they say "look this is alpha" and when they don't they say "look, your error vs the Russell is less than 5%". Some funds (eg big pensions) have enough AUM that this risky piece is a very significant amount of money.

I was working in the city shortly after LTCM failed and one of the interesting things I heard is that several large European institutions were using LTCM for overnight treasury. So at cob in Europe they would sweep funds into LTCM and then move them out the next morning for trading. If that was actually the case it would have caused massive fluctuations in their assets during the day which would be extremely hard to manage.

[djsavvy]

Which book are your referring to?

[400thecat]

When genius failed. there is no other book

[Scoundreller]

> It doesn't quite apply to odd cases like, IDK, Spanish sovereign debt in EUR and "the Euro" since the Spanish government does not control all forms of the issuance of the currency of the bond.

While that's true, Spain could go the tax route and say "gimme more euros this year" or sell off assets it owns. I guess a printer is faster (if they feel like it) but medium-term, developed countries have lots of tools to pay down debts (if they feel like it).

For some reason, people are more comfortable with inflation as a tax than taxes.

[singleshot_]

Well, I would assume apropos of my one economics class that the reason the average person doesn't care too much about inflation is that he has more debt than assets. If you ask me whether I want to pay a lot of taxes on my income or whether I want a big slice of my house to be free in inflation-adjusted dollars, here we would be, assuming I had no assets and most of my income went to my home loan.

(Right? What did I miss by not taking Econ 102?)

[Scoundreller]

> the average person doesn't care too much about inflation is that he has more debt than assets

What the average person forgets is that some people (and businesses) have wayyyyyy more debt, so when it gets diluted, they're a net loser on average.

Kinda like getting a $1000 stimmy cheque while large capital owners gets their equity saved by government bailout money. Everybody wins something, but winning last place isn't a win when no real wealth was created.

[c22]

Hah! I spent my stimulus check before inflation!

[seanhunter]

The thing you missed is that although inflation makes the nominal of the debt less valuable in real terms the associated cost of living increase means the cost of servicing the debt can go up both in real and nominal terms. You have less left over from your paycheck to pay the interest and the interest rates go up.

[mrep]

For most Americans, the biggest debt we have is our mortgage and 90% of mortgages in the US are fixed for the entire duration of the loan so nominal cost stays the same and the real cost goes down.

[seanhunter]

Aah interesting. Here in the UK most “fixed rate mortgages” are actually only fixed for a few years. Fixed for the full term does exist but is definitely less common.

[htss2013]

>For some reason, people are more comfortable with inflation as a tax than taxes.

Because everything doesn't inflate at the same rate at the same time. That means the average person has some theoretical room to reconfigure their spending to minimize the impact of inflation. Ordinary people have no legal options to minimize the impact of higher taxes. That requires expensive CPAs and lawyers.

[whitemary]

> To be honest

Thanks for coming clean.