Those who were active in the markets in 1998 and anyone who is a student of the markets should be asking themselves how the current subprime mortgage mess compares with the Long-Term Capital Management failure of nine years ago.
If you haven’t already read Roger Lowenstein’s excellent When Genius Failed: The Rise and Fall of Long-Term Capital Management, it isn’t too late to do so. Among the events that Lowenstein recounts is the merciless squeezing of LTCM’s positions by Goldman, Salomon and others, activities that may have strong parallels to some of what is going on behind the scenes right now.
The purpose of today’s comparison is to contrast the magnitude of the volatility triggered by the failure of LTCM to what we have seen in the last two months. Keep in mind that according to Lowenstein, LTCM’s capital peaked in April 1998, as shown in the graphic below from Siddharth Prabhu, who utilizes Lowenstein’s data.
As the graph of VIX and SPX from 1998 toward the bottom demonstrates, LTCM’s small losses from April to July have very little impact on the markets, but as the losses grow (and the Russian financial crisis widens), the VIX nearly triples over the course of two months, while the S&P 500 loses approximately 20%. For more historical context, note that by the end of the year the SPX had recovered all of those losses and moved higher, while the VIX returned almost to the pre-crisis lows.
How does the current situation stack up? Looking at the chart at the bottom, once again, the VIX has almost tripled in two months (doubled in one month), while the SPX has lost closer to 10% of its value. For comparative purposes, this means more fear in the current situation, with less in the way of financial losses – at least at this stage.
With LTCM and Amaranth already in the books, you would think that those who are in a position to avert another similar crisis would be in a better position to do so. Keep an eye on the comparisons to 1998 going forward and don’t be so quick to conclude that this time it will be worse than it was nine years ago.