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The costs and benefits of moral suasion: evidence from the rescue of Long-Term Capital Management

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  • Craig H. Furfine

Abstract

This study examines the level of unsecured borrowing done by the firms that would ultimately rescue Long-Term Capital Management in the days leading up to the hedge fund's rescue. Although there is some evidence that these banks borrowed less at the height of the crisis, further examination reveals that this reduction in borrowing was demand-driven and did not result from rationing on the part of the market. This suggests that the market believed that the troubles at LTCM would not have solvency-threatening repercussions for the fund's major creditors. Further, it is shown that large banks that were not involved with the LTCM rescue saw the rates they pay for unsecured funds decline following the hedge fund's resolution. This finding is consistent with an increase in the perceived strength of a too-big-to-fail policy.

Suggested Citation

  • Craig H. Furfine, 2002. "The costs and benefits of moral suasion: evidence from the rescue of Long-Term Capital Management," Working Paper Series WP-02-11, Federal Reserve Bank of Chicago.
    • Handle: RePEc:fip:fedhwp:wp-02-11
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    Cited by:

    1. Philip Strahan, 2008. "Liquidity Production in 21st Century Banking," NBER Working Papers 13798, National Bureau of Economic Research, Inc.
    2. Evan Gatev & Philip Strahan, 2008. "Liquidity Risk and Syndicate Structure," NBER Working Papers 13802, National Bureau of Economic Research, Inc.
    3. Evan Gatev & Til Schuermann & Philip E. Strahan, 2009. "Managing Bank Liquidity Risk: How Deposit-Loan Synergies Vary with Market Conditions," The Review of Financial Studies, Society for Financial Studies, vol. 22(3), pages 995-1020, March.

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    Keywords

    Banks and banking - Costs; Bank capital; Hedge funds;
    All these keywords.

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