Russia's Default and the Fall of LTCM

In the 1990s post-Soviet Russia struggled with collapsing output, weak tax collection and large budget deficits financed by short-term ruble bonds known as GKOs, which foreign investors bought for their high yields. The Asian crisis and falling oil prices, which dropped to around $11 a barrel in late 1998, hit Russia's revenues. On August 17, 1998, the government devalued the ruble, defaulted on its domestic debt and declared a moratorium on some foreign payments. The ruble lost about two-thirds of its value within weeks.

The shock reached Wall Street through Long-Term Capital Management, a hedge fund founded in 1994 whose partners included Nobel laureates Myron Scholes and Robert Merton. LTCM had made huge, heavily borrowed bets that price gaps between similar bonds would narrow; instead, panic widened them. Fearing a chain reaction, the Federal Reserve Bank of New York organized a $3. 6 billion recapitalization by major banks in September 1998. The episode showed how leverage can link distant markets.