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Greenspan defends LTCM rescue

THE COLLAPSE of the hedge fund Long-Term Capital Management risked undermining financial markets and damaging the world economy, Alan Greenspan said yesterday.

It was "a rare occasion, warranted because of the potential for serious disruptions to markets," the Chairman of the Federal Reserve Board told a Congressional committee.

He said that the Fed had jumped in to co-ordinate a rescue package because it was worried about the impact of a collapse.

"Had the failure of LTCM triggered the seizing up of markets, substantial damage could have been inflicted on many market participants, including some not directly involved with the firm, and could have potentially impaired the economies of many nations including our own," he said in an unusually frank comment.

Mr Greenspan was defending the Fed against charges that it had helped prop up an uneconomic enterprise, thus encouraging moral hazard.

The rescue was run by 14 large commercial banks and no public money was involved, he pointed out. If the fund had been left to its own devices, the effects could have been catastrophic.

William McDonough of the New York Fed, which co-ordinated the package, said that to allow the fund to unwind its positions on its own would have caused "unacceptable risks". The Fed feared that "markets would have moved sharply and losses would have been exaggerated," he said.

The Fed's concerns were partly over the size of the fund's investments.

LTCM had used $2bn in capital to buy 125 billion in securities, with which it had entered into financial transactions worth $1.25 trillion, subsequent investigations showed.

"Creditors as a whole most likely underestimated the size and scope of the market bets that LTCM was undertaking, an issue that is currently under review," said Mr Greenspan.