Editing Openai/68ed2ed1-5644-8004-ba30-42213bf3dbfa (section)

==== ⚰️ 1. What almost happened in 1998 ====

Long-Term Capital Management was a hedge fund run by Nobel Prize winners who thought they’d mathematically eliminated risk through diversification and arbitrage.
What they actually did was lever up roughly 25:1 (some positions even 100:1) on trades that assumed spreads between bond yields would stay stable.

Then Russia defaulted on its sovereign bonds in August 1998.
That blew out spreads everywhere and LTCM’s positions — which were supposed to be “uncorrelated” — all moved against them at once.

Here’s the key part you remembered correctly:
* LTCM had over $1 trillion in derivatives exposure.
* Their counterparties were the same major banks that made the trades with them.
* If LTCM defaulted, those positions would instantly transfer onto the banks’ balance sheets at full notional value — obliterating their regulatory capital ratios overnight.

The Fed called an emergency meeting with 14 major banks, and they collectively bailed LTCM out with a $3.6 billion recapitalization just hours before the dominoes started falling.
Had they let it fail, interbank lending would have frozen. That was a dry run for 2008.