Collection of the Museum of American Finance

By Peter C . Earle

Trading desks were relatively quiet throughout the morning of September 29 , 1998 . The news cycle that day — now 25 years ago — was dominated by the Clinton- Lewinsky scandal , periodically interrupted by updates on the conflict in Kosovo . Two days earlier , the Greenwich-based hedge fund Long-Term Capital Management ( LTCM ) found itself in a tense meeting with major Wall Street banks at the New York branch of the Federal Reserve . The discussion revolved around LTCM ’ s precarious financial situation , which would ultimately serve as a stark example of how a mixture of excessive leverage and academic overconfidence could potentially disrupt an entire economy .

LTCM had heavily invested in Russian government bonds , known as GKOs ( Gosudarstvennye Kratkosrochnye Obyazatel ’ stva , Russian short-term obligations akin to bills or notes ) as part of its trading strategy . When the Russian

Russian 10 rubles bank note , dated 1997 . financial crisis struck in the summer of 1998 , the value of Russian bonds plummeted , leading to a debt default and the devaluation of the ruble . LTCM incurred substantial losses as a result . Those losses played a significant role in the financial turmoil that engulfed LTCM , prompting the Federal Reserve to hastily intervene to mitigate systemic risks to the global financial system .

On Tuesday , September 29 , the Federal Reserve shook global financial markets with a sudden intra-meeting 25 basis point rate cut , accompanied by the following statement :

The action was taken to cushion the effects on prospective economic growth in the United States of increasing weakness in foreign economies and of less accommodative financial conditions domestically . The recent changes in the global economy and adjustments in US financial markets mean that a slightly lower federal funds rate should now be consistent with keeping inflation low and sustaining economic growth going forward .

The unexpected policy move sent markets rocketing skyward . In the short remainder of that session , the Dow Jones Industrial Average gained 2.9 %, the S & P 500 leapt by approximately 2.6 % and the NASDAQ Composite posted a 2.1 % increase . This was the denouement of the Russian debt meltdown which had begun two months earlier .

Back to the Beginning

While the immediate trigger for Russia ’ s 1998 debt default was the Asian financial crisis , the origins of the collapse can be traced back to the demise of the Soviet Union .

It is difficult to understate the challenges associated with the conversion of a massive collectivist state into even a middling market economy , in no small part because there are virtually no historical precedents to draw from . The aftermath of the USSR ’ s dissolution in 1991 left an inefficient and poorly maintained industrial economy behind , one in desperate need of both mountains of fresh capital and market expertise . Adding to the overall difficulties were that the initial conversion from a communist economy to a more marketoriented posture was accomplished by a swift privatization which granted private

20 FINANCIAL HISTORY | Winter 2024 | www . MoAF . org