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would be Italian government bonds versus U.S. T-bonds or U.S. mortgages versus U.S. Treasuries.

What caused the LTCM situation? LTCM's view was that the spread would narrow between various pairs of government bonds and other credit instruments. The opposite happened—spreads widened.

Spreads between bonds began to widen by June 1998, exactly opposite of what LTCM's models had forecast. LTCM, relying on historical models, bet that perceived risk would diminish; but prices were moving in the opposite way. As was later revealed, LTCM's models did not go back as far as 1992.11 Part of the cause was Russia declaring a debt moratorium on August 17, 1998, and the fund's heavy use of leverage accelerated its troubles. Leverage at one point was 100:1, without including the derivatives positions.12 One of the implications of the emerging markets dislocations was a global flight to liquidity. Investors wanted only the safest bonds. In July 1998, investors fled junk bonds and went into Treasuries. Yields went higher on junk bonds and lower on Treasuries. Instead of converging, they diverged. Credit spreads between Treasuries and convertible bonds widened. All over the world, investors were buying the safer lower-yielding bonds and selling the higher-yielding riskier ones, pushing the spreads wider.

This global flight to liquidity forced liquidations by other investors in their markets. The flight to liquidity led to a credit crunch; margin calls became prevalent. Highly leveraged funds near their margin-call boundary received margin calls. The banks and brokerage firms were nervous, thus requiring higher margin deposits, and changing criteria.

In reassessing LTCM, John Meriwether said in 2000 that the fund got too big and too risky. Its traders didn't see that others were making the same investments—and would turn on a dime to sell in a crisis.13

LTCM stopped trading at the end of 1999 and quietly liquidated in early 2000. The fund ultimately paid back $1.3 billion to investors.

Meriwether has since formed JWM Partners, a relative value opportunity fund. Meriwether, Eric Rosenfeld, and several other LTCM partners are working from LTCM's old offices in Greenwich, Connecticut. JWM had raised between $350 and $400 million as of late August 2000 despite a $1 billion goal. The same strategy is used: relative value using bonds and stocks. The fund is called the Relative Value Opportunity Fund II. It is billed as a conservative version of the former fund. Leverage is lower, at about 12:1 to 18:1, and the minimum investment is $5 million.