Lecture 5: Crisis II: LTCM II, Russian crisis Galina A Schwartz Department of Finance University of Michigan Business School

Plan of today’s lecture n Financial markets: the trends n LTCM case study u Press 1998 u Press 2000 u John Meriwether renewed? u FED intervention: who was to pay for all this? n Russian Default u Why Russian crisis happened F Big Players’ incentives F Lobbyists & Politics F IMF incentives u Was Russian crisis inevitable? u Was Russian crisis predictable? u Nuclear defense of debt expanse?

Financial markets The trends I n Increase in correlation of the markets due to u More financial instruments [& arbitrage possibilities] u Convergence in financial regulation across markets u More openness [less capital controls & government restrictions] u More prudent monetary policies / standards

Financial markets: The trends II n Increase in market volatility due to u Higher trade volumes u More complex technology n Too big to fail or too well connected to loose? u Buffet & Goldman Sachs: was it a rescue plan? u FED rescue and some mighty events: interest rates cuts and the dollar freefall

LTCM, FED & Financial markets n Pareto improvement – a definition. [or How to make everyone happier?] n Too big to fail or too well connected to loose? or n Was FED really internalizing an externality? [or Was it really a danger of a massive financial crisis if LTCM would have filed for bankruptcy?] u Buffet & Goldman Sachs: was it a rescue plan? u FED rescue and some mighty events: interest rates cuts and the dollar freefall

Theory behind Russian crisis n In one word: what created dis-equilibrium? n Why the dis-equilibrium was long lasting? n Players: u Central bank(s): were not key figures u Government: Russian F benevolent? F commitment constrained? F Constraints? u Government: US F benevolent? F Constraints?

Theory behind Russian crisis (continued) n Players (continued) u Financial industry (and `real` industry) F US (and other Western) F Russian u International organizations: F IMF u Foreign government(s):many n Who could serve as a rescue quad? u Only big and powerful n Who should serve this role? u IMF and other International organizations

Summary [and what is next] n FED and LTCM: u Was a bailout the only choice? u Was the bailout the most cost affective choice? u Regulating Hedge Funds: pros and cons n Russia: u It helps being unique u It hurts being unique u Shock therapy or u Gradual reforms u Is crisis a revolution? n Next Monday: Crisis III: Asia and ?