Counterparties stood to profit financially from the collapse of their own trading partner.

Evidence

As the prices of the options that LTCM had sold rose (in other words, as their implied volatilities increased), LTCM had to transfer collateral into accounts held by its counterparty banks. If LTCM failed, those banks would lose the hedge LTCM had provided them with (in other words, they would be “short volatility”) but they would now own the collateral in the accounts. So it was in their interest that the implied volatility of the index options LTCM had sold should be as high as possible. — Donald MacKenzie, An Engine, Not a Camera, 1066

Categorization

• DEEPTHINKING: A razor-sharp inversion of the counterparty relation: the entity hedged with LTCM becomes better off the worse LTCM does, because the collateral is theirs if LTCM fails. This is the motivating structure laid bare.
• SHARE: Worth sending to anyone interested in derivatives/collateral mechanics — the perverse incentive where LTCM’s hedge providers profited from its failure.
• XREF: connects to: Counterparties had financial incentive to mark LTCM positions at unfavorable prices — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1068

Broader Connections

• Counterparties had financial incentive to mark LTCM positions at unfavorable prices #expands (0.95) — Donald MacKenzie, An Engine, Not a Camera, 1068