LTCM’s extreme leverage did not necessarily mean extreme risk

Evidence

High levels of leverage, however, did not necessarily imply huge risk (as much subsequent commentary suggested). For example, the risks of swapspread trades are rather limited. Bond prices and the terms on which swaps are offered fluctuate considerably, particularly as interest rates vary. LTCM, however, almost always neutralized that risk by constructing “two-legged” trades, in which the effects on one “leg” of a change in interest rates would be canceled by its equal-but-opposite effect on the other “leg.” (The trade in appendix G is an example.) The chief “market risk” of swap-spread trading is of the spread temporarily moving in an unfavorable direction, but if that happens the arbitrageur can simply continue to hold the position and wait until liquidating it becomes profitable. — Donald MacKenzie, An Engine, Not a Camera, 982

Categorization

• XREF: Directly connects the performativity thesis to the LTCM collapse narrative discussed throughout Mackenzie’s book — the market risks were in execution/timing, not the positions themselves. — connects to: Leverage explains vulnerability but not the specific cause of a financial collapse. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1021; LTCM’s crisis did not stem from blind faith in mathematical models. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1017; LTCM’s pre-crisis leverage matched the big investment banks’ ratio. — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 1020

Broader Connections

• Leverage explains vulnerability but not the specific cause of a financial collapse. #corroborates (0.82) — Donald MacKenzie, An Engine, Not a Camera, 1021
• LTCM’s crisis did not stem from blind faith in mathematical models. #corroborates (0.78) — Donald MacKenzie, An Engine, Not a Camera, 1017