Four Key Financial Crashes and the Key Lessons You Can Learn – Introduction
An important aspect about life is the need to learn from it. People who are successful attribute it to the fact that they went through challenges and learnt from everything in it. For investors and traders, it is very important for them to learn from the past crashes. This will help them avoid repeating the same mistakes. This article looks at some of the past crashes and the lessons we can learn from them.
Long Term Capital Management (LTCM)
LTCM was one of the largest hedge funds in the United States. It had more than $126 billion in assets under management. Its growth was attributed to the fact that its founders and senior managers were top economists who had won various Nobel prizes. These were the leading investors if their time. To invest in the firm, the minimum amount was $10 million. After careful analysis, the managers came up with the opinion on hedging against the predictable range of volatility in the foreign currencies and bonds. The decision by Russia to devalue its currency led to increased volatility, with the US market declining by more than 20%. European markets fell by 35%. As the LTCM thesis crumbled, the fund collapsed. This led to intervention by the Federal Reserve Bank of New York, which forced banks to bail out the funds. The collapse of LTCM is an important lesson that the so-called experts are usually not always accurate.
Barings was one of the biggest banks in the United Kingdom. The bank collapsed in 1995, when a rogue trader known as Nick Leeson lost more than $1.3 billion in unauthorized trades. In his book, Leeson said that the bank’s senior managers put pressure on the traders to do whatever it takes to generate profits for the bank. At the time, he was only authorized to do arbitrage trading of the Nikkei 225 futures contract. This arbitrage was mostly because of the differential pricing of the futures in Japan and in Singapore. Instead of doing arbitrage by placing the trades simultaneously, he held his two contracts. He then hoped to make a larger profit by betting on the directional moves. To hide his losses, he used various accounting tricks. When the bank collapsed, he was sentenced to more than 7 years. The lesson here is on the need to avoid being greedy in the market.
Asia has always been an important part of the market. This changed in 1997 when Thailand’s government floated the baht because of the lack of foreign reserves. At the time, baht was pegged to the US dollar but the country had accumulated a lot of foreign debt. This action led to the collapse of the Thai’s baht. This led to Thailand being bankrupt. The risk of the collapse led to the spread of risks, with the most affected countries being Indonesia, South Korea, Malaysia, China, and Singapore. The debt to GDP ratios of these countries increased from under 100% to 167%. Ultimately, the crisis was solved and the countries continues to do well.
Metallgesellschaft was one of the biggest conglomerates in Germany with more than 20,000 employees and more than $10 billion in annual revenues. The company’s subsidiaries totaled more than 250 and specialized in chemicals, trading, finance, and engineering among others. In 1993, after its hedging strategies failed, the company made a loss of more than $1.3 billion. When the spot prices of commodities declined, it led to margin calls. The company was latter bought for a song by GEA Group. The lesson of this is that hedging strategies in trading can go wrong. For this reason, you should take time to study and understand the hedging field before you venture into it.