John Meriwether was finishing up his fund-raising for LTCM in 1994. In February of that year, Greenspan raised short-term interest rates for the first time in five years and in response, bond prices decreased in response to the rise in interest rates. European bonds began crashing. Michael Steinhardt had bet on European bonds and saw himself losing about $7 million with every hundredth of a percentage point and would lose as much as $800 million in only four days. Meriwether took advantage of the investors panicking to sell and in May of that year, Long-term rose 7 percent which resulted in profits. They noticed that markets were linked and that a trend in a certain market could spread over to the next and so on.
Meriwether and LTCM then turned their attention to certain 30-year bonds. There were two kinds, ones that had been issued 6 months prior and ones that were just issued. The ones that were issued 6 months ago were known as off the run and were less desirable due to being less liquid than the ones that were just issued, known as on the run bonds. The on the run bonds were actually yielding 12 basis points less than the off the run bonds. LTCM purchased $1 billion of the off the run bonds, seemingly risking all of their capital right away. LTCM used certain leverage powers they had when interacting with other financial institutions. They refused to pay what was called a haircut when borrowing money (a fee banks charged borrowers to protect themselves from bond prices rising), would convince banks to loan to them for a longer period of time that usual. In the end, LTCM made $15 off of their off the run bond purchase deal. That was but one of many trades that LTCM turned to gold in 1994, they couldn’t miss.
LTCM also participated in the trading of IO’s in 1993, when 2/5 American citizens refinanced their homes. They bought a lot of these IOs and eventually made several hundred million dollars from them. They also participated in trades in Europe and third world markets.
What is a “snap trade”? How would such a trade benefit LTCM and what made it so appealing to them?