The Costs and Benefits of Moral Suasion: Evidence from the Rescue of Long-Term Capital Management
This study examines the level of unsecured borrowing done by the firms that would ultimately
rescue Long-Term Capital Management in the days leading up to the hedge fund’s rescue.
Although there is some evidence that these banks borrowed less at the height of the crisis, further
examination reveals that this reduction in borrowing was demand-driven and did not result from
rationing on the part of the market. This suggests that the market believed that the troubles at
LTCM would not have solvency-threatening repercussions for the fund’s major creditors. Further,
it is shown that large banks that were not involved with the LTCM rescue saw the rates they pay
for unsecured funds decline following the hedge fund’s resolution. This finding is consistent with
an increase in the perceived strength of a too-big-to-fail policy.