How the 1998 Russian Financial Crisis Changed US Investing

This article is an excerpt from the Shortform book guide to "When Genius Failed" by Roger Lowenstein. Shortform has the world's best summaries and analyses of books you should be reading.

Like this article? Sign up for a free trial here.

What was the 1998 Russian financial crisis? How was LTCM affected by the crisis?

The collapse of the Russian ruble in August and September 1998 exacerbated the impending liquidity crisis in global financial markets, intensifying the fund’s difficulties. Russia defaulted on its financial obligations, sending shockwaves throughout global financial markets.

Find out how the 1998 Russian financial crisis contributed to LTCM’s downfall.

The Russian Collapse and the Flight to Treasurys

The 1998 Russian financial crisis triggered widespread panic as investors sought refuge in US Treasury securities.

(Shortform note: Despite the calamity, some financial historians have written that the 1998 Russian crisis taught some valuable lessons. First, it demonstrated the interconnectedness of financial markets and how the default of even a relatively small emerging market like Russia could have a ripple effect on global markets. Secondly, it underscored the unique risks of investing in emerging markets and the need to evaluate political and economic stability, regulatory environments, and currency risks in emerging market investments. Finally, the Russian crisis showcased the importance of robust risk management strategies, diversification of portfolios, and the need to account for possible sharp market fluctuations.)

For LTCM, this situation led to a noticeable difference in prices between US Treasury bonds and other financial products. This difference influenced a broad array of assets, including common ones like stocks and foreign bonds, as well as more complicated financial tools like options, derivatives, and swaps. People rushed to invest in Treasurys, which are seen as safe because they’re backed by the US federal government. This surge in demand caused the prices of Treasurys to go up while the prices of everything else went down.

Does US Political Dysfunction Threaten the Security of Treasurys?

Roger Lowenstein says that investors flocked to US Treasury bills, notes, and bonds, because of their perceived safety. In The Deficit Myth, economist Stephanie Kelton notes that American national debt is created through the sale of these bonds. Because the federal government can never default on these bonds (because it has monetary sovereignty that enables it to always create the dollars it needs to make the interest payments), they are considered risk-free securities. However, some have argued that the growing political dysfunction of the United States could jeopardize that status.

The US federal government has a statutory limit on how much it is allowed to borrow to meet existing financial obligations (the “debt ceiling”). When the Treasury Department informs the president that the government is approaching this limit, Congress is supposed to pass new legislation that raises this figure and allows the government to pay its creditors. To not raise the debt ceiling, therefore, is to force the United States to default on its debt, even though, as Kelton argues, the US has unlimited power to create the dollars it needs to meet its debt obligations.

Unfortunately, the debt ceiling has become a political football in recent years, with Congressional Republicans threatening to withhold the votes to raise the debt ceiling to force spending cuts and other policy concessions from Democratic presidents—as happened in 2011 under Barack Obama and again in 2023 under President Joe Biden. Analysts warn that these brinksmanship exercises hurt confidence in the US dollar and US Treasury debt as safe assets—and could cause them to cede some reserve status to other currencies like the euro.

How the 1998 Russian Financial Crisis Changed US Investing