Posted on July 11th, 2008 at 03:20 PM

In 1998 there was a hedge fund called Long Term Capital Management .  Long Term Capital was rescued by the Federal Reserve and some large financial institutions.  Long term capital's model broke when Russia defaulted on their debt.  They were using MASSIVE leverage to profit from very small spreads in Russian Bonds and many other instruments. Long Term Capital used too much leverage.  When their model broke due to the Russian debt default, all of their trades had to be unwound.  Once the model was broken the leverage was so large that there was no way they could survive.  When you use too much leverage, you hit a tipping point.  Once that point is breached it is not IF you will fail, it is WHEN you will fail.  People who understand leverage understand this very well.  Unfortunately, there aren't many people that understand leverage.  I have only read one story of someone understanding the risk that Long Term Capital posed.  He was fired from his job at Lehman Brothers for speaking publicly about the risks.  Click here for a more detailed description.  I think his ultimate justice lies with the price of Lehman Brothers (LEH ) here and now.