When Genius Failed: The Rise and Fall of Long-Term Capital Management

When Genius Failed: The Rise and Fall of Long-Term Capital Management With A New Afterword Addressing Today S Financial CrisisABUSINESS WEEK BEST BOOK OF THE YEARIn This Business Classic Now With A New Afterword In Which The Author Draws Parallels To The Recent Financial Crisis Roger Lowenstein Captures The Gripping Roller Coaster Ride Of Long Term Capital Management Drawing On Confidential Internal Memos And Interviews With Dozens Of Key Players, Lowenstein Explains Not Just How The Fund Made And Lost Its Money But Also How The Personalities Of Long Term S Partners, The Arrogance Of Their Mathematical Certainties, And The Culture Of Wall Street Itself Contributed To Both Their Rise And Their FallWhen It Was Founded In , Long Term Was Hailed As The Most Impressive Hedge Fund In History But After Four Years In Which The Firm Dazzled Wall Street As A Billion Moneymaking Juggernaut, It Suddenly Suffered Catastrophic Losses That Jeopardized Not Only The Biggest Banks On Wall Street But The Stability Of The Financial System Itself The Dramatic Story Of Long Term S Fall Is Now A Chilling Harbinger Of The Crisis That Would Strike All Of Wall Street, From Lehman Brothers To AIG, A Decade Later In His New Afterword, Lowenstein Shows That LTCM S Implosion Should Be Seen Not As A One Off Drama But As A Template For Market Meltdowns In An Age Of Instability And As A Wake Up Call That Wall Street And Government Alike Tragically Ignored

Roger Lowenstein has reported for the Wall Street Journal for than a decade and is a frequent contributor to The New York Times and The New Republic He is the author of Buffet the Making of an American Capitalist HarperCollins

❮Reading❯ ➼ When Genius Failed: The Rise and Fall of Long-Term Capital Management Author Roger Lowenstein – Online-strattera-atomoxetine.info
  • Paperback
  • 264 pages
  • When Genius Failed: The Rise and Fall of Long-Term Capital Management
  • Roger Lowenstein
  • English
  • 07 April 2019
  • 9780375758256

10 thoughts on “When Genius Failed: The Rise and Fall of Long-Term Capital Management

  1. says:

    Long Term Capital Management was a hedge fund made up of a group of former hotshot bond traders from Solomon Bros., together with some high powered financial academics including two Nobel prize winners , and one former central banker They were the biggest stars in the business, and they had all the arrogance and greed that you could possibly imagine They also seemed to be as good as they thought themselves In five years, they turned a billion dollars into 4.5 billion dollars Then they lost it all in just a few months and came close to bringing down the financial sector in the process It s a great story, and Lowenstein tells it well He makes the complicated trading structures fairly easy to understand For example, he does a good job of explaining how a fund could go long or short on volatility in equities And I m not going to try to repeat that here.There are two main themes here first, is the arrogance and greed involved This led LTCM to trade at leverage of 30 1, and even greater as they started to collapse That means they were controlling about 120 billion dollars in assets when they had 4 billion in equity in the fund And that didn t include their risks in complicated derivatives I m not sure anyone knows what their exposure was there The second main theme is the over reliance on mathematical models Here the models derive from the Black Scholes method for pricing options indeed, Scholes was a partner in LTCM And these, in turn, stem from the efficient market hypothesis, and the random walk theory that goes along with it In a nutshell, these theories are that the current price always reflects everything that is known, and that future moves in price are randomly distributed according to a bell curve.There are a few ironies here LTCM, who believed so firmly in the efficient market, did everything it possibly could to cut better deals with the banks who gave them financing, and with their clearing bank In other words, they didn t simply go with the price that was better One tactic they used was to cozy up to these people by inviting them to a posh golf club in Ireland owned by one of the partners When dealing with their bankers, at least, they felt there was some room for market inefficiency Worse, for the first four years, the fund did unbelievably well In all that time, the worst month they had was down 2.9% The partners saw this as a pure confirmation of their method, and of their own genius And they took this success as a justification for adding on even leverage But no one, not even the book, seems to get that the early success was already a red flag that their models didn t work The success they had was not something that their models would predict The event that wiped out the company, according to their own models, was a 10 sigma event it was something that might happen once in several lifetimes of the universe, but probably not It s worth noting that this 10 sigma event happened a second time the year after the company collapsed So instead of once in forever, the event happened twice in just over a year But no one has said how unlikely their success was according to their own models It may not have been as unlikely as the collapse, but it was far from what anyone, including the partners, expected from the outset In short, the firm lived through two black swan events The first worked in their favor, as volatility shrank and shrank without so much as a hiccup for four years And the second blew up the firm My point is that they should have been paying attention to the first black swan event as well.

  2. says:

    Lowenstein displays remarkable prescience Not only is When Genius Failed a great read, it accurately foreshadows the weapons of mass destruction risks, to quote Warren Buffett, that would lead to the subprime meltdown and Great Recession Reading this book, along with Kindleberger s Manias, Panics, and Crashes allowed me to foresee the Great Recession, steer clear, and avoid damage It also helped me to better understand booms and busts in my own upcoming book Cleantech Con Artists.

  3. says:

    As a student of the efficient market idea I has always wondered what these guys were up to in detail even after seeing the Nova program about the meltdown of Long Term Capital Management in 1998 This is an excellent book that explains as well as can be in a general work of literature less than 300 pages There are several lessons here, that apparently will not be learned.Mathematical models are based on very good math with very many assumptions required to make the computations workable The real world is under no obligation to stay within either the quantitative nor temporal boundaries required to survive an investment program based on these models in the applicable markets The quote from Keynes applies Markets can remain irrational longer than you can remain solvent The technique employed by hedge fund such as Long Term only works by means of very large bets with very big leverage Without these elements there is insufficient return compared to the costs and risk Unfortunately leverage is a two edged sword, if leveraged 10 to 1, a 10% loss in the asset wipes out the investor As things go wrong leverage increases as base equity declines In the example, a 5% loss in the asset means a 50% loss to the investor LTCM was leveraged 20 30 to 1 routinely, and of course much higher, eventually than 100 to 1 as relentless losses hammered their capital.Many events that affect investments are truly unpredictable both as to their source and their impact when they occur For example, a little nation defaults or devalues Maybe no big deal If the little country defaults in the midst of a larger default by a larger nation e.g Russia there might be a disproportionate effect larger than simple sum of the two together, especially if the world s largest players are margined up to the eyeballs on a different outcome when it happens or are tied together by a poorly understood network of derivative contracts that ostensibly hedge the risk, but in practice become linked together to become the rock that sinks the world Crisis scenarios are poorly represented in such models which always are based on predicting the future based on the past In a crisis, linkages occur that are not normally apparent, as the book says correlations converge to one As it happens it was a self delusion on the part of LTCM partners that there was any true diversity in their bets While most were hedged, all were essentially the same bet made on similar goods in many locations They were counting on diversity over thousands of positions to prevent my simple leverage example above from simply taking them out in short run of adverse market conditions But as conditions deteriorated all of their trades suffered in unison and LTCM took the full force of leverage against its equity Another non mathematical fact is that their markets are a small place full of people not automatons Once their distress started to become evident, trading behavior compounded their troubles Although LTCM s secretiveness, arrogance and its deal making practices that skinned safety and profit to the bone for those who helped them finance their trades e.g Sholes warrant would account for malicious trading designed to hit them when they were down that is not the main story The main story is that their success spawned imitators, who had a two fold effect One, it reduced the quantity and quality of the opportunities for which their models work as others sought out and bought the same opportunities Two, when things started to go wrong the arbitrage departments of their lenders were trying to unload positions virtually identical to those held by LTCM flooding an inherently thin market leaving them no good way to liquidate their enormous holdings.On top of that, they did not know when to quit After a few years of great success when their choice market was decaying, partly due to their size and success in it They looked for ways to apply the model to other investments that were a much poorer fit, and eventually started to make directional trades, a fancy term for ordinary speculation without any hedge at all, and still leveraged You may know that buying stock in the US is limited to 2 to 1 leverage LTCM got around this by use of complex derivatives that served as proxies for the actual stock that are not governed by that rule.Summing up we have 1 Sheer hubris.2 Greed.3 Plain foolishness dealing in trades that do not fit the model, where LTCM has no expertise and no real edge, even in principle.4 Reliance on defective technology.When it all came apart, LTCM was bought out by a consortium of banks coordinated by the Federal Reserve with no public funds involved The banks had to be persuaded to do this with great difficulty, since they had losing arbitrage units of their own and most figured they had less to lose by LTCM s immediate failure than the sum required for the buyout and a later failure The fearful unknown that brought them around was what the effects of an LTCM failure would have on markets where their own stock had already lost 40 50%, and the very markets where they would have to unload their own LTCM wannabe positions in the near future in the midst of the massive liquidation of LTCM.At the time this move was decried by many as something government should not do, or setting a bad example of a soft landing for the excesses of private enterprise in a free market But note, that no public funds were used, it was only the prestige of the Fed that was used to create a private sector solution to a private sector problem.Compare that to today when upwards of a trillion dollars of public money will be used to bail out the damage caused by financial institutions, many the same banks that knowingly bet on LTCM despite the risk, as they went on to even larger and imprudent excesses in pursuit of profit without a sound basis for making it The LTCM fiasco was a small dress rehearsal for the potential and realized consequences of massive, complex and poorly understood instruments and unsupervised, unregulated hedge funds, and reckless risk taking on the part of the financial community The modern financial world is a 747 with one engine, no backup systems, and crew than a bit unclear on how it works Everything must work right all the time or there is a crash with little in between It is an inherent problem LTCM committed no crimes, no one went to jail, it cannot be dismissed as an isolated event due to a rogue operator as when Russian oligarchs steal the IMF bailout money This all happened with the best and brightest and the most arrogant following the latest principles completely within the law, with the blessing of the great Greenspan, and a maximal embodiment of the spirit of the free market It s cleaner than Enron a rogue but it still does not work.

  4. says:

    3.5 Eerily similar to a crisis almost exactly 10 years laterAn interesting, well told if brief account of the rise and fall of Long Term Capital Management you remember that one, don t you When things get heated it was along the lines of Sorkin s Too Big to Fail, but otherwise a decent treatment of the significant events in the life and death of LTCM.Don t have too much to share other than how prescient the following quotation the book was written in 2000 was or, perhaps how Wall Street is quick to forget the lessons of the past, or perhaps how Wall Street is building a great track record of huge compensation for finding and exploiting moral hazard None other than Merrill Lynch ovservd in its annual report for 1998, Merrill Lynch uses mathematical risk models to help estimate its exposure to market risk In a phrase that suggested some slight dawning awareness of the dangers in such models, the bank added that they, may provide a greater sense of security than warranted therefore, the reliance on these models should be limited If Wall Street is to learn just one less from the Long Term debacle, it should be that The next time a Merton proposes an elegant model to manage risks and foretell odds, the next time that a computer with perfect memory of the past is said to quantify risks in the future, investors should run and quickly the other way Too bad they didn t when it came to CDOs and such You really almost could ve substituted collateralized debt obligations, credit default swaps and mortgage backed securities in for interest rate swaps and equity volatility trades and the story runs pretty similar Sad thing is that for the most recent crisis, we needed the additional participation of ratings agencies to perpetuate the whole charade One would hope that with an additional historical near crisis and organizations charged with evaluating risk of securities, we d do a better job of avoiding bringing the financial world to ruin Sigh.

  5. says:

    Less a Science than Blind FaithIn 1999, the year before this book was published, my brother and I published a similar book, The Internet Bubble HarperCollins It was a Business Week bestseller for six months.But that financial bubble and the crisis that followed was certainly not on the level of LTCM.When our book was in the publishing pipeline word got back to me from an editor at Fortune magazine that the author of this book had started a book about the tech bubble, but changed course when he found out about our book Well, good thing, because he went on to write this masterpiece.When the original LTCM crisis happened I certainly heard about it, but never looked into the details until now I was too busy covering the tech frenzy in Silicon Valley for Red Herring Magazine.The concept of efficient market hypothesis immediately jumped out to me from this book The efficient market hypothesis EMH is a theory in financial economics that states that asset prices fully reflect all available information It was developed by Eugene Fama who argued that investment instruments always trade at their fair value, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices Consequently, some economists claimed financial bubbles were impossible Others argued that it was a new economy and it was okay for stock prices to be way out of line relative to a company s value We did the math After Yahoo was added to the SP 500 in early 2000, it s paper value almost doubled We plugged that value into our spreadsheet and it showed that Yahoo would have to have 60 BILLION in revenue in five years to justify it s current stock price.People would often bring up these theories regarding our book I used to laugh and say Haven t you read any history Human beings are irrational See tulip mania See railroad stock speculation See betting on bitcoin with no underlying value.I am no expert on the nuances of bond trading LTCM was involved in, but I can recognize false assumptions when I see them The intricacies of LTCM s academically driven system earned Myron Scholes and Robert Merton the Nobel Prize for Economics it s actually the Swedish Bank Prize in 1997, a year before their fund went into a free fall that almost brought down the world economy The author nails the problem in these three short excerpts As the English essayist G K Chesterton wrote, life is a trap for logicians because it is almost reasonable but not quite it is usually sensible but occasionally otherwise It looks just a little mathematical and regular than it is its exactitude is obvious, but its inexactitude is hidden its wildness lies in wait Lawrence Summers, now the U.S Treasury secretary, told The Wall Street Journal after the crash, The efficient market hypothesis is the most remarkable error in the history of economic theory After tech entrepreneur, Mitchell Kapor, took Merton s finance course, he decided that quantitative finance was less a science than a faith a doctrine for ideologues blinded by the power of the model It appealed to intellectuals who craved a sense of order, but could lead them disastrously astray if markets moved outside the model In the case of LTCM, what fell outside the model ended up being the fall of Asian markets and Russia following them A crash resulted Such events are sometimes referred to as black swans because they deviate beyond what is normally expected of a situation and are extremely difficult to predict Black swan events are typically random and unexpected.The metaphor is taken from what Europeans saw upon their first arrival to Australia They thought all swans were white, but were shocked to see black swans on that continent Our tech bubble book came out in November 1999 with a clear warning of what was ahead, but most people disagreed with us We racked up one star reviews on Meanwhile, Myron Scholes had moved to San Francisco and became a lecturer at Stanford But it seemed Scholes still hadn t learned his lesson In the early months of 2000, I read an interesting snippet in a local paper about a Q A session at Stanford after a lecture Scholes gave there He was asked if there was a tech stock bubble and he said no I sent a brief letter to the editor refuting his answer and it was published Lo and behold, the prime market for tech stocks, NASDAQ, imploded two months later The Noble Prize winner was wrong again.

  6. says:

    Imagine losing US 5 billion in 5 weeks This is the real life account of how Long Term Capital Management, run by a bunch of the supposedly smartest guys in the world, including two Nobel laureates, went bust It is a tale of recklessness and arrogance and most of all, lack of experience in real markets It s also a good reminder to turn away and run whenever an academic tries to lecture you on how to trade the markets The amazing thing is, some of these guys managed to return from the dead not once, but several times by starting new funds I can t understand how any investor could still give them money to manage after the first debacle I ve even seen one of them going around giving TED Talks Jeez.This was a great read with not too many technicalities that non financial readers would find difficult to digest Anyway the technical explanations on markets and derivatives are not really essential to get the full benefit of the book.

  7. says:

    They had forgotten the human factor Sometimes vulgar Marxist accounts of economics can be eerily similar to efficient markets theory because they assume a sort of natural outcome of exploitation and trading This allows them to make simple predictions about the future Yet people in markets continuously do things that aren t even in their narrow self interest And they do these things because of their personalities and prejudices They are arrogant or bold or timid You can t understand financial crises without digging into these difficult and confusing issues of psychology This book is pretty straightforward journalism but it makes one point very well without considering relationships between people you can t understand why the most celebrated finance types in the world could make bets of a size that no reasonable person would otherwise ever agree to.

  8. says:

    I started reading this book in summer of 2007 and then picked it up again this fall In 1997 I was blithely running around France checking out art while this country s financial system nearly came to a halt, the Fed had to step in and major banks suffered huge losses as a result of hubris and lack of understanding the true risks they were taking Lowenstein brilliantly takes us behind this scenes to unravel how real geniuses Long Term s marketing strategy was touting the number of Nobel prize winning economists they had on staff took on huge amounts on highly leveraged bets based on data that was fundamentally flawed um, sound familiar In short, Long Term bet on bond spreads, and that rational actors will buy and sell stocks and bonds in a or less random pattern Lowenstein never dismisses this idea entirely, but what he does show is how human behavior and the newly interconnectedness of global markets mean that the odds can go against your favor big time again, sound familiar just as your money runs out He also points out how other investment banks Goldman in particular were trying to go public so that they could place even bets with shareholder money one of the real crimes of this era He then at the end goes on a well justified tirade against Greenspan and this is written in the Maestro era and the Fed s lack of oversight of the derivatives market and how this would lead to government intervention Lowenstein s book, published in 2000, was the warning bell Well worth taking another look.

  9. says:

    Too big to fail LTCM might have not been the first to be bailed out It wasn t the last However, it might have the dubious distinction of being possibly the only firm who had a lion s share to play in what eventually turned into a global contagion Read and re read Save for posterity The fund boys Meriwether, the leader, Victor Haghani Larry Hilibrand, the overbearing maverick traders, Profs Merton and Scholes, the Nobel laureates and tutors to the rest of the street and many others.The Others Corzine Goldman Intentions unclear, ability unquestionedHerb Allison Merrill Early mover, chief negotiator, fall guyBuffet Yes, No, MissingSandy Weill Salomon, travellers, Citi Maintained a safe distance.And humble folks Bear, UBS, Swiss Bank, A must read for macro enthusiasts.An example that 1 risks, even if measured cannot be contained always 2 Leverage amplifies the whiplash in times of trouble 3 Human ingenuity can cause and overcome a lot of problems 4 Genius can fail

  10. says:

    Roger Lowenstein s book is a captivating look at what happens when even brilliant people rely on models and ignore the human element in investing Their models did not take into consideration that when people are motivated by fear and greed, they are capable of extreme behavior And as John Maynard Keynes is quoted as saying in the book, Markets can remain irrational longer than you can remain solvent LTCM discovered the truth of that statement too late.LTCM earned great returns in the early years through the use of leverage, derivatives and easy credit terms from its banks But when the market failed to behave as LTCM s models predicted they would, LTCM s leverage and large, illiquid trades caused them to quickly spiral downward Even if they had ultimately been proven correct, they could not remain solvent long enough to benefit from their risky trades.The story of LTCM, as told by Lowenstein, is fascinating But the thing that intrigued me the most is that it does not appear that the Wall Street banks learned a lasting lesson from the debacle In order to avoid systemic losses throughout the financial system, there were 14 banks that ultimately bailed out the LTCM fund, including firms like Lehman Brothers, Merrill Lynch, Chase, Goldman Sachs, Salomon Smith Barney, UBS, etc These financial institutions saw firsthand the devastating losses that could occur due to overleveraging, excessive use of derivatives and providing easy credit terms to borrowers, and yet many of these same firms suffered severe losses in 2008 due to these very same factors It does make you wonder if this cycle of greed and fear is bound to repeat itself, or if a new paradigm will emerge among financial institutions and regulators to prevent these meltdowns in the future.

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