When Genius Failed : The Rise and Fall of Long-Term Capital Management
Author: Roger Lowenstein
List Price: $14.95
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ISBN: 0375758259
Publisher: Random House Trade Paperbacks (09 October, 2001)
Sales Rank: 676
Average Customer Rating: 4.17 out of 5
Customer Reviews
Rating: 5 out of 5
Financial alchemy gone haywire____A cautionary Tale
An absorbing account of the Long Term Capital Management (LTCM) fiasco that almost scuttled Wall Street in the summer of '98.Mr.Lowenstein has done a superb job putting this book togather given that most of the managers at the ill-fated fund were reluctant to talk , for obvious reasons .In retrospect , the story of LTCM's rise and fall seems to have the inevitability of a Greek tragedy _____ greed,hubris,brilliance and riches blinding the protagonists to the fatal dangers lurking in the unborn future . To put things in perspective , had you invested 1 dollar with LTCM in '94 it would have grown to 4 by the spring of '98 .Those 4 dollars would have shrunk to 25 CENTS in a little less than three months later after the dust had settled !The underlying principle behind LTCM being to take advantage on the "discrepencies" between bond and equity spreads (looking for "inefficiencies" ) with the assumption that markets tend to overshoot in the short term but revert to the baseline in the longer term . A bevy of ex-Salomen arbitrageurs (headed by John Meriwether) and a couple of Nobel laureates were supposed to gain LTCM an edge over the market . To amplify their results (since fluctuation in bond spreads are relatively small) they used leverage to their gills ____with assets of 4 billion dollars they were leveraged to the tune of 120 billion !Their plans worked brilliantly till '98 when the Russian default set off a domino effect that shook the entire international financial system : the spreads on LTCM trades instead of narrowing actually WIDENED (flight to safety) .This coupled with LTCM's fatal reliance on leverage saw to it that the fund was decimated as its Wall Street competitors (especially Goldman Sachs) smelling blood actually shorted the trades LTCM was long !!! The rest as they say is history .The Fed realising that LTCM's implosion could virtually dynamite Wall Street stepped in and engineered a buyout of its assets by 6 major firms .This is a page-turner and Lowenstein should be commended for it.
Rating: 4 out of 5
So Certain, So Wrong
"When Genius Failed" is the amazing story of Long Term Capital Fund, a huge hedge fund (over $5 billion in equity capital) managed by people who were suppose to be brilliant (two partners won the Nobel Prize in Economics, three were former Harvard professors and several had advanced degrees from MIT and Harvard), which recorded astonishing growth in its first four years ($1 invested in May 1994 was worth $4.11 in April 1998) and then suddenly crashed ($5 billion lost in five months) during a time when the stock market was booming (mid- to late-1998).
Using complex economic models, the fund's managers had precisely calculated the risk of the fund losing twenty percent of its value to be an event that would occur no more often than once every fifty years and the risk of the fund crashing completely to be so statistically remote as to be nonexistent. So confident were the partners that they not only invested their own personal fortunes (some of the partners had net worths in the hundreds of millions), but also leveraged the funds assets to over $100 billion (a leverage ratio of 30 to 1) and exposed it to risks of over $1 trillion (through derivative investments). Investors were eager to participate and nearly all of the major investment banks (Merrill Lynch, Chase Manhattan, Bear Sterns, Bankers Trust, JP Morgan, Lehman Brothers, Morgan Stanley Dean Whitter, and Salomon Smith Barney, to name just a few) had big stakes in it. So successful was LTCF that less than a year before its demise, it returned $2.7 billion in cash to investors, since it had simply run out of opportunities in which to invest.
The errors that brought LTCF down were in a sense quite basic. (1) It not only underestimated the human element of the markets, it ignored that factor altogether. People - and therefore markets - sometimes act irrationally, but the precise mathematical models LTCF was using to predict market behavior couldn't account for that. (2) It was both extremely leveraged and extremely illiquid, which in combination is a highly risky position (ask any real estate developer who's had to carry a project through slow times). And (3) while it foolishly thought it had diversified its investments, it really hadn't. Though it had numerous investments, which made it look diversified, they almost all mirrored each other. The same market condition that affected one investment necessarily affected nearly all of them.
LTCF's rise and fall is a fascinating story filled with great themes -money, greed, hubris, success, failure - topics that make for great literature. That its a true story makes it all the more incredible. As a former columnist for the Wall Street Journal, Roger Lowenstein is well qualified to tell the story and he does a commendable job. Readers unfamiliar with economics may occasionally need to re-read sections to understand some of the investment concepts, but this flaw is easy to overlook. WGF is an otherwise fast read and one that will appeal to a wide audience.
Rating: 5 out of 5
Is it true? Mindblowing
Great story. Appears to be very well researched. My only criticism would be that I felt the author was striving for a conclusion or something we could learn from the story. Whilst it certainly kept me turning the pages with intrigue (and I, like some of the other reviewers I notice, wanted to find the right conclusion too), there was no answer and I don't think there is an answer. No doubt we will be persuaded and tempted by fantastic academics with ideas for awesome returns again and no doubt we'll be burnt again too.The story appears to describe a key episode in history which has influenced how the financial world has developed into what it is today. These few brilliant academics may have brought the largest banks in the world to the brink of collapse and perhaps we should frown upon them for it but they can also, arguably, be credited with shaking up the industry.
The book still, a year on, philosophically entertains me. Is an efficient market a good thing? What kind of greed motivated these people? Can we ever fully compensate for risk?
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