Product Description

How One Small Bank Created a Trillion-Dollar Hole When Genius Failed is the extraordinary final instalment in a financial saga that began with the gambling on the futures markets in the 1980s. It is the conclusion of the poker players so memorably depicted in Liar's Poker and, fictionally, in Bonfire of the Vanities. By 1994 John Meriweather, the pivotal figure on the trading floor at Salomon Brothers during the 1980s when the firm had made $500 million annual profits in arbitrage alone, was out of work. To fill his time, he created a financial institution as much a product of the era of the 1990s as the futures floors had been in the 1980s: a hedge fund, named Long-Term Capital Management. Meriweather took to LTCM the brightest of his disciples from Salomon and added Nobel prize-winning economics from Harvard. The team believed that it could outsmart the markets in a strategy of hedge betting, leveraged to levels previously unseen. Even a small percentage profit could be turned into a huge financial gain if the stake placed was big enough. So LTCM bet big, very big. Hedge funds are the equivalent of private clubs on Pall Mall or exclusive Oxbridge colleges: you have to be invited to join. And you have to be extremely rich. LTCM's partners quickly included every bank on Wall Street and many of Europe's premier banks as well. They built up a fund of $100 billion. Which meant that they could really put some money down. And they made spectacular profits for a while. Until the pressure to keep achieving led to increasingly risky speculations and less protected gambles. When the markets in Brazil, Indonesia and Russia all crashed within months of each other it was as if a wrecking ball had ploughed through LTCM. But because they had continued to leverage their investments at very high multiples the effect was shared throughout the world's banks. When LTCM went down it threatened to open up a trillion-dollar black hole, a financial abyss that could have busted a continent and an entire banking system. In a classic tale of greed, ambition, pride and overbearing confidence in their ability to beat the market, Meriweather's poker players play out their last hand. A parable of extraordinary drama, it is also a brilliant morality story of our times and a vivid warning of capitalism's ability to consume its own.

Product Details

• Amazon Sales Rank: #649 in Books
• Published on: 2002-01-02
• Binding: Paperback
• 275 pages

Amazon.co.uk Review
On September 23, 1998, the boardroom of the New York Fed was a tense place. Around the table sat the heads of every major Wall Street bank, the chairman of the New York Stock Exchange, and representatives from numerous European banks, each of whom had been summoned by the Fed to discuss the highly unusual prospect of rescuing what had, until then, been the envy of them all, the extraordinarily successful bond-trading firm of Long-Term Capital Management. Roger Lowenstein's When Genius Failed is the gripping story behind the Fed's unprecedented move, the incredible heights reached by LTCM, and its eventual dramatic demise.

Lowenstein, a financial journalist and author of Buffet: The Making of an American Capitalist, uncovers and examines the personalities, academic expertise, professional relationships, and layers of numbers behind LTCM's roller-coaster ride with the precision and knowledge of a skilled surgeon. The fund's enigmatic founder, John Meriwether, spent almost 20 years at Salomon Brothers, where he formed its renowned Arbitrage Group by hiring academia's top financial economists. Though Meriwether left Salomon under a cloud of the SEC's wrath, he leapt into his next venture with ease, and enticed most of his former Salomon hires--and eventually even David Mullins, the former vice-chairman of the US Federal Reserve--to join him in starting a hedge fund that would beat all hedge funds.

LTCM began trading in February 1994, after completing a road show that, despite the Ph.D.-touting partners' lack of social skills and their disdainful condescension of potential investors who couldn't rise to their intellectual level, netted a whopping 1.25 billion dollars. The fund would seek to earn a tiny spread on thousands of trades, "as if it were vacuuming nickels that others couldn't see," in the words of one of its Nobel laureate partners, Myron Scholes. And nickels it found. In its first two years, LTCM earned 1.6 billion dollars, profits that exceeded forty percent even after the partners' hefty cuts. By the spring of 1996 it was holding $140 billion in assets. But the end was soon in sight, and Lowenstein's detailed account of each successively worse month of 1998, culminating in a disastrous August and the partners' subsequent panicked moves, is riveting.

The arbitrageur's world is a complicated one, and it might have served Lowenstein well to slow down at the start and explain in greater detail the complex terms of the more exotic species of investment flora that cram the book's pages. However, much of the intrigue of the Long-Term story lies in its dizzying pace (not to mention the dizzying amounts of money won and lost in the fund's short lifespan), and Lowenstein's smooth, conversational, but equally urgent tone carries it along well. The book is a compelling read for those who've always wondered what lay behind the Fed's controversial involvement with the LTCM hedge-fund debacle. --S. Ketchum

Synopsis
This title tells the story of long-term capital management where a group of elite investors believe they can beat the market and, like alchemists, create limitless wealth for themselves and their partners. In fact, they create a trillion-dollar hole in the international banking system.

About the Author
Roger Lowenstein has reported for the Wall Street Journalfor more 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.

Customer Reviews

The writing on the wall
I am not an expert in finance; neither do I want to look into the details of LTCM's trading strategies. I was therefore still at a loss about what the LTCM's intricate financial schemes was all about even when I finished reading this book. Nevertheless, Lowenstein's work has impressed me very much since I read his another book 'Buffett: The Making of An American Capitalist' a few months ago. 'When Genius Failed' didn't disappoint me as well.

History repeats itself. Somewhat different as the backdrop and story of those events might have been, numerous financial debacles have taken place so far. Writers of financial history seem to find no shortage of materials on financial disasters. Sooner or later other similar books on the story of money games will appear in bookshops.

Utterly imprecise
Horrible book. Very interesting topic but very poor story telling. The author clearly knows next to nothing about statistics and finance and did very poor research; non experts in the field will struggle to understand the key concepts behind the trading strategies. True, some of those trades were extremely complex, but at least the basic concepts could and should have been explained more clearly. If I didn't work in finance myself I would have understood very little.
One passage is particularly worth commenting on, when the author mentions theoretical models whereby asset "prices follow the normal distribution, or, in mathematical terms, the log-normal distribution". ??? Unless we speak a different language, this phrase means that the log-normal is the mathematical definition of what is commonly known as the normal distribution. The truth is of course very different: if data is lognormal, then its log is normally distributed, i.e. they are 2 different distributions, related but different!!! A mistake so huge I don't even have words to comment.

Essential Reading
It would be a shame if this book were confined to readers of the 'Business' section. It should be required reading for anyone whose life is affected by the machinations of the financial sector - i.e. everyone.

In itself the tale is one of high drama, but it helps that it's told by a writer with the ability to keep up the pace and energy throughout, despite the complexities and opaqueness of a lot of the subject matter - and then distil the argument into one killer sentence: "Neither the Nobel prize nor all the degrees mattered now; the professors were rolling the dice." This single phrase encapsulates the essence of the story. Emboldened by their initial success and oblivious to any flaws in their 'system' they took on the mind-set of the gambler in the casino who 'knows' he can beat the house and throws caution to the wind. Thus a buttoned-up bunch of academics and highly rational financiers succumbed to the not-always-rational dictates of markets, convinced to the end (and beyond) that it was the world outside their number-crunching computer programs that had got it 'wrong'.

To the layman a further irony seems to be contained in the fact that a group who'd focussed so much on translating the disciplines of science into the world of finance seemed to have ignored the market equivalent of the observer effect - the possibility that their own theorems might in some way influence behaviour in the markets, effectively making their 'rear-view mirror' calculations based on past experience if not redundant then less reliable than expected. Maybe in trying to follow the Black-Scholes paradigm contemporary players were adjusting market reactions in a way that computer progams premised on projections from the past simply didn't accommodate? Perhaps, paradoxically for such a cards-to-the-chest operation, they had signalled their own reactions in advance (revealing your strategy in any circumstance isn't the way to win at poker!). Or perhaps they were just victims of their own success - in securing such a major stake in the game they actually changed the rules and then set themselves up as an easy target to be picked off by their rivals as soon as the odds went against them. In any case, their belief in their own omniscience seems like an invitation to failure.

There's an element of shadenfreude in seeing arrogance get its come-uppance, but this is tempered by a (sometimes grudging) admiration for the way Meriwether was able to change the world around him through sheer force of his (albeit reserved) personality and (almost) bring it off - particularly after the apparent injustice of his demise at Salomon. If he'd been able to impose his more cautious impulses on to his gung-ho acolytes, or trust the gut instincts that had served him so well at Salomon over Nobel prize-winning theorems, his success wouldn't have been so short-lived. Still, you needn't feel too sorry for the partners who lost $1.9bn in five weeks - they would fare better than some of their employees, who ended up with nothing.

It gives you the sort of entertainment you get from watching a car wreck, as the banks scrabble round to find a way of protecting themselves - without doing too much for each other. Certainly there's an element of black comedy as one participant comments: '"They had a different view of the world ... they're completely self-interested." Suddenly these paragons of individual enterprise seethed with communitarian fervor.'!

More worryingly, given that little seems to have changed as a result in terms of the kind of improved reporting on derivatives called for by Lowenstein, it looks like, in this age of 'collateralized debt' instruments, more such debacles are almost inevitable - it's just the scale of the collapse that remains in the balance. One thing is for sure, the regulators are pretty much in the dark as far as derivative trading goes, and it seems we're dependent on threats of Mutually Assured Destruction to keep us above water if liquidity crises aren't going to sink the whole ship (I'll leave you to ponder how a lack of liquidity can sink a ship).

What I'm trying to say is that this book is as relevant today - if not more so - than when published, and suggests that the sub-prime problems that have almost submerged Northern Rock may be just the tip of the iceberg (sorry, I just can't get the image of the Titanic out of my head!), and Adam Applegarth's defence of his business model does resound with the injured pride and lack of comprehension that characterised the protestations of the LTCM partners as they continued to defend their models in the face of mounting disaster.

Meanwhile, the balancing act that the regulatory authorities face, between discouraging moral hazard and safeguarding the system from wreckless gambling seems increasingly precarious - and will continue to be, so long as extreme neoliberal sentiments dominate. No doubt those that resist even self-regulation would argue the the LTCM saga provides an object lesson in how markets can repair themselves - but it was a close run thing.