Library:When Genius Failed
| When Genius Failed: The Rise and Fall of Long-Term Capital Management | |
|---|---|
| Author | Roger Lowenstein |
| First published | 2000 |
| ISBN | 978-0-375-50317-7 unverified |
| Role | Analysis |
| Domains | Business, Finance & Scams |
| Tactics | Statistical & Evidentiary Distortion |
When Genius Failed: The Rise and Fall of Long-Term Capital Management is a 2000 book by Roger Lowenstein.
Summary
Roger Lowenstein, a former Wall Street Journal reporter, tells the story of Long-Term Capital Management (LTCM), a hedge fund founded in 1994 by the celebrated bond trader John Meriwether and staffed by former Salomon Brothers traders and academics, including the economists Myron Scholes and Robert Merton, who shared the Nobel Prize in economics in 1997. For several years LTCM earned spectacular returns using mathematical models and enormous borrowing. In 1998 it lost most of its capital in a few months, and the Federal Reserve Bank of New York organized a rescue by major banks to prevent wider damage to the financial system.
The models
LTCM's strategy relied on finding small price differences between related securities, such as bonds of slightly different maturities, and betting that the differences would narrow. Each trade earned little, so the fund borrowed heavily to multiply its returns, at times controlling positions worth many times its capital, plus a huge web of derivatives contracts. Its models, based on historical data, suggested that large losses were extremely unlikely.
The collapse
In August 1998 Russia defaulted on its debt, triggering panic in global markets. Investors fled to the safest assets, and the price differences LTCM had bet would narrow instead widened dramatically, across many markets at once. Because its positions were so large and so many other traders held similar bets, LTCM could not sell without driving prices further against itself. It lost about $4.6 billion. In September 1998 the New York Fed brought together fourteen banks, which put about $3.6 billion into the fund in exchange for control, so that its positions could be wound down in an orderly way.
Lessons
Lowenstein argues that LTCM's partners mistook the precision of their models for certainty. Their models assumed markets would behave as they had in the past and that their trades were independent, when in a crisis everything moved together. The prestige of the founders, including Nobel laureates, discouraged lenders and counterparties from asking hard questions.
Relevance to Bullshitopedia
When Genius Failed is not a story of fraud but of overconfidence dressed in mathematical authority. It shows how credentials and sophisticated models can create a false sense of safety, a lesson that anticipated the 2008 financial crisis.