Enterprising Investor Forum

When Genius Failed, R. Lowenstein Tuesday, September 11, 2007

As the book cover states, this is the tale of the rise and fall of Long-Term Capital Management (LTCM) and how one small bank created a trillion-dollar hole. Lowenstein details how the financial and academic ‘experts‘ that ran the fund nearly managed to collapse the world’s entire financial system.

The story is both fascinating and alarming. This hedge fund was being run, not only by some of Wall Street’s Superstars but also by a former Vice-Chairman of the Federal Reserve and two economic Noble prize winners. It should serve as a reminder to even the best investors that arrogance and greed do not offer a sustainable longterm proposition.

John Meriwether and his Partners were indeed arbitrage specialists and had perfected the risk-management strategies of their hedge fund. From March 1994 (when LTCM started trading) the fund showed a ROI of over 40% per year in the first four years of operation! The issue was that to keep producing this kind of performance, their bets had to involve bigger and bigger positions, more leverage and therefore more risk. Due to the success and the fact that everyone wanted a piece of the action, they became even more convinced that they were completely invincible and lenders did not hesitate to keep on funding them as the results where there….

However, once markets turned against them, LTCM had no chance to get out in time. They lost close to 2 billion dollars in one month alone! Furthermore, due to all the leverage, derivatives and other complex financial hedges, the fall of LTCM also meant that banks, governments and institution worldwide where in the midst of this imminent financial disaster. Ultimately, the Fed had to step in and lead a bailout….

Enjoy!