When Genius Failed: A Review
Just finished Roger Lowenstein's page-turning high finance thriller When Genius Failed Once again, I'm giving the book two thumbs up and recommending everyone go out and read it. The book details the rise and fall of perhaps the most intriguing hedge fund that ever lived -- Long Term Capital Management. Almost everyone who works on Wall street has heard of LTCM, but few understand how they made money and busted after years of phenomenal double-digit returns.Let me backtrack a bit, here. First of all, LTCM was a fund comprised of the nations top traders and academics -- they had two Nobel Laureates on their team. Second, they had fiscal strength unparalled by most standard assets-under-management calculations (for hedge funds back in the late 90s at least). Lastly, skill. It was the techniques and tools the fund implemented that enabled them to return over 30 % to their investors in the funds first year.
But as they do, parties eventually crash. LTCM made money through a risk management exercise called bond arbitage. Arbitrage is best explained as the leveraging of assets to achieve above normal results. But leverging involes -- naturally -- a shitload of borrowing. That means that when things don't go your way, your left with sizable losses and debts since your exposure is so large. Since LTCM was playing so many diffrent bond markets all at once, when the Asia crisis hit, and Russia defaulted on its debt, LTCM went down with it. The fund was losing several million a day, sometimes a lot more. But that is all conversation -- the real reson LTCM imploded was because the fund managers miscalculated how humans operate, even on the most simple level. No computer or abstruse theory from the Ivory Tower can forecast how fear and greed will decimate the capital markets. When Joe runs, so will Joe's friend. We've seen the cycle repeat itself through history, yet no one wants to learn. LTCM shut its doors just as the bubble was close to bursting.
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