When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein

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Our Review
Liar's Poker, Indeed
A few years ago, probably not five Americans in a thousand could say what a hedge fund is -- an investment partnership serving the interests of an exclusive hundred or fewer clients. But in the flush mid-'90s, Long-Term Capital Management quickly established itself as the most successful hedge fund on the scene. In no time at all, the fund was a major player in the world's financial markets. And for a few years it enjoyed the very best of times. And then, quite suddenly, over the summer and fall of 1998, amid a global financial crisis that Secretary of the Treasury Robert Rubin characterized as the most turbulent in half a century, Long-Term Capital Management came to taste the very worst of times.

How did a financial institution that few Americans had heard of find itself suddenly facing its imminent demise -- and threatening, to boot, to undermine the stability of the world's financial markets? How did a company boasting legendary trading talent, two Nobel Prize-winning economists, and a former officer of the Federal Reserve come to such a predicament? Roger Lowenstein, formerly a financial journalist for The Wall Street Journal and today a columnist for SmartMoney, has written a riveting narrative and the most comprehensive account to date of the hedge fund's short and spectacular career, When Genius Failed: The Rise and Fall of Long-Term Capital Management.

In its first heady years, LTCM, a Greenwich, Connecticut, hedge fund employing fewer than 200, posted record gains. Its profits soared like a hot-air balloon carried aloft by the trade winds. The fund quickly quadrupled its initial investment stake (a record $1.25 billion). LTCM was the envy of Wall Street.

But in December of 1997, the Thai currency crashed and 56 of Thailand's top 58 finance houses were forced to close overnight. The crash triggered an economic recession that rippled across Asia. And when, months later, Russia announced it was defaulting on its foreign loan payments, fear in Washington and in the financial markets was palpable. Wealthy individual investors and institutional traders undertook increasingly frantic efforts to find safe havens for their funds, havens high enough to ride out the anticipated tidal backlash.

For six harrowing months in 1998 -- from April through September -- the hedge fund was in free fall, losing tens and even hundreds of millions of dollars daily. LTCM dropped like an elevator with snapped cables. In that improbably brief stretch, the fund lost $5 billion -- a sum representing more than 90 percent of its operating capital. But that was only part of the story, only part of the immediate danger: The hedge fund's leveraged derivative bets, it gradually emerged, exposed the fund and the financial houses that had so heedlessly lent LTCM the money to extend its financial bets to potential losses of $100 billion. There was hardly a bank that could hope to escape unscathed.

It took a controversial last-minute Fed-orchestrated bailout by a banking consortium to pull LTCM back from the brink of collapse. The banks ultimately allowed that they were wiser to swallow the bitter medicine of bailing out LTCM from bankruptcy than to brave the fallout that the fund's ruin might wreak on even the largest banks and investment houses.

Lowenstein relates this chapter of recent financial history with sure-handed skill and a keen eye for drama. And When Genius Failed tells us more than LTCM's story, for the hedge fund's partners were more knowledgeable about the new finance and more practiced at working with the new financial instruments than anyone else on Wall Street. The traders at the core of LTCM had, after all, ushered in that financial revolution with stunning success as arbitrage traders at Salomon Brothers in the 1980s. (Indeed, they were the very same characters Michael Lewis memorialized in Liar's Poker, the "Young Professors" hired and trained by John Meriwether, himself probably the best-known trader of his generation.) And Robert C. Merton and Myron Scholes, partners at LTCM who in 1997 won Nobels for their contributions to economics, had themselves authored the ideas forming the intellectual framework of contemporary financial thought and practice. As a unit, LTCM's partners were commonly regarded as the sharpest financial minds at work among the Wall Street powers.

When Genius Failed, then, offers a superb capsule history of the last generation's financial innovations. Lowenstein has written a bracing cautionary tale, too. For it isn't the least of the ironies attending the LTCM partners' fall from grace that, to a man, they were committed to (and had staked their personal fortunes on) realizing the ideals of managed risk in finance. But in their devotion to a hyper-rational faith in their mathematical models, they lost sight of the real, human, and unpredictable dangers in the markets they plied. Together, they unwittingly helped shape conditions of financial crisis on an almost unimaginable scale.

Lowenstein allows, however, that there is plenty of blame to be shared. The failures of accountability were systemic. John Meriwether, as always unwaveringly loyal to his traders, failed to rein in his partners' most extravagant gambles. The banks, made greedy by LTCM's gaudy profits, recklessly threw their money at the hedge fund traders, no questions asked. And even Alan Greenspan, the chairman of the Fed, comes in for a share of criticism for turning a blind eye to the need for regulating the derivative markets and hedge fund operators. When Genius Failed provides a shrewd, skeptical take on high finance today. It is a gripping, satisfying read.

--Gregory Tietjen

From the Publisher

John Meriwether, a famously successful Wall Street trader, spent the 1980s as a partner at Salomon Brothers, establishing the best--and the brainiest--bond arbitrage group in the world. A mysterious and shy midwesterner, he knitted together a group of Ph.D.-certified arbitrageurs who rewarded him with filial devotion and fabulous profits. Then, in 1991, in the wake of a scandal involving one of his traders, Meriwether abruptly resigned. For two years, his fiercely loyal team--convinced that the chief had been unfairly victimized--plotted their boss's return. Then, in 1993, Meriwether made a historic offer. He gathered together his former disciples and a handful of supereconomists from academia and proposed that they become partners in a new hedge fund different from any Wall Street had ever seen. And so Long-Term Capital Management was born.
        In a decade that had seen the longest and most rewarding bull market in history, hedge funds were the ne plus ultra of investments: discreet, private clubs limited to those rich enough to pony up millions. They promised that the investors' money would be placed in a variety of trades simultaneously--a "hedging" strategy designed to minimize the possibility of loss. At Long-Term, Meriwether & Co. truly believed that their finely tuned computer models had tamed the genie of risk, and would allow them to bet on the future with near mathematical certainty. And thanks to their cast--which included a pair of future Nobel Prize winners--investors believed them.
        From the moment Long-Term opened their offices in posh Greenwich,Connecticut, miles from the pandemonium of Wall Street, it was clear that this would be a hedge fund apart from all others. Though they viewed the big Wall Street investment banks with disdain, so great was Long-Term's aura that these very banks lined up to provide the firm with financing, and on the very sweetest of terms. So self-certain were Long-Term's traders that they borrowed with little concern about the leverage. At first, Long-Term's models stayed on script, and this new gold standard in hedge funds boasted such incredible returns that private investors and even central banks clamored to invest more money. It seemed the geniuses in Greenwich couldn't lose.
        Four years later, when a default in Russia set off a global storm that Long-Term's models hadn't anticipated, its supposedly safe portfolios imploded. In five weeks, the professors went from mega-rich geniuses to discredited failures. With the firm about to go under, its staggering $100 billion balance sheet threatened to drag down markets around the world. At the eleventh hour, fearing that the financial system of the world was in peril, the Federal Reserve Bank hastily summoned Wall Street's leading banks to underwrite a bailout.
        Roger Lowenstein, the bestselling author of Buffett, captures Long-Term's roller-coaster ride in gripping detail. Drawing on confidential internal memos and interviews with dozens of key players, Lowenstein crafts a story that reads like a first-rate thriller from beginning to end. He explains not just how the fund made and lost its money, but what it was about the personalities of Long-Term's partners, the arrogance of their mathematical certainties, and the late-nineties culture of Wall Street that made it all possible.
        When Genius Failed is the cautionary financial tale of our time, the gripping saga of what happened when an elite group of investors believed they could actually deconstruct risk and use virtually limitless leverage to create limitless wealth. In Roger Lowenstein's hands, it is a brilliant tale peppered with fast money, vivid characters, and high drama.

Business Week

Lively, smoothly written, and elaborately researched, Buffett is likely to stand as the definitive biography.

Chicago Tribune

A significant contribution to the craft of biography as well as an illuminating and comforting story for investors everywhere.

Barron's

The singular achievement of Lowenstein's excellent biography.. is that it burnishes the Buffett myth while deconstructing it with heavy doses of reality.

Los Angeles Times

Lowenstein has accomplished something remarkable.

Financial Times

Thoroughly researched and perceptive . . . a highly readable account.

New York Times Book Review

A delightful portrait . . . Mr. Lowenstein has done a masterly job.

Publishers Weekly

In late September 1998, the New York Federal Reserve Bank invited a number of major Wall Street investment banks to enter a consortium to fund the multibillion-dollar bailout of a troubled hedge fund. No sooner was the $3.6-billion plan announced than questions arose about why usually independent banks would band together to save a single privately held fund. The short answer is that the banks feared that the fund's collapse could destabilize the entire stock market. The long answer, which Lowenstein (Buffett) provides in undigested detail, may panic those who shudder at the thought of bouncing a $200 check. Long-Term Capital Management opened for business in February 1994 with $1.25 billion in funds. Armed with the cachet of its founders' stellar credentials (Robert Merton and Myron Scholes, 1997 Nobel Prize laureates in economics, were among the partners), it quickly parlayed expertise at reading computer models of financial markets and seemingly limitless access to financing into stunning results. By the end of 1995, it had tripled its equity capital and total assets had grown to $102 billion. Lowenstein argues that this kind of success served to enhance the fund's golden legend and sent the partners' self-confidence off the charts. As he itemizes the complex mix of investments and heavy borrowing that made 1994-1997 profitable years, Lowenstein also charts the subtle drift toward riskier (and ultimately disastrous) ventures as the fund's traditional profit centers dried up. What should have been a gripping story, however, has been poorly handled by Lowenstein, who obscures his narrative with masses of data and overwritten prose. Agent, Melanie Jackson. Author tour. (Sept.) Copyright 2000 Cahners Business Information.

Library Journal

This is a marvelous, unauthorized chronicle of the rise, fall, and re-emergence of Long-Term Capital Management, a private hedge fund that in September 1998 benefited from a Federal Reserve-orchestrated $3.6 billion bailout. Based primarily on interviews with key players from the six banks that participated in the rescue of the firm, Lowenstein, who previously wrote Buffett: The Making of an American Capitalist, presents a well-crafted, easy-to-follow text. Readers will better appreciate the inner workings of the firm; the nuances of the individual partners; primary differences among investing in stocks, bonds, and derivatives; the fallacy of the efficient market hypothesis; the impact of computers on financial trading; and the importance of moderation. Recommended for both academic and public libraries. [Previewed in Prepub Alert, LJ 5/15/00.]--Norman B. Hutcherson, Kern Cty. Lib., Bakersfield, CA Copyright 2000 Cahners Business Information.\

Economist

This book is story-telling journalism at its best...Mr. Lowenstein's description of what went wrong is detailed and readable.

New York Times Book Review - Norris

Lowenstein does a masterly job of explaining both the theories used and how the fund succeed brilliantly in 1995 and 1996 . . . he makes a convincing argument...Lowenstein [is] one of the best financial journalists there is...

Business Week - Gary Weiss

Lowenstein has written a squalid and fascinating tale of world-class greed and, above all, hubris...we probably won't get a better account about the events that roiled the markets in 1998.

Details from Seller

• ISBN: 0375758259
• Publisher: Random House Publishing Group
• Pub. Date: October 2001
• Condition:

Comments from the Seller: Westminster, Maryland, U.S.A. 2001 Softcover Fine This 5 x 8 softcover has 264 pages. The rollar-coaster ride of Long-Trem Capital Management in gripping detail.

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