When Genius Failed, by Roger Lowenstein
Feb 7th, 2008 by Nut
How we got here: I had seen this book mentioned somewhere a long time ago and forgot all about it. Then a friend of mine lent it to me and when I saw the author’s name, I knew I had to read it. Roger Lowenstein is the author of the superb biography, Buffett: The Making of an American Capitalist, which I thought was fantastic.
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The book is about a hedge fund that operated back in the late nineties called Long-Term Capital Management. The guy at the helm was John Meriwether (who I recognized from Michael Lewis’ Liar’s Poker), an interesting, super intelligent guy who was put on this earth to make billions of dollars.
The interesting thing about this hedge fund is that they brought in some well-known professors (some even won the Nobel Prize in Economics) to set up a system that allowed them to profit on tiny trades repeated thousands of times. The scale was small, but these guys borrowed so much money that those small moves amounted to a huge pile of cash.
If you’re interested in what these trades were all about, here’s what I can tell you: they traded bonds and their spreads. Sometimes prices for bonds would diverge from the option to buy a bond, and they would go in there and exploit that small difference. They call it arbitrage. Whenever the spreads didn’t do what they thought should happen according to their models, they would wait it out—knowing that it was just a matter of time.
They made a ton of money and built more wealth for themselves and their clients than anyone could ever spend in several lifetimes.
Then it all came tumbling down.
This is the fun part of the book—when the rich, stubborn dudes lose all their money. It’s the payoff part of the book and it’s well worth it.
The only thing about this book I didn’t like was that Lowenstein obviously knows his stuff and he wants to give us a shot at understanding it too. But page after page of how these obscure financial dealings work is not fun.
“Just get to the part where they get in trouble and lose all their money,” is what I found myself thinking.
Lowenstein uses sports analogies here and there to get his point across, which I liked since I’ve been trying to create my own analogies to help explain much more basic investment topics.
The epilogue is spot on, as he talks about how easily these guys got off. They weren’t punished for over leveraging themselves and putting the whole economy at risk (that’s how much they had borrowed and invested). They were bailed out and a few years later Meriwether started another fund that made him more money.
He even drops a line that seems rather omniscient for 2001:
Will investors in the next problem-child-to-be, having been lulled by the soft landing engineered for Long-Term, be counting on the Fed, too?
Well, that’s what’s happening today with the whole sub-prime mortgage mess. Who is being punished? No one. Instead, the rules are being changed to it “doesn’t happen again.”
Way to go people.
Coming up Next: The Lay of the Land, by Richard Ford.
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