Sunday Musings: When Genius Failed

Last week, I finished reading a fascinating book called “When Genius Failed” by Roger Lowenstein. It captures the roller-coaster ride of Long-Term Capital Management (LTCM) from 1993 to 1998.

Back then, LTCP was hailed as the most impressive hedge fund in history. Led by the notoriously successful bond arbitrageur John Meriwether, the firm boasted a partnership that included two Nobel-Price-winning economists and a cadre of Wall Street’s and academia’s elite traders.

However, after four years, in which the firm dazzled Wall Street as a $100 billion moneymaking juggernaut, it suddenly suffered catastrophic losses that jeopardized not only the biggest banks on Wall Street but the stability of the financial system itself.

From being a viable entity to no longer being able to operate took only 6 weeks. The biggest problem LTCM had faced was its absolute massive leverage coupled with one-sided trades that, due to external circumstances (Russia and developing countries defaulting), could not be closed out.

As LTCM was sliding into oblivion, their equity dwindled to $1 billion; however, they still controlled $100 billion in assets. That’s 100 to 1 leverage! It would take only a 1% move against their positions to render them bankrupt.

I found it fascinating to read inside story but, at the same time, I had an eerie feeling that this was nothing new because we are currently seeing a very similar scenario with the Subprime/credit crisis. The pig may be wearing a different lipstick, but the underlying facts are the same: Overleveraged institutions holding undervalued assets, which can only be liquidated at a loss.

If you like to read about financial tales of our time, you will enjoy this high drama of fast money and vivid (still living) characters. I couldn’t wait to finish it.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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