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Business. Finance. Nonfiction. HTML:�A riveting account that reaches beyond the market landscape to say something universal about risk and triumph, about hubris and failure.��The New York TimesNAMED ONE OF THE BEST BOOKS OF THE YEAR BY BUSINESSWEEK In this business classic�now with a new Afterword in which the author draws parallels to the recent financial crisis�Roger Lowenstein captures the gripping roller-coaster ride of Long-Term Capital Management. Drawing on confidential internal memos and interviews with dozens of key players, Lowenstein explains not just how the fund made and lost its money but also how the personalities of Long-Term�s partners, the arrogance of their mathematical certainties, and the culture of Wall Street itself contributed to both their rise and their fall. When it was founded in 1993, Long-Term was hailed as the most impressive hedge fund in history. But 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. The dramatic story of Long-Term�s fall is now a chilling harbinger of the crisis that would strike all of Wall Street, from Lehman Brothers to AIG, a decade later. In his new Afterword, Lowenstein shows that LTCM�s implosion should be seen not as a one-off drama but as a template for market meltdowns in an age of instability�and as a wake-up call that Wall Street and government alike tragically ignored. Praise for When Genius Failed �[Roger] Lowenstein has written a squalid and fascinating tale of world-class greed and, above all, hubris.��BusinessWeek �Compelling . . . The fund was long cloaked in secrecy, making the story of its rise . . . and its ultimate destruction that much more fascinating.��The Washington Post �Story-telling journalism at its best.��The Economist.… (more)
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This book could have been just another rehashing of Wall Street greed but it is more than that. Lowenstein offers up enough information about the major players to humanize them, each with their own foibles, ambitions and wants. The reader who is not familiar with John Meriwether and Long Term Capital Management will be on the edge of their seat as the story unfolds watching each personality react to dire situations.
The book does quite a good job of explaining to those not in the know about various financial bits and pieces. The star of the show is the Black-Scholes pricing for options. Lowenstein explains how this is based on random walks and Gaussian distributions. The whole LTCM business was based on crazy complex mathematical games. Lowenstein unpacks the games quite well.
My biggest complaint here is the way he diagnoses the errors of LTCM. I would point out three levels of mismatch between the efficient market hypothesis and reality. The most basic is the prevalence of fat tailed distributions in the place of Gaussian distributions. The next level is that the market is dominated by human behavior with all its wildness, e.g. folks getting swept up in whatever panic or enthusiasm of the day. The third level is that reality always stretches past any mathematical model. Lowenstein mentions all three of these problems, but he seemed to scramble them a bit. Fat tailed distributions can be modeled mathematically with wonderful precision - of course, there are many such distributions, but one can accumulate a shelf-full of books about them (trust me on this!) Even human behavior is not utterly impossible to model mathematically. No doubt even the breaking of waves on a rocky shore is going to exceed precise mathematics, and human behavior much more so. But if I were building models to support risk management on large portfolios, I'd be building fat tailed models that incorporate models of human behavior... and still leaving room for those frontiers of reality that exceed models. One method for addressing those frontiers is to work with multiple scenarios and with multiple models.
The copyright of the book says 2000. I'd say the copy got finalized in the early months of 2000. It'd be interesting to get another look at LTCM from the perspective of the 2000 crash, and especially of the 2008 crash. What's around the corner now, one is inspired to wonder!
Not only do the principals involved not really get their just desserts, the
It seems to me that, among other things, the following could be added to the mathematics
* replace normals in certain situations with fatter-tailed curves
* construct finite universe models (ie models in which there is only so much demand and supply, and in which huge trades will result in a drying up of liquidity)
* dynamic rather than static models, ie models that, rather than assuming a stable equilibrium (thermodynamics), try to model exactly how things change (including, in the simplest case, how things approach equilibrium). Such a model might include different types of environments, leading to different dynamics, for example a bear market environment, a bull market environment and a panic environment. Thus we get something closer to statistical mechanics.
On the other hand, it may well be that the mathematicians know exactly how to make better models, but are also well aware that in spite of the rhetoric, the system will usually bail them out when something goes wrong, so why not take risks with high upside and limited downside?
I was especially surprised about the unique characters of some of the geniuses these hedge funds have and this one had. It's always fascinating to here about the maladaptive and weird personalities of these chess masters or math minds.
I would suggest this book to anyone who likes business, even though it's about finance a bit.
Dunbar - a physicist by trade - is more interested in the theoretical economics that went into the risk arbitrage fund in the first
Lowenstein, by contrast, barely mentions either the Black-Scholes model (he barely touches on option pricing at all, as a matter of fact) or the Italian convergence trades which eventually blew the gaffe on the fund, but instead tells the human story, exposes the inevitable egos, and indulges in more than a little smuggery (this book is long on wisdom after the fact) in dissecting the naivety of the LTCM hedging and trading strategy and the people who ran it.
As long as he sticks to the egos and the posturing, When Genius Failed is a dandy read: the negotiations amongst the Wall Street top brass as the fund is going under rate with anything served up in Barbarians at the Gate, and as this is a large part of the book, it rips along quite nicely.
But the schadenfreude grates: One of the lessons of the whole fiasco was that the smart money is with the guy who can predict the future: any old mug can be a genius with hindsight. Lowenstein spends a lot of his time wisely pointing out what the traders should have done.
Additionally, Lowenstein employs some metaphors which indicate he might not have much of a grip on his subject: for one, he states "a bit of liquidity greases the wheels of markets; what Greenspan overlooked is that with too much liquidity, the market is apt to skid off the tracks." It's a poor metaphor, because it isn't excess liquidity which causes markets to skid, rather, it's the sudden disappearance of it. As this is the fundamental lesson of the Long Term story, it's a bad mistake to make for the sake of a smart-alec aphorism.
Similarly, in the epilogue states, with regard to the putative diversification in the fund "the Long-Term episode proved that eggs in separate baskets *can* break simultaneously". Again, this conclusion is not supported by the text, which observes several times that in a market crash, liquidity drains and the correlation risk of instruments in the market goes to one: that is to say, it turns out all your eggs are in the same basket after all. Diversity wasn't the problem; the problem was you wrongly thought you had it.
For these reasons I prefer Dunbar's more academic work: it may not be such a sizzling read, but nor does it misguidedly kick a fund when it's down.
It is a story with few heroes, but one with many lessons to be learned. However, beyond merely offering a cautionary tale of how greed, hubris and myopia almost brought down the entire financial system, Lowenstein also provides the reader with an excellent description of the myriad investment strategies that continue to be employed by the hedge fund industry today. At the very least, this is a book that will challenge what you think you know about leverage, liquidity and diversification.
And even leverage can be handled. You can work with it. For a while. Like a cocaine habit. But since you are dealing with the real world, where new things come along now and again; and with people, whose reactions can be hard to predict, accounting for all the risks is, really, impossible. So even geniuses are faced with the possibility that their risk models aren't sufficient. That they will, quite suddenly, be on the line for massive margin calls (the collateral on all that money they borrowed to lay down their many, many small-profit bets) that they just can't meet. And even if this is only the result of a short-term market irrationality (YOU ARE, AFTER ALL, PLAYING THE GAME OF MARKET IRRATIONALITY) you must pay or, as LTCM--the genius-packed company that is the subject of this book--had to, go bankrupt. Lowenstein's book is a good basic telling of this story, but he unfortunately doesn't seem to really appreciate the richness of the irony when a company that runs on exploiting irrationality gets eaten by another aspect of that same human irrationality. And is outraged.
The sector in which their money was made is the world of bond arbitrage. Arbitrage is about making money not in the rise and fall of asset prices, but in profiting on the spread between similar or almost identical assets. Spreads, on bonds in particular, are infinitesimally small. The only way to consistently make significant sums money on them is if you work on a massive scale with massive leverage [in LTCM's case, 30:1].
The monumental failing of the mathematicians behind this fund was that they assumed the economy was a collection of totally random incidents. They thought it would be absolutely impossible for a trend to carry through the entire economy. Such an oversight is utterly bizarre, as obviously, the global economy experiences meta-trends all of the time.
The book is very well researched and is a good mix of facts along with a narrative surrounding the personalities of the people involved.
I would have liked to have heard a greater analysis of the systemic risks that led to the bailout, but it could be that this information just doesn't exist. Maybe the instabilities caused by LTCM were just totally unpredictable, and that's why they were assumed too much of a risk.