Book Review: When Genius Failed

I read the book When Genius Failed: The Rise and Fall of Long-Term Capital Management a long time ago. I re-read it last weekend in light of the recent news about the failure of hedge fund Carlyle Capital Corp. and the Fed’s emergency loan to Bear Stearns. After I finished the book, news came that the Federal Reserve organized the sale of Bear Stearns to JPMorgan Chase for $2 a share (Bear Stearns closed last Friday at $30 a share). This is very similar to the story of Long-Term Capital Management 10 years ago. History has a habit of repeating itself.

Long-Term Capital Management (LTCM) was a hedge fund set up by some smartest Wall Street traders and academics including two Nobel laureates. It used complex math models for trading bonds. It was very successful. From its start in April 1994 to April 1998, in four years of time, it turned every dollar invested into four dollars. That’s an average return of more than 40% a year. Then the tide turned. Everything worked against them. High leverage made things a lot worse. It went bust in six months. The Federal Reserve twisted the arms of some other Wall Street firms into rescuing LTCM. LTCM’s investors were basically wiped out. The Wall Street firms took LTCM’s positions and slowly unwound them.

The author Roger Lowenstein chronicled the rise and fall of LTCM in details. The fascinating tale reads more like a thriller than a business book. If you want to understand what’s going on with Carlyle Capital or Bear Stearns, I highly recommend this book. It’s amazing to see exactly the same story line unfolding right in front of us. Only time and characters changed.

Rating: *****

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  1. david says

    I’m curious – did they necessarily do anything “underhanded” or was it that they just placed to much faith on their models?

  2. Harry Sit says

    David – I assume by “they” you meant LTCM. LTCM trusted their models. They also believed in diversification and non-correlation. They had hundreds of bets in different markets. They thought it was impossible for all of those bets to go bad at the same time. Then the unthinkable happened. The seemingly unrelated markets connected together and went against their bets at the same time. Being leveraged 30:1 killed them.

  3. Kristin says

    A lot of us are counting on diversification to protect our portfolios. It can lead to a false sense of security.

    Not enough investors are aware that correlations between asset classes can and do change over time.

    This book sounds like a worth while read.

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