In the US equity volatility was increasing – very dangerous for LTCM’s substantial short positions in equity volatility. Opportunities were still scarce and LTCM further relaxed its risk standards in order to put all that money to work. By now the company had strayed far from its core competencies and was taking largely unmeasured risks. In 1995, Long-Term earned 59%, 43% net of fees, despite the Mexican crisis during the year. Taking derivatives into account, the return was even smaller and leverage even larger. The Ph.D.’s at LTCM disregarded the possibility of black swan events (made ever so popular by Nassim Taleb’s book).

It is written in a compelling, accessible style that should appeal to readers unfamiliar with financial jargon. As this book is now 15 years old, it was interesting to view it against the backdrop of the financial crisis of 2008.

About Roger Lowenstein

However, its enormously leveraged gamble with various forms of arbitrage involving more than $1 trillion went bad, and in one month, LTCM lost $1.9 billion. On the precipice of not only an American financial disaster, the fund’s imminent collapse had significant international monetary implications, jeopardizing the financial system itself. Lowenstein’s What is A-Markets story gives the Fed a small operational role in the resolution of the LTCM crisis, relegating the New York Fed to an administrative role . The Fed did nothing to directly bail out LTCM, according to the author. But, the Fed, putting a very high value on limiting market turbulence, did lend its prestige to the effort to resolve the crisis.

Nine months before LTCM failed 1997, Merton and Scholes shared the Nobel prize in economics. Merton, Scholes and Stanford’s William Sharp are some of the founders of modern finance, which attempts to apply quantitative techniques to market analysis. Merton and Scholes jumped at the chance to join LTCM where they could not only apply their theoretical work but make a great deal of money. Modern trading is now almost entirely paperless and takes place in the cyberspace of computers and computer networks. The instincts of market traders are being augmented and in some cases replaced by mathematical pricing models. Traders are being drawn from schools like MIT, rather than the City College of New York.

As someone in financial services industry, I would recommend it to people interested in the field. A lot of current risk management practices stem from this every case. The book tells the story of a darling of the Wall Street in the 1990s, the firm that attracted awe of investors, financial regulators, academia and Foreign exchange reserves business leaders in general. The firm which was called Long-Term Capital Management was established and ran by the cream of the cream in the U.S. financial industry and financial education. Its investment placements were based on sophisticated mathematical models developed largely by the founders themselves.

Rather, the banks relied on the brand name that LTCM had established through its roster of partners. LTCM is a great story/fable populated with memorable characters. Lowenstein does a nice job in pacing the story and I recommend reading the book for these reasons alone. There is a certain pleasure reading about the demise of the haughty and rich . The book fails, however, in communicating a convincing moral. Bestselling author Roger Lowenstein masterfully tells the story of Long-Term Capital Management – one of the most illustrious hedge funds of its day. A financial market power that made Merrill Lynch’s “thundering herd” seem like a bunch of noisy kids at its heyday, today LTCM is a case study of greed, hubris, and the marriage of academia and Wall Street.

The potential loss of LTCM’s contracts was estimated at approximately $3-4b. Through mid-August 1998, LTCM had $3.6b in capital, 40% belonging personally to the partners. At the end of their third year, the initial partners’ $146m had grown nine times to $1.4b. The problem with LTCM’s academics’ theory was that it blindly relied statistically calculated volatilities based on historical observations to be reflective of real life future market shocks.

One Up On Wall Street

This threw out LTCM’s trading models as bond prices diverged. Long-Term Capital Management was a hedge fund set up by some smartest Wall Street traders and academics including two Nobel laureates. From its start in April 1994 to April 1998, in four years of time, it turned every dollar invested into four dollars. The Federal Reserve twisted the arms of some other Wall Street firms into rescuing LTCM. The Wall Street firms took LTCM’s positions and slowly unwound them. “Past performance is not necessarily indicative of future performance.” This mantra of financial markets was eschewed by the gurus at LTCM and this book thoroughly explains the early payoffs and late demise of their hedge fund. A must read for industry professionals, though readers with only a passing interest or knowledge of the derivatives market will find it difficult to keep up.

Meriwether developed the Arbitrage department at Salomon Brothers, hiring academics to develop mathematical and computerized models to predict prices based on market volatility. When Meriwether left Salomon, he basically duplicated the set-up he had there and hired away many of the traders and staff to form Long-Term. The hedge fund was set up with a system of feeders as a Cayman Islands partnership and had a Long-Term Capital Management company which managed the investments of the partners. The book gives a look into the world of international investment banking and bond and equities trading. Meriwether and his cronies developed the concept of arbitrage, or hedge trading.

• In 1977, John Meriwether formed a group at Salomon Brothers that focused on arbitrage.
• Finally, the gods who intervened during the crisis faced skepticism from previously fawning acolytes.
• As befits a Big Swinging Dick market trader, LTCM was to be a Big Swinging Dick of a Hedge fund, capitalized with two and a half billion dollars.
• Thus, when there is some sort of conflict, we are SUPPOSED to remember that Harvard MBA #1 is timid while Wharton MBA#3 is assertive, but the average reader will find the many, many names in this book running together.
• By the end of the year LTCM had returned $2.7b to investors and its leverage was 28 to 1 .
• If you push the swing, it will rise and fall until it returns to its resting point.

At the start of the year, that would have seemed remote, for Long-Term’s capital had been $4.7 billion. But during the past five weeks, or since Russia’s default, Long-Term had suffered numbing losses-day after day after day. For four years, Long-Term had been the envy of Wall Street. The fund http://infinitypersonnel.co.uk/review-of-mark-minervini-s-trade-like-a-stock/ had racked up returns of more than 40 percent a year, with no losing stretches, no volatility, seemingly no risk at all. Its intellectual supermen had apparently been able to reduce an uncertain world to rigorous, cold-blooded odds-they were the very best that modern finance had to offer.

When Genius Failed Key Idea #2: Ltcm Leveraged Heavily In Order To Maximize Their Profits

The number of investors in a hedge fund is limited and they are restricted, in theory, to only those who can afford the risks which may be associated with the hedge fund. In the current article, I would highlight the most important lessons that life of LTCM teaches stock investors.

Relying on Gaussian models and standard deviations as measures of uncertainty, they conjured a Gaussian world where every risk was quantified, but as they would later find out, erroneously. They strong armed everyone on the market, got the best deals, made a stunning portfolio and for the first 4 years, quadrupled their funds value. This books gets three stars because it is a serviceable summary of its topic but is in now way outstanding. If you like finance, specifically statistical modeling and hedging strategies, you will find this tale of Nobel Prize hubris gone wrong because “muh models” didn’t predict multiple standard deviation events intriguing.

Book Review

They feared that if LTCM lost control, all its earnings were in danger. But as time passed, their position only worsened, and they were left with no other choice. The fewer buyers there are in the market, the more severe the losses for the seller. By the end of August, LTCM had lost 45 percent of its capital, had reached a leverage rate of 55 times that capital, and were stuck with $125 billion in assets which they couldn’t sell.

Finding proper opportunities – risky enough to generate a return and safe enough not lead to financial problems – was anything but easy. In 1994, Alan Greenspan increased interest rates, afraid that the economy was overheating. This created a market overreaction, which sent bond yields higher than they should be – a great opportunity for LTCM to apply its arbitrage models. The book is interesting reading even though it is a little technical. It helps if the reader has some knowledge of financial markets, although it is not necessary. But it is a fascinating story of how a group of men went from fantastic wealth to near bankruptcy in five short weeks.

An investor does not need to have an IQ of 150 to succeed in stock markets. If intelligence had a correlation with the results in stock investing, then LTCM, which had some of the most intelligent people alive on earth, could never have failed. People run companies but somehow this fact is forgotten by investors. Many investors start assuming companies as mathematical models where a fixed amount of investment in assets or R&D would bring a fixed amount of return. Companies show vastly varying performances, many times for no apparent reasons. Their managers believed to predict markets using computer models. However, investing is dealing with assets & companies managed by humans.

A Calculated Bet Not Market Failure

Alan Greenspan had to cut interest rates two times to stabilize the situation. After another round of haggling between the creditors and the partners, along with an army or lawyers, they signed a deal. The Fed rallied the largest bankers and brokers, most of them creditors to LTCM, put them in a room and, basically, asked them to sort out the mess.