"When Genius Failed: The Rise and Fall of Long-Term Capital Management" by Roger Lowenstein
Overall, a great book. Lowenstein is an excellent writer. Throughout the book, Lowenstein contrasts Greenspan's ludicrous public admonitions for less regulation of hedge funds and derivatives with the egregious excesses at LTCM. An excellent passage:
Greenspan's more serious and longer-running error has been to consistently shrug off the need for regulation and better disclosure with regard to derivative products. Deluded as to the banks' ability to police themselves before the crisis, Greenspan called for a less burdensome regulatory regime barely six months after it! The early Greenspan (in thrall to Ayn Rand) once wrote, "The basis of regulation is armed force." In fact, it is in countries that lack transparency (such as Russia) that markets need to be defended by soldiers.
Something I didn't understand before reading the book was the situation in late 1997 when they returned capital to investors. I had thought they were deleveraging, but in fact they increased their leverage. Basically, they reduced their capital base while keeping on the same amount of assets as before. This is particularly shocking because this was at a point when they were starting to run out of ideas for investments. This naturally led to them reaching into areas like merger arbitrage about which they knew little.
Lowenstein points out that, during its heyday, LTCM's return on ASSETS was around 2%, possibly less. Only through 30 to 1 leverage were they able to generate decent returns on EQUITY. Essentially, what LTCM did better than its competition (when it was doing well) was raise money well. They could trade on more margin with better terms, simply due to the reputations of their partners. In the end, they made the fatal mistake of going against Michael Burke. They risked everything to make a little bit of money, when the proper bet is always to risk a little bit to make a ton.
Their rejection of Buffett's offer to bail out the fund seems to me like lawyer BS. They claimed his offer was not valid, but I suspect it was rejected because it called for the immediate firing of the entire staff, including all partners. |
