Einstein Has Left the Building

We use the term "genius" in this business way too often. Call me erudite, but I like to save the word "genius" for Mozart, Shakespeare and maybe Beethoven, but only because he was hearing impaired.

However, as long as I have been in the business I have heard that Long-Term Capital is the closest thing to the Manhattan Project that anyone has ever assembled.

Wednesday, the genuises at Long-Term Capital announced that they are down 50% for the year and they need more capital to continue. I mean no disrespect for these geniuses. They may be very nice geniuses indeed. They have always gotten the best of press.

To me, however, this decline of genius is a brutal reminder that things can go very wrong in the investment world. Long-Term Capital isn't a bunch of cowboys masquerading as money managers. These guys had the best minds, best tools, best understanding, best history, heck, best food for all I know, and they blew it.

The announcement was suitably cryptic, mixing a little Russian paper with some mix-matching of securities. I speculated to my partner Jeff that perhaps they were long pools of mortgages and short Treasuries and the mortgage pools prepaid above expectations. That's a common ailment that trading desks suffer.

Who knows?

But it was no coincidence that the market traded down badly after the disclosure of Long-Term's problems. (No affiliation to Long-Term Credit Bank of Japan, which has a similar balance sheet.) When geniuses are in trouble, mere mortals want to kick everything out, particularly bank stocks, because the lenders to Long-Term Capital are no doubt worried right now and we don't know who those lenders are, so we shoot every lender and then buy back the ones that didn't lend. This news says, "More charges ahead!"

And the pattern becomes, OK, I thought I was safe because XYZ bank didn't lend to hedge funds that do business in Russia, but how about hedge funds that do business in Euros and Zeroes. Did XYZ lend money to those guys?

Soon it just gets to be too difficult to own any of the big-name financials, and their multiples, after moving up respectably over the seven years, begin to shrink back to 1990 levels.

When geniuses stumble, people want to take on less merchandise, they want to be less exposed, they want more cash, they want to be more certain before taking on risk.

Those instincts again produce selloffs and lower prices.

In short, this was a seminal blowup. It struck at the heart of all of those on Wall Street who think that this racket is a science that can be measured, structured, derived and gamed. It reintroduced the notion of risk into market-neutral and risk-free and properly hedged.

Hopefully it will also restore the term genius to its rightful owners: Shakespeare, Mozart and yes, Beethoven.

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Random musings: Record sign-up days for TheStreet.com. We signed up more in a day than we did in some months last year. I was right that we would make it, I guess, but a year too early in thinking that we could do the numbers we are doing now. Congratulations, members and TSC staffers! The 21-hour days are at last paying off. But I'm not quitting my Day Job!