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When Genius Failed: Lowenstein Talks LTCM

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This article was originally published on RealMoney.com on November 11, 2000.

In the fall of 1998, whispers began running through the canyons of Wall Street about a hedge fund in trouble. Big trouble. Investments had gone awry and a massively leveraged portfolio teetered, and, some say, the financial system teetered along with it.

We are, of course, talking about Long Term Capital Management, the hedge fund run by Nobel prize laureates and Wall Street geniuses. Its demise drew in Federal Reserve officials, big brokerage firms and well-known personalities such as Warren Buffett and George Soros.

Roger Lowenstein, one of the finest financial journalists in the country, has offered insight into the Long Term Capital debacle with his recent book, When Genius Failed. It's a crackling good read, and Roger's an interesting student of the financial world.

Brett D. Fromson: First of all, just how hard was it to do this book with John Meriwether himself not cooperating?

Roger Lowenstein: It was really hard. For one thing, my own previous comparable experience was doing the book with Warren Buffett. And that might seem analogous because Buffett also did not cooperate. There was a big difference, though, because Buffett was the story of a winner, and all of the concentric circles around Buffett were basically eager to cooperate, because everybody likes to be part of the story of a winner. This was the story of titanic losers.

Brett D. Fromson: How about the clients?

Roger Lowenstein: Nobody wanted to go on record. Nobody wanted to be part of this story. The employees themselves were initially totally off limits, because they had all signed confidentiality agreements. There was a very low proportion that ultimately decided to talk anyway, God bless 'em, but it was a tough book.

Brett D. Fromson: Right. Well, you must be glad it's over.

Roger Lowenstein: Yes. You're always glad when the book is over.

Brett D. Fromson: What about just the technical issues? A great deal of the book is somewhat more complex than equities. You're talking about credit spreads, swap spreads and motility data.

Roger Lowenstein: Right. That was a struggle, too, an internal struggle the whole way about how much to go into. Basically, I kept cutting back and cutting back and what I tried to do was give the reader a good idea of what they were betting on. For instance, if they were betting on higher volatility in the stock market or lower volatility in the stock market. But -- though very sparingly, and sometimes not at all -- on how they would execute that, or which 18 trades would arrive at that bet. And the final product had much less of that than the first draft. If there had been a future draft, there would have been less. Every time I went over it, I just skimmed some of that out.

Brett D. Fromson: Did you finally get some of the partners to speak with you? It seems that you did.

Roger Lowenstein: Let's see, it's in the book that Eric Rosenfeld cooperated in an informal, sporadic way and not in a formal or open-ended sense. I did reach people at all levels of the firm.

"This was the story of titanic losers."

Brett D. Fromson: Is this a morality tale? How did you come to understand the story at the end?

Roger Lowenstein: There are two morals in it. One is the tale about the limitations of human intelligence bordering on genius and almost the temptations and the risks of extreme intelligence when it's not tempered by judgment. Others who might have a different perspective than the three or four or 12 geniuses themselves. And as it relates to the financial markets specifically, I think it's a cautionary tale about inherent limits of models, of historical lookbacks.

Brett D. Fromson: Now thinking about LTCM, I saw a piece you wrote recently in the Times main section. Why are you concerned with the lack of regulation over hedge funds?

Roger Lowenstein: I'm not really concerned with a lack of regulation over hedge funds, because unless we've accepted that the Fed is going to sponsor a bailout every time there's trouble ... but I assume we haven't gotten there yet. I'm concerned about the lack of required disclosure over derivatives, regardless of who does them. The reason I am, if you look at the balance sheet of a healthy traded bank or a bank with insured deposits, you can get a pretty good idea of their liabilities. It's still their derivative exposures that are really shrouded in a haze for almost any outsider who looks, and the obligations are just as great.

Brett D. Fromson: The obligations of the institution?

Roger Lowenstein: Yes. These are contracts that intertwine really all institutions. There's potentially no limit on the size, because if you need little or no cash to make these obligations, you and I simply agree to exchange an amount of funds according to what happens in the market, whereas, if you decide to buy a security, you have to put down at least margin.

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