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When Genius Failed: Lowenstein Talks LTCM

Brett D. Fromson: Or an admission of mistakes.

Roger Lowenstein: Yes, and they were somewhat diffident on the issue of whether they had been deleveraged. That was a sticking point with them.

Brett D. Fromson: In what way?

Roger Lowenstein: They said leverage isn't the right measure of risk.

Brett D. Fromson: What is?

Roger Lowenstein: You know, they would say volatility around the mean, which I think is one of the things that got them into trouble. Because volatility is a backward-looking measure, it doesn't tell you what volatility tomorrow is going to be. I think they certainly realized that their position size was too big. Recently, of course, Meriwether came out and said the strategy was fundamentally flawed. That's a pretty interesting remark. It's just not in agreement with what they've been saying for two years to many, many people.

Brett D. Fromson: Basically flawed in what regard? Did he say?

Roger Lowenstein: I believe he referred to position size, I believe he did refer to leverage, but you better check. I don't know the extent to which this was a change of heart, the extent to which it was PR. I certainly called him on it when I learned about the "new openness," but apparently the window had closed.

Brett D. Fromson: Question...

Roger Lowenstein: Did they? What had they learned? They learned some humility from this, yes.

Brett D. Fromson: Not to put too fine a point on it, but they lost a lot of money that wasn't theirs. That should chasten a person.

"In two days in August and September, each of two days, they lost more than $500 million."

Roger Lowenstein: Yes. They also lost a lot of money that was theirs. They lost about $4.5 billion at the top. Almost $2 billion was theirs. Losing other people's money chastens you. Losing your own chastens you, too.

Brett D. Fromson: Did they admit that maybe some big position size was a problem? Did anyone come back and say we actually were unable to manage the risk, the volatility around the mean and we were being paid to manage that volatility around the mean and you know what? We failed. Or would you disagree that they failed to manage the volatility? Or would you say it's just unmanageable?

Roger Lowenstein: They would say that. To me it's unmanageable.

Brett D. Fromson: They would say what?

Roger Lowenstein: They would say they failed. Obviously, something failed. But this expression, managing risk, I don't know what it means. It's like managing the speed of a snowball rolling down in an avalanche. I mean, once it rolls, you can talk all you want about managing, but you're going downhill. They had a program that said they were unlikely to lose more than $40 million or so on any given day. In two days in August and September, each of two days, they lost more than $500 million.

I believe one lesson for them was the apparent failure of diversification. It's strange that it would have been such a lesson, because in 1987, being in different types of stock or being in stocks in different countries wasn't going to help you. When people get scared, when they get really scared ... that happens in financial markets.

Brett D. Fromson: Although bonds would have helped you in 1987.

Roger Lowenstein: Bonds would have helped.

Brett D. Fromson: Treasuries rallied.

Roger Lowenstein: Yes, they did.

Brett D. Fromson: And they did here, as well.

Roger Lowenstein: In general, when people start to panic, they're not discriminating. That's almost the definition of panic. The other thing -- and I think some of them still disagree with me on this, David Mullins does when we talk -- it seems that not only did diversification fail, but they were less diversified than they seemed to think.

Brett D. Fromson: How were they positioned going into this crisis?

Roger Lowenstein: They had a huge bet on swap spreads in Europe and the U.S. and basically on swap spreads narrowing.

Brett D. Fromson: Swap spread, again, is essentially the difference between the rate of interest normally charged in a rather conventional, sort of thick-loading derivative swap and Treasuries?

Roger Lowenstein: The swap rate is the amount someone charges to switch from float and fixed. The difference between that and Treasury is the spread.

Brett D. Fromson: In times of fear that spread widens, meaning it's hard to say who's the better credit in a panic.
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