This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
Stocks Under $10 with 50-100% upside potential - 14 days FREE!

When Genius Failed: Lowenstein Talks LTCM

Roger Lowenstein: It's cumbersome to say that the spread rate is overpriced at default risk and therefore I'll short that and buy a bunch of risky credits. It's cumbersome and you sort of have to wait a long time until people realize that the market's overpricing credit risk. For instance, if the market is overpricing the default risk of (AMZN) , you can just buy the bonds, say, because they're so cheap, and as the bonds come in, you'll make money. It's more cumbersome, and there are great debates about what the spread precisely represents, but it's certainly true that as fear grows, it grows and vice versa.

They had that bet in the U.S., they had that bet in England, and both of those bets were bets on the perception of risk and fear and were false. The bet in Europe was mitigated somewhat because they were betting the other way in Germany. They had an analogous bet on equity volatility, which is to say the volatility of stock markets, and they were betting that the amount that a stock market moved around, the volatility would lessen or that the perceived future volatility of risk would drop. These are all bets on lessened risk perception, lessened volatility. They took a riskier side of the Russian bond spectrum, the riskier side of the mortgage-backed spectrum and the riskier side of the junk bond spectrum.

Brett D. Fromson: They were betting on a reduction in volatility.

Roger Lowenstein: They were betting that the world would look a little rosier.

Brett D. Fromson: And they were wrong.

Roger Lowenstein: And in each of these things, with the exception of, say, the German case where the hedge was in England, most of their bets were bets that the world would seem a tamer, safer, less volatile place. It's certainly true that some of the individual bets had little to do with others. But, when people decided that they no longer knew what the boundary of risk was, they just wanted out of risk, they were on the wrong side of all those bets.

Brett D. Fromson: Why did LTCM blow up, whereas none of the big derivative dealers blew up?

Roger Lowenstein: You mean like Morgan?

Brett D. Fromson: Morgan, Goldman, some of the Swiss banks.

Roger Lowenstein: Well, that was LTCM's only business. I think J.P. Morgan was a better-managed firm. Goldman was up to its neck in trading, and it lost a billion dollars, but it was 1 billion, not 4 billion, and they had other businesses, it was more diversified. Merrill also lost a billion or so in bonds, but they were obviously more diversified.

"So, $1 from start to finish turned into 33 cents at a time when the stock market was doubling."

Brett D. Fromson: Do you think the bank regulations caused them to be not only less monomaniacal in the business focus, but also to hold more capital relative to position sizes, or were they equally leveraged?

Roger Lowenstein: I don't know the answer to whether they were equally leveraged, but people who are running public companies are much more cognizant of the riskiness of the trading business. Sandy Weill hated that business. He was very pressured. He got Salomon Smith Barney out, or halfway out, but they still had big losses.

Brett D. Fromson: Out of Russia?

Roger Lowenstein: Out of Russia, and out of funds that they closed down, divesting their U.S. fixed-income arbitrage group. He and Jamie Dimon did it at Salomon Smith Barney. They did still have heavy losses, but it could have been a lot worse. Those guys want regular, rising profits every quarter, which you don't get in this business. Goldman was preparing for its IPO, and the extent to which they should rely on trading has always been an issue there.

But, if you looked at that question in a different light, as a company that is going public as soon as LTCM would have, Merrill thought it had no exposure. Merrill was shocked and a lot of heads rolled in bond trading afterwards. It has based its business really on the idea of having no exposure. The problem is, anybody who holds an inventory in bonds is going to hedge them in Treasuries. So they were sort of inadvertently in the LTCM trade.

Brett D. Fromson: In what sense?

Roger Lowenstein: In the sense that they were long riskier stuff and short Treasuries.

Brett D. Fromson: Their relationship with LTCM was that they were an investor, or a lender, or both?

Roger Lowenstein: They were both. I mean, they were a supplier of credit, a supplier of swaps and they were the firm that had taken LTCM on the road. They had done the dog-and-pony show and raised the first billion, but David Komansky had been offered the chance to become a big investor, put $100 million in, and he said, "No, thanks." So, the basic answer to your question is yes, all these firms, public firms, either because of what they disclosed or because of what they knew they would have to disclose in the event of a lawsuit, had different mindsets about taking these risks.

4 of 6

Select the service that is right for you!

Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 17,356.87 +288.00 1.69%
S&P 500 2,012.89 +40.15 2.04%
NASDAQ 4,644.3120 +96.4780 2.12%

Brokerage Partners

Rates from

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs