My rating: 5 of 5 stars
Great book on the rise (1994-1997) and fall (1998) of Long Term Capital Management (LTCM). Very well told, with the right amount of details and story in 236 pages. Lesser financial problems have gotten bigger books, but this book’s strength is its brevity, no unneccesary detours. How academic arrogance led to a tail-spin, instigated by the Russian ruble crisis. With a clear lesson: “a reminder that foolishness [e.g. Imprudent risks] carries a price would be no bad thing” (p230)
How very smart people underestimated fat tails; “The correlations had gone to one (…) The professors had ignored the truism – of which they were well aware – that in markets, the tails are always fat. (…) they had forgotten that traders are not random molecules, or even mechanicalmlogicians (…) The professors hadn’t modeled this. (…) They had forgotten the human factor.” (p173).
And: “during a crisis, the correlations always go to one. When a quake hits, all markets tremble. Why was Long-Term so surprised by that?” (p188)
“Long-Term put supreme trust in diversification – one of the shibboleths of modern investing, but an overrated one. As Keynes noted, one bet soundly considered is preferable to many pporly understood. The Long-Term episode proved that eggs in separate baskets can break simultaneously.” (p233).
The seeds for LTCM were laid in John Meriwether’s (J.M.) Arbitrage group at Salomon. JM hired and protected his ‘porfessors’. “The professors spoke of opportunities as inefficiencies (…) and [had as a] credo, learned from academia, that over time, all markets tend to get more efficient”
“Every price was a “statement”; if two statements were in conflict, there might be an opportunity for arbitrage.” (p12)
Nice anecdote on JM; a losing trader asks permission to double up and JM gave it rather offhandedly. “Don’t you want to know more about this trade?”. Meriwether’s trusting reply deeply affected the trader. J.M. Said, “My trade was when I hired you.” (p15)
When LTCM approached Warren Buffett for starting capital “The jovial billionaire was his usual self – friendly, encouraging, and perfectly unwilling to write a check.” (p32)
“As Scholes remarked at its [LTCM] inception, “We’re not just a fund. We’re a financial-technology company”” (p65; Lowenstein’s footnote cites this Business Week article from 1994, but I could not find the quote there https://www.bloomberg.com/news/articl…)
P89: [Chase banker] Pflug was too smart to go head-to-head with the guy [Scholes] who had invented the formula. “You can overintellectualize these Greek letters,” Pflug reflected, referring to the alphas, betas, and gammas in the option trader’s argot. “One Greek word that ought to be in there is hubris.”
“A bit of liquidity greases the wheels of markets; what Greenspan overlooked is that with too much liquidity, the market is apt to skid off the tracks.” (p106; Lowenstein adds an endnote here; “The phraseologyis so close to that of an earlier writer that I must add an (end)note of gratitude to Louis Lowenstein, my father” Nice touch!).
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