"When Genius Failed" is about the collapse of the hedge fund Long Term Capital Management (LTCM) in 1998. Started reading it at the library and finished it at home (I have the book at home actually). It's an amazing story of how complacency and an unwavering belief in statistics while ignoring the human factor resulted in a problem of astronomical proportions.
In the midst of all the criticism that the management team came under, I still think they are a talented bunch in terms of intellect and very left brained may I add. My opinion is that being left brained in such an industry is a good thing since it helps to minimize your emotional tendencies. Yet they failed, once again, to consider a contingency plan. If there is one important lesson to be learn from the book, it is this..."Being able to quantify risk does not eliminate it." With most of the team having PhDs, they had an uncanny ability to quantify their risk to very precise numbers. There was something like a one in ten to the power of 24 chance that the fund would lose its entire capital in a year. A seemingly insignificant number but that was in parameters that were considered in calculating that risk. It was all based on rationality and history but capital markets aren't the most rational things in the world. They lost around 4 billion in equity in close to 5 weeks. Their tumble came in the midst of irrational markets as most would agree (I think) and ironically, it's in these markets that the best deals are found. Well, another lesson is that leverage is truly a dangerous tool. Over leveraging leaves you high on empty when things go against you and you're forced to sell in times that you wish to buy.
Yet another irony brought up is that creditors are as much at the mercy of their debtors as vice versa. Merril Lynch was as much in need of a bailout of LTCM as was LTCM in need of a bailout. Should the fund file for bankruptcy, Merril probably wouldn't stand to benefit as much both in terms of reputation and money. Such is the irony of banking..."If you owe the bank $10,000 and cannot pay, you have sleepless nights. If you owe the bank $10billion and cannot pay, the bank has sleepless nights." Ironical but true.
On a side note, the author plays out the story beautifully. Perhaps I'll go find and read his other book "Buffet: The makings of an American Capitalist". I'm getting more confident in my ability to pick books out for myself and others!
In the midst of all the criticism that the management team came under, I still think they are a talented bunch in terms of intellect and very left brained may I add. My opinion is that being left brained in such an industry is a good thing since it helps to minimize your emotional tendencies. Yet they failed, once again, to consider a contingency plan. If there is one important lesson to be learn from the book, it is this..."Being able to quantify risk does not eliminate it." With most of the team having PhDs, they had an uncanny ability to quantify their risk to very precise numbers. There was something like a one in ten to the power of 24 chance that the fund would lose its entire capital in a year. A seemingly insignificant number but that was in parameters that were considered in calculating that risk. It was all based on rationality and history but capital markets aren't the most rational things in the world. They lost around 4 billion in equity in close to 5 weeks. Their tumble came in the midst of irrational markets as most would agree (I think) and ironically, it's in these markets that the best deals are found. Well, another lesson is that leverage is truly a dangerous tool. Over leveraging leaves you high on empty when things go against you and you're forced to sell in times that you wish to buy.
Yet another irony brought up is that creditors are as much at the mercy of their debtors as vice versa. Merril Lynch was as much in need of a bailout of LTCM as was LTCM in need of a bailout. Should the fund file for bankruptcy, Merril probably wouldn't stand to benefit as much both in terms of reputation and money. Such is the irony of banking..."If you owe the bank $10,000 and cannot pay, you have sleepless nights. If you owe the bank $10billion and cannot pay, the bank has sleepless nights." Ironical but true.
On a side note, the author plays out the story beautifully. Perhaps I'll go find and read his other book "Buffet: The makings of an American Capitalist". I'm getting more confident in my ability to pick books out for myself and others!