The book chosen for review is considered to be one of the most important for understanding the complicated system of derivatives and general reasons of economic crisis. When genius failed: the rise and fall of long-term capital management is the book written by financial journalist Roger Lowenstein who has written articles for the "Wall Street Journal" for more than two years. He has published three books and also initiated various publications for "Smart Money" and "The New York Times". The work When genius failed: the rise and fall of long-term capital management provides readers with fundamental basis for deep analysis of economic catastrophes on different levels. The author conducts analysis of particular company which influenced the whole market system. On the example of Long-Term Capital Management, specializing in arbitrage of spreads on bonds and transactions involving special types of derivatives, the author reveals the reasons for prosperity of hedge funds analyzing success of LTCM. He has also shown that the fall of this company was actually determined by its initial success.
The story of the hedge Fund Long-Term Capital Management narrated by R. Lowenstein is not ordinary. This company was unique in its intellectual potential and technical aspects. Some officers were Nobel Prize winners such as Merton Schouls who used the most advanced mathematical models and achieved impressive results in business. During three years the hedge fund managed to beat the market. At the moment, when it seemed that they found the magic formula of eternal success it all went to hell and the company was on the verge of bankruptcy.
Evidently the history of Long-Term Capital Management cannot be called tragedy. However the author tries to make clear the factors invoking such developments. He studies key actors who believed that they can always beat the market. As the result of that crisis these ideas have failed. As story of LTCM has shown us modern financial market is not effective. It is highly vulnerable and not always able to auto-correction system.
Only due to the intervention of the Federal Reserve System, private banks were forced to cooperate and became rather single coordinator of the joint efforts aimed at elimination of the problems caused by the crisis. Long-Term Capital Management threatened to cause the meltdown of the markets.
Furthermore in his book R. Lowenstein provides reader with specific addition relating to the nature, characteristics and prospects of the modern market, which remains a trap for the logically thinking people. Sometimes the market can be beat. The big luck happens when someone is able to do that a few times, very rarely - even several times in a row. But it is impossible to beat the market constantly. The game of the highest risks requires extreme caution and stringent self-discipline especially if the success of the players depends on the borrowed funds.
At the same time this book is rather artistic reflection of the reality. The author has missed some important details and missed some important statistic data. Although such a trick makes this book easier for understanding it would be better to make more references to other visions of these events and make more impersonal conclusions. Nevertheless the book can be considered to be essential in order to get a clear estimation of reasons and outcomes of the company failure. The language style and coherency suit the purposes of the author to provide the reader with reliable information. He also tries to generalize his conclusions in order to make them applicable to estimation other similar events. The author draws parallels to the world crisis happened in 2008-2009.
The bibliographical aspect of the book is really high as it makes possible to follow the line of events. There is a mention of personal stories of the authors to find out psychological reasons for their conclusions about the market. Sometimes such conclusions were based on their worldview and personal feelings despite all the mathematical models and scientifically-proved theories applied.
It is interesting to analyze some ideas of the author relating to shaping new line of behavior for hedge-funds and the innovative approach to the market system definition. This book has useful lessons which reflect that the adoption of high leverage (30:1 in the case of LTCM) and the implementation of arbitration and more speculative system finally leads to ruin. The author also reaffirms the unreality of the hypothesis of market efficiency at least in its rigorous formulation. The theories of risk management and portfolio management are also declared to be rather inefficient. Actually, the conclusion stated are proven by the example of bankruptcy of the fund, which activities were based on the theory created by two Nobel Prize winners.
Personally for me the book has some minuses that are necessary to be mentioned in this review. The book does not change the consciousness of reader considering the particular features of the market structure. There is no strategy suggested in order to provide practical solution to the similar situations like LTCM has forced to overcome. The book is written in documentary and journalistic spirit that sometimes results in missing important data and figures for backing up the conclusions of the author. Nevertheless there are some interesting conclusions provided by the book, which make this book unique and significant among other works written about the fund market.
1) leverage
2) funding leverage through repo
3) monitoring value-at-risk.
The initial strategy of the company proved to be quite efficient for the first time. Playing on "convergence" within the bond markets and options became increasingly difficult, so LTCM was engaged in more risky trade, shifting "the philosophy of convergence" to the uncharted waters. Primarily, the strategy included transactions with pairs of stocks issued by one company listed on different exchanges and risk arbitrage on mergers and acquisitions. The managers believed in history repetition, but they were wrong and the market proved to be vulnerable mechanisms and that is the main reason of such significant collapse.
Conclusions
The book written by Lowenstein narrates of the unique work of the hedge-fund LTCM which almost entirely consisted of financial geniuses. Its failure was really unexpected, the author tried to find out various reasons for such crisis. The manner of writing is aimed at providing reader with easily understanding of complex problems of the fund-market. This book should be read in order to get the ability to analyze the company behavior on the fund market and formulate strategies to prevent the same situations in future. The arguments mentioned by the author are reliable and strong enough to support overall ideas of the book.
References
Roger, L. (2000). When Genius Failed: The Rise and Fall of Long-Term Capital Management. New York: Random House.
