The book titled “When Genius Failed: The Rise and Fall of Long-Term Capital Management”, written by one of the famous financial journalists, Roger Lowenstein gives an account of how the 1998 collapse of Long-Term Capital Management (LTCM), a hedge fund panicked the financial markets . The author explains in his book about how banks relied on various brand names that have been established LTCM through its partners and how lenders were ignorant to the assets and strategies of LTCM. He illustrates several examples that suggest the models, strategies and trades used by LTCM, thereby offering valid reasons as to how competition from new entrants posed a serious threat to profits. While the techniques implemented as a part of LTCM were not unique, it was able to generate huge returns due to leverage. Lowenstein asserts the role of leverage in magnifying returns and losses. Lowenstein outlines how lower financing costs acted as a major source for acquiring extraordinary profits for LTCM . Especially, investments and commercial banks assumed that they would gain profits by offering short-term funding to LTCM at favorable interest rates and provisions. The author provides an example of how banks lowered the costs for LCTM by putting lenders at greater risks and losses by ignoring the necessity of collateral and trusting the brand names.
In his book, Lowenstein argues that lack of emphasis on competitive advantage compounded difficulties for LTCM by ignoring the areas that profited from competitive advantage. He explains how partners reacted to rising competition by moving away from bond markets to stock markets, which was a relatively new field when compared to the former . The best example is that of firms betting on the accomplishment of mergers, in spite of failing to lend themselves to the analysis and skills of LTCM, thereby leading to unreliable equities and ultimate failure of LCTM. In the book, Lowenstein credits Meriwether for hiring some of the successful graduates of Massachusetts Institute of Technology for transforming the bond market. The author excels at describing some of the obscure financial topics and clarifying the nature of hedge funds, including distinct strategies and types of arbitrage. He also discusses about the swift fall of LTCM with exceptional insight and clarity. Lowenstein presents a series of events, which eventually led to Russia declaring a debt moratorium, weakening of Mexican and Brazilian bonds and the decline of the Asian markets as a result of LTCM unexceptionally going bad .
The book is a valuable treatise as Lowenstein guides the readers through the narrow concepts of finance. It is important to understand that the book is not a criticism of new financial markets or technology. It is rather an insight that explains how firms that have easy access to money encounter intense competition over time, thereby shifting away to inexperienced markets by relying on incompetent strategies, which ultimately make them vulnerable to unfavorable price fluctuations . The author provides appropriate evidence that undermines the claim that model devotion ran out of control for LTCM. After analyzing the descriptions of Lowenstein, the readers are compelled to believe that firms were already aware that there models were susceptible to adverse circumstances. The book makes the readers understand that the purchase of illiquid assets would fail to sustain a potential value when quickly sold .
I totally disagree with Lowenstein’s argument that the Federal Reserve Bank did nothing to resolve the LCTM crisis . The reality is that the Federal Reserve Bank placed high value on restricting market turbulence, thereby lending its prestige for offering a resolution to the crisis. The book also fails to communicate a convincing moral at the end as Lowenstein considers the failure of LTCM as a prior warning to harnessing high-technology, financial theories and models of effective capital markets to financial markets, which is not sensible. I disapprove the typical suspicion about the effectiveness and stability of financial markets that loiters all over the book. The author failed to distinguish between the failure of firms and the failure of financial market . The potential drawback of the book is that it hints at the ill-conceived government policies and systemically flaws to explain a convincing answer to what went wrong for LCTM. However, the lucid style of the author and occasional sense of humor are on the positive note. The book compels the readers to question themselves whether the beneficial financing of LTCM went beyond its trust on the brand name and support of the government of the United States. After reading the book, it is evident that the anticipation of future bailouts might have resulted in the growth of LTCM. It is also evident that the advantages of the role of the Federal Reserve Bank in the resolution of the LCTM crisis might have outweighed the costs.
Reference
Lowenstein, R. (2001). When Genius Failed: The Rise and Fall of Long-Term Capital Management. New York, NY: Random House Publishing Group.
