Introduction
In his book “ When Genius Failed,” Roger Lowenstein`s fundamental argument is that the events and the activities that occurred at the Long Term Capital Management hedge fund ultimately acted as a trigger or precursor to the 2008 Global Financial Crisis that occurred 8 years after the fund`s winding up. Throughout the book, Lowenstein gives a detailed account of the formation, growth, expansion and ultimate fall of the fund which was founded and run successfully for 5 years by John Meriwether.
Although Lowenstein does not make any specific reference to the 2008 financial crisis since after the entire book was published before these drastic events, arguments have been made that the events at LTCM were in fact a precursor to this crisis when it eventually occurred. This argument will be explored further in the book review contained in this paper.
Supporting Evidence
In interrogating the question as to whether the activities at the Long Term Capital Management hedge fund were indeed a precursor to the 2008 Global Financial Crisis, it is important to begin by evaluating any existing similarities between the two events. Firstly, both events were the outcome of the trading of complex financial instruments in the form of derivatives whose underlying financial assets were issued bonds by both private and public entities.
In the case of the Long Term Capital Management hedge fund, Lowenstein notes that the bond arbitrage trades and shorting of equity volatility trades that the fund engaged in were so complex that they 999 out of 1000 Americans could not decipher them (Lowenstein 113). This level of complexity was also witnessed in the mortgage security instruments that resulted in the Global Financial Crisis of 2008 through the Collateralized Debt Obligations (CDOs) and Collateralized Mortgage Obligations (CMOs) that were issued by the underlying investment banks that were charged with the responsibility of underwriting these bond issues.
Secondly, it is important to note that in both instances, the underlying securities that defaulted and led to the collapse of LTCM and the many major financial institutions in the case of the Global Financial Crisis of 2008 were issued bonds. In this regard, it is easy to draw a parallel between the two by concluding that complex arranging and trading of bond issues can and has resulted to adverse financial outcomes in both instances.
Thirdly, in both cases, the collapse of LTCM and the affected financial institutions in the Global Financial Crisis of 2008 were spearheaded by top Wall Street professionals who were in charge of their respective institutions. In the case of LTCM, the man responsible for its collapse was John Meriwether who founded the fund back in 1994.
Contradicting Evidence
In further exploring the notion that the failure and collapse of the Long Term Capital Management hedge fund was a precursor to the 2008 Global Financial Crisis, certain facts that are laid bare by Lowenstein in his book however, do contradict this assertion. Firstly, unlike the case of the underlying mortgage securities that were largely unsecured and which led to the 2008 crisis, the Long Term Capital Management`s strategy was based on sound financial models such as the Black and Scholes Model (Lowenstein 113).
Secondly, the Long Term Capital Management hedge fund`s operating strategy was highly secretive and the fund only accepted investment funds from a selected pool of investors unlike the 2008 financial crisis in which the underlying securities were widely marketed to a number of prospective investors by the underlying investment banks.
Lowenstein further notes that at the height of its success, the fund was consistently and constantly profitable and by 1996 just 2 years into its operations, it had accumulated assets under control of more than $140 Billion.
Thirdly, the LTCM hedge fund enjoyed a lot of approval, positive public perceptions and admiration from Wall Street according to Lowenstein during its most successful years. This confidence is best summarized by the fact that the fund`s board members were jointly awarded the Nobel Memorial Prize in Economic Sciences in 1997 as an appreciation and recognition of the fund`s newly invented approach to the determination of the value of derivative instruments in financial markets according to Lowenstein.
Missing Evidence
For the activities and engagements of the Long Term Capital Management fund to have been a precursor to the 2oo8 Global Financial crisis, the implication would be that some of the activities that the fund engaged in were carried on by the perpetrators of the 2008 Crisis thus, drawing the connection between the two. However, Lowenstein in his book fails to bring to the fore any mentioned activities of the fund that could have created such a precursory precedent as previously asserted.
In the book, Lowenstein notes that part of the problems that led to the collapse of the Long Term Capital Management hedge fund can be attributed to the moratorium by the Russian Government in which it defaulted on the bonds that were held by foreign western interests such as the LTCM Fund. This eventuality was largely unexpected and beyond the control of the fund and by extension, it resulted in adverse consequences on both the fund`s profitability as well as its overall solvency.
In sharp contrast, the 2008 Global Financial Crisis was caused by the reckless activities of the investment banks and professionals that were responsible for the underwriting of the risky mortgage assets whose default ultimately resulted in the crisis. To this extent, the connection between these two adverse financial outcomes is not clearly brought out in Lowenstein’s assertions and arguments in the book. This missing evidence link therefore, can be concluded to mean that the occurrence of the two events was not dependent on one another; neither were the activities at the LTCM fund in any way a precursor to the collapse of the global financial system that occurred during the crisis in 2008.
Conclusion
Rodger Lowenstein has given a detailed account of the operations of the Long Term Capital Management hedge fund, highlighting its key successes and the factors that contributed to its ultimate demise in the year 2000. The basis of this critical book review was to establish whether the activities of the fund did indeed act as precursor to the Global Financial Crisis that occurred in the year 2008.
A comprehensive examination and analysis of the arguments contained in the book reveals that whereas there were significant similarities in the manner in which the crisis occurred in 2008 with the fall of the LCM hedge fund, there does not seem to appear any direct link between these two events. Subsequently, any similarities between these two adverse outcomes can be perceived more as a coincidence rather than as mutually-successive events.
Work Cited
Lowenstein, Rodger. When Genius Fails. New York: Random House, 2001. Print.
