When Genius Failed: The Rise & Fall of LTCM

This is a book review of When Genius Failed: The Rise and Fall of Long-Term Capital Management by Roger Lowenstein. For other reviews of the best books for traders and investors, please visit our book reviews section.

In When Genius Failed, Lowenstein chronicles the meteoric rise of Long-Term Capital Management (LTCM) and its subsequent failure. To this day, many investors and traders do not fully understand the impact of LTCM's failure on financial markets. When Genius Failed highlights the importance of risk management and not relying on mathematical "certainties" in real-world trading. Here is what we have to say about When Genius Failed.

Rise of LTCM

The first six chapters of When Genius Failed describe Long-Term Capital Management's inception and success. First, readers are introduced to the high-profile academics and quants behind the infamous hedge fund. Indeed, these people are the reference to "genius" in the title of the book.

Main Characters

Most notably, the top LTCM characters include: John Meriweather, Larry Hilibrand, Eric Rosenfeld, Robert Shustak, Victor Haghani, and Jon Corzine. The hedge fund's primary founder, John Meriweather, started LTCM after leaving Solomon Brothers. While at Solomon, Meriweather made the firm tremendous amounts of money as the head of the domestic fixed income arbitrage group. After Solomon's infamous Treasury securities trading scandal in 1991, Meriweather resigned. Subsequently, he started Long-Term Capital Management using the same strategies he developed at Solomon.

Trading Strategy

Long-Term Capital Management's primary strategy was to use arbitrage to exploit relative mispricing in various securities. The strategy relies upon the price convergence of the mispriced securities. Specifically, there were four main types of trades: intra-Europe sovereign bonds, U.S. & Japanese sovereign bonds, U.S. government bonds, and emerging market sovereign bonds.

Long-Term Capital Management's Growth

As you probably guessed, many institutional investors chased Meriweather's returns and forked over billions of capital. At its inception in 1994, LTCM had roughly $1.3 billion in assets under management (AUM). The hedge fund achieved annualized returns of 40% for two years in a row. By 1997, the fund had $7 billion in AUM and leveraged itself to control $134 billion in capital. In 1998, Meriweather returned $2.7 billion to initial investors. Around this time, Long-Term Capital Management's swap positions had a total notional value of $1.25 trillion. This represented 5% of the entire global market.

Fall of LTCM

Unfortunately, LTCM's success did not last. On August 17, 1998, Russia defaulted on its debt and devalued the Ruble. Moreover, this came on the heels of the 1997 Asian financial crisis. Long-Term Capital Management's largest single day loss came on August 21, 1998, when the hedge fund lost $550 million.

The simplified explanation of the state of the global market at this time is that investors were flocking to safety. Indeed, LTCM held positions in illiquid assets to capture the liquidity premium and shorting the safer assets like sovereign debt. Therefore, investors flocking to safe assets resulted in price divergence instead of LTCM's intended price convergence.

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Eric Bruin

Eric Bruin

Founder. Kelley School of Business ’17. Write about stocks and business news. Contact for business inquiries or to write articles for The Stock Trader Blog.

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