EP53 When Genius Failed - The Rise & Fall of Long-Term Capital Management

Roger Lowenstein's book "When Genius Failed" is one of the best business failure case studies I've ever read. As we come up on the 25-year anniversary of Long-Term Capital Management's downfall, I thought it would be a great time to explore the lessons behind their fall from grace. LTCM started as a hot new hedge fund in the mid-90s, ready to deliver outstanding returns through their team of "genius" Ph.D. financial experts and unique bond arbitrage strategy. They posted incredible results over the first 4 years, multiplying their investor's capital by 4x, but then only 6 months later, nearly lost it all. The story of Long-Term contains many valuable insights on what NOT to do, such as ignoring fat tail risks, loading up on leverage, and letting hubris reach unbearable levels amongst the partners. I'm excited to share with you the illuminating rise and fall of Wall Street's greatest fund ever, or at least the one with the highest IQs, Long-Term Capital Management!

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When Genius Failed: The Rise and Fall of Long-Term Capital Management - Roger Lowenstein

How the Eggheads Cracked - Michael Lewis

INVERT episodes: Liar's Poker, Bull! A History of the Dotcom Bust, A Short History of Financial Euphoria, Zeckendorf, The Liar's Ball

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The Web of Ideas: When Genius Failed (my notes on the book)

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Show Notes:

4:30 - Salomon's trading scandal

9:38 - An edge of PhD "geniuses"

13:00 - Long-Term's core thesis: betting on convergence & efficient markets

18:06 - Leveraging their capital 20-30x

22:14 - Having little understanding of how Meriwether's gang actually operated

26:58 - 1994 the fund starts

28:19 - Buying the illiquid securities

34:03 - Nearly every trade it touched turned to gold

36:38 - The secret of bond arbitrage is out

37:46 - Trading equity for more leverage

41:30 - A fat tail event can be catastrophic

45:53 - A flight to quality within US Treasuries

51:12 - The Russian Ruble tail event they never expected

53:33 - Just because it's never happened before, doesn't mean it won't happen in the future...

55:09 - All the buyers have suddenly disappeared

57:21 - Long-Term is dependent on the kindness of strangers and is running out of friends

1:02:11 - The correlations had gone to one

1:07:34 - What NOT to do - playing Russian roulette with a highly leveraged portfolio