Interestingly, the big bestseller in the financial world of 2020 is the exact opposite of this book, The Man Who Solved the Market: How Jim Simons Launched the Quant Revolution. Did genius actually fail, or did the partners stop acting like geniuses? Lowenstein’s descriptions of their missteps make me think that the latter was the case. Managing a small risk is very different from managing a large one, and much easier too. The partners were arbitrageurs who used enormous leverage, and when their positions became too big to efficiently arbitrage, they started to place one-sided bets, or failed to sufficiently hedge, or took liquidity for granted. It’s an age-old tale of hubris and its comeuppance, of getting too big for your breeches, of success going to one’s head, and a thousand other clichés.Īnd the missteps that the partners in Long-Term Capital Management made were made not because the formula that they used was wrong, but because they stopped using the formula. You know more or less what’s going to happen from page one, and every few pages you are reminded that pride goeth before a fall. But the book is a cautionary tale, and cautionary tales are morality lessons. There are plenty of edge-of-your-seat moments, especially when the giants of Wall Street are trying to decide whether to rescue LTCM - and how. The book is superbly researched the tale is superbly told.

Is the same mistake being made today? One can only guess what is certain is that derivative securities remain mind-bogglingly complex, enormous leverage is still common, and billions of dollars are still at stake. Of course, nobody making policy in Washington paid attention to it, and the result was that the same mistake was made ten years later, leading to the Great Financial Crisis of 2008. The lesson - that speculating in complex derivative securities using a lot of margin is extremely dangerous, and that risk management models don’t adequately take into account the fat tails of the probability distribution (the likelihood of extreme events) - was very clear to everyone who read the book, which was a major bestseller. In the end, the fall of Long-Term Capital Management almost brought Wall Street to its knees, and the firm had to be bailed out through government intervention.

It tells how a firm consisting of PhDs and financial wizards - including two Nobel prizewinners, Robert Merton and Myron Scholes - conquered Wall Street in the space of four years, making unprecedented gains, only to see their fortunes completely collapse. Roger Lowenstein’s When Genius Failed: The Rise and Fall of Long-Term Capital Management was first published in 2000 (it was republished with a new afterword in 2011) and is now considered a classic book of business history.

When genius failed