Friday, October 7, 2016

When Genius Failed (Chapter 9)

LTCM was in big trouble right after the crisis that occurred in Russia. Merriwether sent a letter to his investors to tell them about the losses that happened in the month of August and was relatively calm and optimistic for the month of September. The rest of Wall Street knew that Long-Term was in trouble and rival firms were starting to sell because to get themselves out of trouble. Long-Term was in desperate need of help and struck a deal with Goldman who offered $1 billion of their clients’ money and a promise to help Long-Term raise another billion dollars. Nobody wanted to invest in Long-Term including big names such Warren Buffet, Michael Dell, and Alwaleed bin Talal bin Abdulaziz al-Saud. The firm was losing millions of dollars quickly and couldn’t afford to wait to make any moves. As the firm lost more money, tensions between the partners also started to rise. Goldman continued in search of an investor, but they couldn’t find enough to cover the $1 billion that they promised to raise. The complicated partnership structure is what drew a lot of investors away from Long-Term. Eventually, Buffet decided to invest as long as Goldman handled the details.

Question: Long-Term had invested in risky bonds all over the world which is why they made so much money, but was also the reason why the firm failed. At the time, do you think the firm was right in their decision to continue to buy these bonds before the Russian crisis knowing that they could potentially lose everything or do you think they should have played it safer just in case something did go wrong?


  1. I think most people would agree that the professors should have invested more conservatively in Russia as this is what seemed to start the fall of Long Term. However, this is clearly not what the guys were known for and given how leveraged they were, the fact that they also took on this risk should not come as a surprise. Also, clearly the investors were geniuses and their arbitrage strategy was legitimate, but they should have realized that at the end of the day there is still the possibility that something could go wrong. They were way outperforming the market when times were good, but as soon as times became bad, Long Term’s leverage and bold strategy ended up destroying it.

  2. In hindsight it is easy for us to say that Long Term should have tread more carefully in their Russian spread investments. However the professors at Long Term had believed so heavily in the predictive modeling they were using that they knew the risks, but never thought that they would ever be wrong. After the success of their early years and their time at Salomon brothers, had convinced them that would never be wrong. However when things started to turn for the worse in August 1998. When spreads continued to widen in the Russian default the model the professors held in such high regard had finally gone bust.