Occasionally, I read something so compelling that I must talk about it. If I see a parable relating to the aerospace sector and my experiences in many ways, I must also write about it. (My prior book reviews are here.) I can add “When Genius Fails: The Rise and Fall of Long-Term Capital Management” to this list. The book is not new–it was published in 2000, then updated a decade later with an afterword about the 2008 financial crisis. (So many similarities.)
You will learn that the main characters are quants in a world dominated by gut-feel investment and speculation–the 1990s. Yet the company, LTCM, is undone by the speculation they pretended they were above. These are no ordinary number crunchers, either. These are Harvard, MIT, and CalTech alumni led by John Meriwether (J.M.), an early trader in financial futures. A world-renowned economist, Robert C. Merton, would go on to a Nobel with Myron Sholes. The infamous Black-Sholes model for calculating the value of options–yes, that Sholes.
There are models and a fixation with following the models, all the way to the end. There is the element of sustainability, missed in the leverage and the markets and the numbers. While the author often points at hubris as the cause of the funds eventual downfall, there are more than enough culprits to debate.
What happens when lending that seemed an open spigot ends? (No liquidity.) When funds have disappeared and the option is throwing good money after bad, as with Russia’s debt default? This sets LTCM’s downward spiral in motion.
Models, genius, numbers, leverage, and getting carried away. Not seeing when the numbers don’t add up, not anymore, and won’t again anytime soon.
It was a weekend read.
Zapata Talks NASA 