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

Чтение книги онлайн.

СКАЧАТЬ that Gutfreund give up an acrimonious fight that he was waging with Salomon for back pay. Though overlooked, Gutfreund had played a pivotal role in the Arbitrage Group’s success: he had been the brake on the traders’ occasional tendencies to overreach. But it was not to be. At Long-Term, J.M. would have to restrain his own disciples.

      In any case, J.M. wanted more cachet than Gutfreund or even his talented but unheralded young arbitrageurs could deliver. He needed an edge—something to justify his bold plans with investors. He had to recast his group, to showcase them as not just a bunch of bond traders but as a grander experiment in finance. This time, it would not do to recruit an unknown assistant professor—not if he wanted to raise $2.5 billion. This time, Meriwether went to the very top of academia. Harvard’s Robert C. Merton was the leading scholar in finance, considered a genius by many in his field. He had trained several generations of Wall Street traders, including Eric Rosenfeld. In the 1980s, Rosenfeld had persuaded Merton to become a consultant to Salomon, so Merton was already friendly with the Arbitrage Group. More important, Merton’s was a name that would instantly open doors, not only in America but also in Europe and Asia.

      Merton was the son of a prominent Columbia University social scientist, Robert K. Merton, who had studied the behavior of scientists. Shortly after his son was born, Merton père coined the idea of the “self-fulfilling prophecy,” a phenomenon, he suggested, that was illustrated by depositors who made a run on a bank out of fear of a default—for his son, a prophetic illustration.⁷ The younger Merton, who grew up in Hastings-on-Hudson, outside New York City, showed a knack for devising systematic approaches to whatever he tackled. A devotee of baseball and cars, he studiously memorized first the batting averages of players and then the engine specs of virtually every American automobile.⁸ Later, when he played poker, he would stare at a lightbulb to contract his pupils and throw off opponents. As if to emulate the scientists his father studied, he was already the person of whom a later writer would say that he “looked for order all around him.”⁹

      While he was an undergrad at Cal Tech, another interest, investing, blossomed. Merton often went to a local brokerage at 6:30 A.M., when the New York markets opened, to spend a few hours trading and watching the market. Providentially, he transferred to MIT to study economics. In the late 1960s, economists were just beginning to transform finance into a mathematical discipline. Merton, working under the wing of the famed Paul Samuelson, did nothing less than invent a new field. Up until then, economists had constructed models to describe how markets look—or in theory should look—at any point in time. Merton made a Newtonian leap, modeling prices in a series of infinitesimally tiny moments. He called this “continuous time finance.” Years later, Stan Jonas, a derivatives specialist with the French-owned Société Générale, would observe, “Most everything else in finance has been a footnote on what Merton did in the 1970s.” His mimeographed blue lecture notes became a keepsake.

      In the early 1970s, Merton tackled a problem that had been partially solved by two other economists, Fischer Black and Myron S. Scholes: deriving a formula for the “correct” price of a stock option. Grasping the intimate relation between an option and the underlying stock, Merton completed the puzzle with an elegantly mathematical flourish. Then he graciously waited to publish until after his peers did; thus, the formula would ever be known as the Black-Scholes model. Few people would have cared, given that no active market for options existed. But coincidentally, a month before the formula appeared, the Chicago Board Options Exchange had begun to list stock options for trading. Soon, Texas Instruments was advertising in The Wall Street Journal, “Now you can find the Black-Scholes value using our … calculator.”¹⁰ This was the true beginning of the derivatives revolution. Never before had professors made such an impact on Wall Street.

      In the 1980s, Meriwether and many other traders became accustomed to trading these newfangled instruments just as they did stocks and bonds. As opposed to actual securities, derivatives were simply contracts that derived (hence the name) their value from stocks, bonds, or other assets. For instance, the value of a stock option, the right to purchase a stock at a specific price and within a certain time period, varied with the price of the underlying shares.

      Merton jumped at the opportunity to join Long-Term Capital because it seemed a chance to showcase his theories in the real world. Derivatives, he had recently been arguing, had blurred the lines between investment firms, banks, and other financial institutions. In the seamless world of derivatives, a world that Merton had helped to invent, anyone could assume the risk of loaning money, or of providing equity, simply by structuring an appropriate contract. It was function that mattered, not form. This had already been proved in the world of mortgages, once supplied exclusively by local banks and now largely funded by countless disparate investors who bought tiny pieces of securitized mortgage pools.

      Indeed, Merton saw Long-Term Capital not as a “hedge fund,” a term that he and the other partners sneered at, but as a state-of-the-art financial intermediary that provided capital to markets just as banks did. The bank on the corner borrowed from depositors and lent to local residents and businesses. It matched its assets—that is, its loans—with liabilities, attempting to earn a tiny spread by charging borrowers a slightly higher interest rate than it paid to depositors. Similarly, Long-Term Capital would “borrow” by selling one group of bonds and lend by purchasing another—presumably bonds that were slightly less in demand and that therefore yielded slightly higher interest rates. Thus, the fund would earn a spread, just like a bank. Though this description is highly simplified, Long-Term, by investing in the riskier (meaning higher-yielding) bonds, would be in the business of “providing liquidity” to markets. And what did a bank do but provide liquidity? Thanks to Merton, the nascent hedge fund began to think of itself in grander terms.

      Unfortunately, Merton was of little use in selling the fund. He was too serious-minded, and he was busy with classes at Harvard. But in the summer of 1993, J.M. recruited a second academic star: Myron Scholes. Though regarded as less of a heavyweight by other academics, Scholes was better known on Wall Street, thanks to the Black-Scholes formula. Scholes had also worked at Salomon, so he, too, was close to the Meriwether group. And with two of the most brilliant minds in finance, each said to be on the shortlist of Nobel candidates, Long-Term had the equivalent of Michael Jordan and Muhammad Ali on the same team. “This was mystique taken to a very high extreme,” said a money manager who ultimately invested in the fund.

      In the fall of 1993, Merrill Lynch launched a madcap drive to recruit investors. Big-ticket clients were ferried by limousine to Merrill’s headquarters, at the lower tip of Manhattan, where they were shown a presentation on the fund, sworn to secrecy and then returned to their limos. Then, Merrill and various groups of partners took their show on the road, making stops in Boston, Philadelphia, Tallahassee, Atlanta, Chicago, St. Louis, Cincinnati, Madison, Kansas City, Dallas, Denver, Los Angeles, Amsterdam, London, Madrid, Paris, Brussels, Zurich, Rome, Sao Paulo, Buenos Aires, Tokyo, Hong Kong, Abu Dhabi, and Saudi Arabia. Long-Term set a minimum of $10 million per investor.

      The road show started badly. J.M. was statesmanlike but reserved, as if afraid that anything he said would betray the group’s secrets. “People all wanted to see J.M., but J.M. never talked,” Merrill’s Dale Meyer griped. The understated Rosenfeld was too low-key; he struck one investor as nearly comatose. Greg Hawkins, a former pupil of Merton, was the worst—full of Greek letters denoting algebraic symbols. The partners didn’t know how to tell a story; they sounded like math professors. Even the fund’s name lacked pizzazz; only the earnest Merton liked it. Investors had any number of reasons to shy away. Many were put off by J.M.’s unwillingness to discuss his investment strategies. Some were frightened by the prospective leverage, which J.M. was careful to disclose. Institutions such as the Rockefeller Foundation and Loews Corporation balked at paying such high fees. Long-Term’s entire premise seemed untested, especially to the consultants who advise institutions СКАЧАТЬ