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

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СКАЧАТЬ who was continually angling to raise Long-Term’s pedigree, went to Omaha for a steak dinner with Buffett, knowing that if Buffett invested, others would, too. The jovial billionaire was his usual self—friendly, encouraging, and perfectly unwilling to write a check.

      Rebuffed by the country’s richest investor, J.M. approached Jon Corzine, who had long envied Meriwether’s unit at Salomon and who was trying to build a rival business at Goldman Sachs. Corzine dangled the prospect of Goldman’s becoming a big investor or, perhaps, of its taking Meriwether’s new fund in-house. Ultimately, it did neither. Union Bank of Switzerland took a long look, but it passed, too. Not winning these big banks hurt. Despite his bravura, J.M. was worried about being cut out of the loop at Salomon. He badly wanted an institutional anchor.

      Turning necessity to advantage, J.M. next pursued a handful of foreign banks to be Long-Term’s quasi partners, to give the fund an international gloss. Each partner—J.M. dubbed them “strategic investors”—would invest $100 million and share inside dope about its local market. In theory, at least, Long-Term would reciprocate. The plan was pure Meriwether, flattering potential investors by calling them “strategic.” Merton loved the idea; it seemed to validate his theory that the old institutional relationships could be overcome. It opened up a second track, with J.M. independently courting foreign banks while Merrill worked on recruiting its clients.

      Merrill moved the fund-raising forward by devising an ingenious system of “feeders” that enabled Long-Term to solicit funds from investors in every imaginable tax and legal domain. One feeder was for ordinary U.S. investors; another for tax-free pensions; another for Japanese who wanted their profits hedged in yen; still another for European institutions, which could invest only in shares that were listed on an exchange (this feeder got a dummy listing on the Irish Stock Exchange).

      The feeders didn’t keep the money; they were paper conduits that channeled the money to a central fund, known as Long-Term Capital Portfolio (LTCP), a Cayman Islands partnership. For all practical purposes, Long-Term Capital Portfolio was the fund: it was the entity that would buy and sell bonds and hold the assets. The vehicle that ran the fund was Long-Term Capital Management (LTCM), a Delaware partnership owned by J.M., his partners, and some of their spouses. Though such a complicated organization might have dissuaded others, it was welcome to the partners, who viewed their ability to structure complex trades as one of their advantages over other traders. Physically, of course, the partners were nowhere near either the Caymans or Delaware but in offices in Greenwich, Connecticut, and London.

      The partners got a break just as they started the marketing. They were at the office of their lawyer, Thomas Bell, a partner at Simpson Thacher & Bartlett, when Rosenfeld excitedly jumped up and said, “Look at this! Do you see what Salomon did?” He threw down a piece of paper—Salomon’s earnings statement. The bank had finally decided to break out the earnings from Arbitrage, so Long-Term could now point to its partners’ prior record. Reading between the lines, it was clear that J.M.’s group had been responsible for most of Salomon’s previous profits—more than $500 million a year during his last five years at the firm. However, even this was not enough to persuade investors. And despite Merrill’s pleading, the partners remained far too tight-lipped about their strategies. Long-Term even refused to give examples of trades, so potential investors had little idea of what the partners were proposing. Bond arbitrage wasn’t widely understood, after all.

      Edson Mitchell, the chain-smoking Merrill executive who oversaw the fund-raising, was desperate for J.M. to open up; it was as if J.M. had forgotten that he was the one asking for money. Even in private sessions with Mitchell, J.M. wouldn’t reveal the names of the banks he was calling; he treated every detail like a state secret. With such a guarded client, Mitchell couldn’t even sell the fund to his own bosses. Although Mitchell suggested that Merrill become a strategic partner, David Komansky, who oversaw capital markets for Merrill, warily refused. He agreed to invest Merrill’s fee, about $15 million, but balked at putting in more.

      At one point during the road show, a group including Scholes, Hawkins, and some Merrill people took a grueling trip to Indianapolis to visit Conseco, a big insurance company. They arrived exhausted. Scholes started to talk about how Long-Term could make bundles even in relatively efficient markets. Suddenly, Andrew Chow, a cheeky thirty-year-old derivatives trader, blurted out, “There aren’t that many opportunities; there is no way you can make that kind of money in Treasury markets.” Chow, whose academic credentials consisted of merely a master’s in finance, seemed not at all awed by the famed Black-Scholes inventor. Furious, Scholes angled forward in his leather-backed chair and said, “You’re the reason—because of fools like you we can.”¹¹ The Conseco people got huffy, and the meeting ended badly. Merrill demanded that Scholes apologize. Hawkins thought it was hilarious; he was holding his stomach laughing.

      But in truth, Scholes was the fund’s best salesman. Investors at least had heard of Scholes; a couple had even taken his class. And Scholes was a natural raconteur, temperamental but extroverted. He used a vivid metaphor to pitch the fund. Long-Term, he explained, would be earning a tiny spread on each of thousands of trades, as if it were vacuuming up nickels that others couldn’t see. He would pluck a nickel seemingly from the sky as he spoke; a little show-manship never hurt. Even when it came to the fund’s often arcane details, Scholes could glibly waltz through the math, leaving most of his prospects feeling like humble students. “They used Myron to blow you away,” said Maxwell Bublitz, head of Conseco’s investment arm.

      The son of an Ontario dentist, Scholes was an unlikely scholar. Relentlessly entrepreneurial, he and his brother had gotten involved in a string of business ventures, such as publishing, and selling satin sheets.¹² After college, in 1962, the restless Scholes got a summer job as a computer programmer at the University of Chicago, despite knowing next to nothing about computers. The business school faculty had just awakened to the computer’s power, and was promoting data-based research, in particular studies based on stock market prices. Scholes’s computer work was so invaluable that the professors urged him to stick around and take up the study of markets himself.¹³

      As it happened, Scholes had landed in a cauldron of neoconservative ferment. Scholars such as Eugene F. Fama and Merton H. Miller were developing what would become the central idea in modern finance: the Efficient Market Hypothesis. The premise of the hypothesis is that stock prices are always “right”; therefore, no one can divine the market’s future direction, which, in turn, must be “random.” For prices to be right, of course, the people who set them must be both rational and well informed. In effect, the hypothesis assumes that every trading floor and brokerage office around the world—or at least enough of them to determine prices—is staffed by a race of calm, collected Larry Hilibrands, who never pay more, never pay less than any security is “worth.” According to Victor Niederhoffer, who studied with Scholes at Chicago and would later blow up an investment firm of his own, Scholes was part of a “Random Walk Cosa Nostra,” one of the disciples who methodically rejected any suggestion that markets could err. Swarthy and voluble, Scholes once lectured a real estate agent who urged him to buy in Hyde Park, near the university, and who claimed that housing prices in the area were supposed to rise by 12 percent a year. If that were true, Scholes shot back, people would buy all the houses now. Despite his credo, Scholes was never fully convinced that he couldn’t beat the market. In the late 1960s, he put his salary into stocks and borrowed to pay his living expenses. When the market plummeted, he had to beg his banker for an extension to avoid being forced to sell at a heavy loss. Eventually, his stocks recovered—not the last time a Long-Term partner would learn the value of a friendly banker.¹⁴

      While Merton was the consummate theoretician, Scholes was acclaimed for finding ingenious ways of testing theories. He was as argumentative as Merton was reserved, feverishly promoting СКАЧАТЬ