Monday, July 20, 2009

When Genius Failed...Again

"'GIVE ME but one firm spot in which to stand,' Archimedes declared, 'and I will move the earth.' While the ancient Greeks discovered the principle of leverage some 2,200 years ago, it was John Meriwether and his Long-Term Capital Management LP that showed how far leverage could take you in financial speculation." - Forbes article by Robert Lenzner in 1998

John Meriwether, is closing his latest failed hedge fund (JWM Partners) after losing 44% in less than 18 months. Of course, Meriwether is best known for the Long-Term Capital Management (LTCM) disaster back in 1998. Back then, many feared LTCM's failure would threaten the stability of the global financial system without intervention. As a result, a bailout was organized by the Federal Reserve Bank of New York in order to prevent a wider collapse in the financial markets.

The book When Genius Failed tells the full story, but basically LTCM was an extremely leveraged outfit that gambled with various forms of arbitrage and lost a ton of money.

LTCM was made up of several former professors, including Nobel Prize-winning economists Robert Merton and Myron Scholes.

...its enormously leveraged gamble with various forms of arbitrage involving more than $1 trillion dollars went bad, and in one month, LTCM lost $1.9 billion. On the precipice of not only an American financial disaster, the fund's imminent collapse had significant international monetary implications, jeopardizing the financial system itself. - From Wikipedia on the book, When Genius Failed

From a recent Bespoke Investment Group post on his latest failed fund:

Only a little less than ten years after his first hedge fund [LTCM] blew up and threatened the stability of the financial system, John Meriwether has announced that his current fund, JWM Partners, will wind down operations after a loss of 44% from September 2007 through February 2009.

Bespoke also added...

...Bloomberg reported that, "For many investors, John Meriwether is by now just another hedge-fund manager." Just another hedge-fund manager? How many other hedge fund managers do you know with a resume that includes a US Treasury trading scandal, Long-Term Capital, and now this?

Here's an excerpt from an article about John Meriwether that was published earlier this year:

"Some people really do live a cartoon life. They blow themselves up, and for a second, there they are, all charred and burned. But then in the next frame, they've got a fresh stick of dynamite in their hands and they're good as new. Such is the fanciful tale of John Meriwether, the mad genius behind Long-Term Capital Management, the original hedge-fund disaster story. There are some analysts who now see the 1998 government bailout of LTCM as planting the seeds of our current predicament — the moment when sophisticated financial managers learned that causing systemic risk was something they didn't really have to worry about, because the government would be there to have their backs." - From John Meriwether, The Wile E. Coyote of Hedge Funds by Hugo Lindgren

We've seen this movie:

1) Excess leverage,

"Leverage is the only way a smart guy can go broke." - Warren Buffett on The Charlie Rose Show

2) complex formulas,

"Beware of geeks bearing formulas." - Warren Buffett in the 2009 Berkshire Hathaway Shareholder Letter

3) and overconfidence based on high IQ.*

"We'd argue that what's taught is at least 50% twaddle, but these people have high IQs. We recognized early on that very smart people do very dumb things, and we wanted to know why and who, so we could avoid them." - Charlie Munger at the 2007 Berkshire Hathaway Shareholder Meeting

"If you have a 150 IQ, sell 30 points to someone else. You need to be smart, but not a genius. What's most important is inner peace; you have to be able to think for yourself. It's not a complicated game." - Warren Buffett at the 2009 Berkshire Hathaway Shareholder Meeting

When all three are combined, it's smart to keep hard earned money as far away as possible.


Related posts:
Smart Money?
The Madness of Crowds
Max Planck: Resistance of the Human Mind

* From John Kenneth Galbraith's bookA Short History of Financial Euphoria"...the investing public is fascinated and captured by the great financial mind. That fascination derives, in turn, from the scale of the financial operations and the feeling that, with so much money involved, the mental resources behind them cannot be less.

Only after the speculative collapse does the truth emerge. What was thought to be unusual acuity turns out to be only a fortuitous and unfortunate association with the assets. Over the long years of history, the result for those who have been thus misjudged (including, invariably, by themselves) has been opprobrium followed by personal disgrace or a retreat into the deeper folds of obscurity. Or it has been exile, suicide, or, in modern times, at least moderately uncomfortable confinement. The rule will often be here reiterated: financial genius is before the fall."

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