When Genius Failed Book Review (Book Review Sample)

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A Critical Review: When Genius Failed
Introduction
Roger Lowenstein has been a reporter for The Wall Street Journal for a long time and gained intense recognition in the finance world. He is renowned for clearly bringing out the events that precede the success or fall of a business empire. He is the author of the bestseller, Buffet: The Making of an American Capitalist. The book ‘When Genius Failed’ is the story of the creation, success, collapse and immediate save of Long-Term Capital Management (LTCM), a hedge founded by John Meriwether. John's departure from Salomon Brothers resulted in a tremendous increase in his wealth as well as his partners. Roger divides the book into two parts: the rise and the fall of LTCM. It tells the story of an American hedge fund that accounted for over $100 billion in assets. A hedge fund is an investment or fund for wealthy institutions and pension funds. Edwins states that though a hedge fund may be organized as a limited liability company, most are organized as limited liability partnerships to invest the money of their partners. They are unregulated in nature and are limited to wealthy investors capable of assessing involved risks (Edwins, 190). It represents the true story of Wall Street traders, academics, and hubris. The author clearly establishes character and shows how ego, arrogance, and Wall Street’s herd mentality created an avoidable crisis.
The author tries give a cautionary tale regarding financial professionals and why it is wrong to idolize them. His book suggest that the lenders involved (mostly banks) were ignorant of the nature of LTCM’s assets and strategies but rather were confident of the brand name that the hedge had established and the partners that it had attracted over time. The book is able to explain how the bond and equity markets function, relation of profits and losses to leverage amongst other factors.
John Meriwether was one of the top bond traders at Salomon Brothers, and he later became head of the fixed income securities department which at that time was responsible for trading bonds and mortgage security. He recruited several physicists and mathematicians into Wall Street and turned them into bond traders. Their work was to develop mathematical and computerized models that would predict prices based on market volatility. In 1991, while still the head of Salomon Brothers, a trader in his department falsified a US Treasury bill bid. The result of this was losing his job but in turn he became very wealthy. He was thus able to duplicate the same set-up he had earlier and hired a significant number of workers to form Long-term. The hedge fund was set up based on a partnership between LTCM and Cayman Island Partnerships.
The book can pass several lessons. First, in a market situation where there are above-normal profits, the absence of barriers will lead to new entrances into the market consequently driving down returns. LTCM’s initial returns were very high. In 1994, profits after the deduction of fees were 20%. In 1995, the profits after the deduction of cost services increased to an astonishing 43%. However, Roger suggests that with time, new entrants either began copying their successful models or that their strategies were commonplace. As a result, competition ensued and with time, the LTCM's profits begun decreasing. Second, Roger points out another reason for success for LTCM as cheap financing and production costs. Lenders had the mentality that they would gain enormous amounts of profit by providing short-term loans at affordable rates. The lenders did not necessarily require any collateral. Roger points this out as one of the reasons that may have caused a further decline in LTCM. This is because the hedge fund put its lenders at a considerable level of risk. The book suggests that the banks were ignorant of LTCM’s assets. They chose to overlook it and base their confidence in the name of the brand that LTCM had made. By externally observing the organization rather than gaining inside information on the operations of the organization, LTCM was able to grow profitably.
Third, Roger states that returns and losses are magnified by leverage. In his book, Roger explains that Long-Term Capital’s leverage was closer to 1 to 30 as early as 1995. LTCM scooped up loose change when there was an imbalance in financial markets. However, the high amount of leverage created enormous returns from a relatively small amount of bet. For every dollar of assets in the fund, they borrowed about $25 to place trading bets. Most of the loans made to LTCM were the equivalent of signature loans as no one backed them up neither were calls made when the value of the hedge fund’s asset dropped. Such high leverage amounts caused the firm be vulnerable to price shift in the market. They magnified their profits if the bets became successful but at the same time they significantly increased their losses when the market turned against them.
Fourthly, Roger mentions liquidity as one of the factors that may have caused LTCM not withstand the market pressure. When the market forces turned against LTCM, the number of buyers decreased. When they wanted to trade in interest rate contracts after incurring losses, they were unable to go about it since they could not set up reasonable prices as there were few buyers. Their massive capital base pushed them to venture into markets that had less liquidity. In normalcy, funds worry about the market impact that their trades have. The larger the fund, the bigger the posed challenge. LTCM could only trade in the most liquid market. Lastly, Roger emphasizes why knowing and focus on one’s competitive advantage over another organization is important. His book shows LTCM facing its problem by somehow shifting away from areas it initially benefited from through comparative advantage. To counter competition from new entrants in the market, partners and staff, in general, moved from the bond market which they had perfected as their area of expertise to stock markets which they had little experience in. The firm made some bets on completion of certain mergers without necessarily considering whether they added skill to it. This sway also created a shift in equities, and this did not go well for LTCM: it may have contributed to its failure.
A notable flaw of his book is that Roger fails to mention details of the investment strategies used by LTCM at the expense of the story. LCTM mostly used derivatives in most strategies. A derivative is a security that derives its value from the underlying market of an asset. On the other hand, a stock option derives its value from the price of a stock index. Strategies used to make money in the two mentioned models can be complex. Roger fails to mention the details. As explained in the book, LTCM lost most of its money on swaps and volatility bets. This shows that the omitted d...