When Genius Failed: The Rise and Fall of Long-Term Capital Management

by Roger Lowenstein

Veteran arbs quickly realized that somebody new had entered the game and that the somebody was both very big and indiscriminate—or, as Rosenfeld put it, not “information sensitive.” By buying in such volume, Long-Term was boosting deal stocks across the board, squeezing spreads to unprofitable levels. As usual, Long-Term was content to earn relatively tiny spreads because it intended to multiply its returns with leverage. Still, one marvels at Long-Term’s audacity, sauntering into a corner of Wall Street—one in which savvy veterans had been working for years—and rewriting the economics of the field overnight. Long-Term was the gorilla that announces the rules wherever it goes. One night, Hilibrand, J.M., and Mullins had dinner with Daniel Tisch, a prominent risk arbitrageur. Tisch, son of the investor Larry Tisch, had the impression that Long-Term was thinking about the business solely in mathematical terms. Indeed, Hilibrand expressed every financial puzzle in terms of a spread. In risk arb, spreads were roughly 4 percent to 10 percent, much greater than bond spreads. “Our business looks very attractive next to their business, where they trade to make a couple of basis points,” Tisch noted. “The only trouble is, if you’re wrong on a government bond the spread may change by a half a point. If you’re wrong on risk arb, you can lose half your position.” In short, the reason that deal spreads were so much wider than bond spreads was that you could lose a lot more money on mer...