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

by Roger Lowenstein

Long-Term knew it had to reduce its positions, but it couldn’t—not with markets under stress. Despite the ballyhooed growth in derivatives, there was no liquidity in credit markets. There never is when everyone wants out at the same time. This is what the models had missed. When losses mount, leveraged investors such as Long-Term are forced to sell, lest their losses overwhelm them. When a firm has to sell in a market without buyers, prices run to the extremes beyond the bell curve. To take just one example, yields on News Corporation bonds, which had recently been trading at 110 points over Treasurys, bizarrely soared to 180 over, even though the company’s prospects had not changed one iota. In the long run, such a spread might seem absurd. But long-term thinking is a luxury not always available to the highly leveraged; they may not survive that long.