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

by Roger Lowenstein

Notice that there is a key difference between a share of IBM (or an infectious disease) and a pair of dice. With dice, there is risk—you could, after all, roll snake eyes—but there is no uncertainty, because you know (for certain) the chances of getting a 7 and every other result. Investing confronts us with both risk and uncertainty. There is a risk that the price of a share of IBM will fall, and there is uncertainty about how likely it is to do so. So many variables—political, economic, managerial, competitive factors—can affect the result that the uncertainty all but overwhelms us. Seen in these terms, Long-Term’s letter represented a dramatic leap. While it heartily acknowledged risk, it banished uncertainty by putting numerical odds on its likelihood of loss. To J.M. and his traders, money management was less an “art” requiring a series of judgments than it was a “science” that could be precisely quantified.