When Idiots Failed
"Statistically, they had IQs of 165...they really were twice as smart as I was," Jim went on "but you guys must've got it wrong. You couldn't – you can't possibly understand risk. All your models, and all your theories, and all your teaching, and all your learning, and everything you guys stand for can't be right. Because if it was right, this wouldn't have happened."
"We were there on Sunday. We were there for the whole day. Things were printed out at the time. We didn't have the internet," Jim continued motioning to his iPhone. "So we were turning pages, like here's our Italian bond position. Here's our French equity basket position. Here's our Japanese JGB position. Bum, bum, bum. We had a $1.3 trillion extended balance sheet. This is a hedge fund. This is not a bank. $1.3 trillion in 1998 Dollars."At the end, Peter Fisher [then head of open market operations at the New York Federal Reserve], his face is white, looks to us and says, 'I knew you guys could destroy the bond market, but I didn't realize you could destroy the stock market.'"
"Peter Fisher told us, 'You guys are gonna close every stock market in the world and every bond market in the world, and take down the banks.' Now, it looks that way."Monday morning, he has breakfast with David Komansky, CEO of Merrill Lynch; Sandy Warner, who at the time was CEO of J.P. Morgan; Jon Corzine, who was CEO of Goldman; and the – oh, it was like the – I think it was the No. 2 guy at Citigroup, down at – Derek Lawn, I think. But we gotta do something. So they cogitate for three days."So Wednesday afternoon, we get a term sheet. This is the beginning of the consortium. Fourteen Wall Street banks send us a term sheet for the bailout. Now, they didn't bail us out. They bailed themselves out, because we were on our way to zero."
"The Fed would say," Jim recalls, "'We served warm Cokes, but that's all we did. We let these guys figure it out among themselves.' They were Big Brother. But nobody in those days thought the government could do it. I mean, they had the resources, but nobody thought the government had any business bailing out a hedge fund. That idea was way off the table.'"
"When Meriwether left," David told us during a meeting we hosted in Baltimore this past Wednesday, "and Rickards and all the rest of them joined him, I knew him pretty well. When he launched Long Term Capital Management, he raised something like a billion Dollars, which in those days was unheard of."Meriwether had a cocktail party, and he invited to come, so I went. I met Myron Scholes. I had heard of him...I mean Black-Scholes was something I knew of even then. I was speaking to him over a couple of drinks, and I said, 'What is your strategy in terms of your targets and expected returns and level of risk, and what are you telling these investors?' Because it was quite a phenomenon that they raised a billion Dollars in something like two months."And he said, 'Well, our target return is 45%.'"I said, 'Wow! You're going to take a hell of a lot of risk for that, aren't you?'"And he said, 'None.'"Because they had a black box. And it worked for like four or five years. The made huge returns, and more money piled in...until 1998, and then the thing blew sky-high."
"What happened," Stockman helps to explain, "when the crisis came in 1998 – the new Greenspan era – there was a flight from so-called risk on into Treasuries, and Treasuries rallied like never before. What it did was it destroyed their firm in a couple of weeks. Because the hedge that was supposed to be generating offsetting income against the prop trades that were failing actually went against them."If you're massively short the Treasury as a hedge and the Treasury bond is rising, you're getting killed by your hedge...even as you're losing a ton on all your various fancy prop trades."There had never been one of these massive flights to safety – it never had happened before. So therefore, in their model, there was no case where they would lose money, let's say, on a high-yield bond, and there was a high-yield bond market then – Russian bonds or whatever."
"I had made millions at Greenwich Capital," Jim Rickards laments, "And then I made millions more at Long Term Capital. I was the highest-paid lawyer on Wall Street. I wasn't making $25, $30 million. I wasn't a trader. But for a lawyer to be banging out a couple million Dollars a year, I was probably the highest-paid lawyer on Wall Street, other than maybe a litigator who was doing tobacco cases. And I put all that money into Long Term."Now, I know that's stupid. I get it. But I was like, 'Hey. I'm a lawyer, okay? You guys, you won a Nobel Prize. You're the head of the finance faculty at Harvard. You're the head of finance faculty at Berkeley. You're the head of the finance faculty at the University of Chicago. I'm the dumbest guy in the room. I'm a lawyer. I got all this money. What better thing could I do than give it all to you?'"So I'm all in at Long Term Capital, right? A big stack, it was all in Long Term Capital. So that week...I lost 92% of everything. I ended up 8 cents on the Dollar. So I wasn't broke, but I got, like, six figures out of what I put in. Meanwhile, believe it or not – I had actually paid off my mortgage. Big house in Connecticut. I had no debt. But I went and took out a mortgage so I could put more in, because I'm like, what could be better than investing in the Feds, right?"And I didn't think about diversification."