No longer masters of the universe

The men at the centre of the LTCM debacle are still cursed by the hedge fund's collapse
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The Independent Online

When Myron Scholes got married in September 1998, he jokingly suggested that from then on he be known by his new wife's surname. Uninformed guests attending the celebrations in New York laughed at the suggestion, coming as it did from a Nobel laureate and one of the financial markets' biggest and most feared traders.

When Myron Scholes got married in September 1998, he jokingly suggested that from then on he be known by his new wife's surname. Uninformed guests attending the celebrations in New York laughed at the suggestion, coming as it did from a Nobel laureate and one of the financial markets' biggest and most feared traders.

But the cognoscenti understood why Mr Scholes might want to renounce a surname which was once the toast of both Harvard and Wall Street. Indeed, at least one of them, John Meriwether, was equally keen to forget himself. Only a week before, Mr Meriwether and Mr Scholes were among the partners of Long-Term Capital Management (LTCM) who had been forced to succumb to a humiliating bail-out of their hedge fund, lost £1.9bn of their wealth and been deprived of their glittering reputations as "Masters of the Universe".

It is two years since LTCM collapsed, two years since a consortium of 14 investment banks showed an unprecedented sense of harmony in coming together to concoct a $3.5bn (£2.4bn) rescue of the hedge fund. The alternative, it was feared, was a systemic collapse of global markets with casualties far more numerous and innocent than a group of bond traders who had chosen to believe their own hype.

It has, by coincidence, taken Mr Meriwether two years to admit he was wrong - and sorry. He had little choice. Next week, the first definitive account of LTCM's demise will be available with the publication of When Genius Failed, written by Roger Lowenstein and published by Fourth Estate. The book will do little for Mr Meriwether's hopes of attracting money to his new fund, JWM Partners.

Mr Scholes' wedding day came at a traumatic time for Mr Meriwether, who spent much of the time engaged in delicate negotiations on his cell phone. The 53-year-old golf fanatic, who part-owns the links of Waterville in Ireland, was in the course of giving away for a pittance a fund which once was worth $4.7bn.

That year, Mr Meriwether had predicted that stock market volatility - a measure of price movements in either direction - would die down. He also bet that swap spreads - which gauge global confidence in the creditworthiness of banks and large companies - would fall. But, as investors panicked at the implications of Russia's debt default, both these trades flew violently against Mr Meriwether's expectations. True, it was a time when most market players lost money, but only LTCM had chosen to bet the bank.

"These trades cost them $3bn of the $4bn-plus that they lost," says Mr Lowenstein. "The key was the size and the degree of leverage they had built up. It shows how desperate they were for better opportunities."

Students of Mr Meriwether would not have been surprised that he should fall from such a great height. This was the hero of Liar's Poker, that chronicle of Wall Street excess at Salomon Brothers, who was once challenged by his boss to a £1m-a-hand game of cards - and insisted that they play for no less than £10m. When he left Salomon Brothers to set up LTCM, it was Mr Meriwether who attracted the cream of Wall Street trading talent to a fund which had the world's largest banks queueing up to back it.

If LTCM's problem was that it became too big then he need have no such concerns about his new venture. After a period of soul-searching, he is again on the hunt for funds - a campaign to raise $1bn from investors so far has yielded a mere $250m.

Mr Lowenstein says: "He hasn't received money since, because he is nursing an incredible black eye. It's so much easier for institutions to say 'no'. If they lose money again, they couldn't say that they had no idea what would happen."

Mr Meriwether's return to the public eye has coincided with the emergence of several of his cronies, four of whom have joined him at JWM Partners. Mr Scholes has been entrusted by Texas's Bass family to manage some of its fabulous wealth. Robert Merton, a brilliant academic, has returned to Harvard as a consultant on risk management. Only David Mullins, the gamekeeper-turned-poacher who joined LTCM from the US Treasury, has perhaps wisely chosen to keep his head down.

The central bankers who organised LTCM's bail-out have emerged with their reputations intact. Their mission - to ensure that the hedge fund's fall did not cause a domino effect by toppling other institutions - was achieved. They feared that, with details of LTCM's trades seeping out, rivals would drive the markets into even more skewed positions which would tip other exposed firms into liquidation.

Instead, the positions were inherited by 14 investment banks which possessed the balance sheet strength to restore order. Or so the story goes. "The Fed had a good opportunity to remind the US of what happens when people take too much risk," says Mr Lowenstein.

Indeed, Federal Reserve chief Alan Greenspan has since admitted that there was a sense of "moral hazard" in the Fed's action: that the failure of LTCM could have been used pour décourager les autres. Perhaps the Fed had other things on its mind.

Nicola Meaden, a director of Tass Investment Research, says: "Other proprietary desks at investment banks were big players as well. They took very leveraged positions. One reason why they had to bail out LTCM was that so many other banks had similar positions."

If LTCM had been forced to dispose of its positions in the open market, the likes of Goldman Sachs and Merrill Lynch would have suffered. But they were in a position to ensure that never happened.

"People said they were worried about the impact of LTCM's collapse on Wall Street," says Mr Lowenstein. "The Fed felt they were looking after the entire system, but the people they were talking to were the investment banks. It is easy to confuse your subjects with your charges."

The suspected behaviour of some investment bankers at the time of LTCM's bail-out suggests they were motivated by self-interest alone. Rumours abounded that at least two banks, Salomon and Goldman Sachs, were instructing traders to drive the markets further away from the stricken hedge fund, the cheaper to assume its positions. Mr Lowenstein reports that dealers from Goldman spent hours in LTCM's offices in Greenwich, Connecticut, relaying information about its portfolio to head office.

Neither Goldman nor its rivals admitted to such duplicity. Jon Corzine, then joint chief executive officer of Goldman, comes in for particular flak for his part in trying to hatch a rival rescue attempt. Warren Buffett, the multi-billionaire investment guru and Mr Corzine's partner-in-crime, was accused of dancing on Mr Meriwether's grave.

Two years on, the banks do have cause for some celebration. Conrad Volstad, who was seconded from Merrill Lynch to run the positions, has since closed them at a small profit for the 14 - Barclays referred coyly to its windfall in its annual report.

Not that Mr Meriwether has been vindicated, the markets having bounced back only slightly from the "abnormal" levels he was trying to exploit. Still, Mr Volstad has been able to extract returns which Mr Meriwether will feel were rightly his.

Individually, however, some bankers who were instrumental in the rescue must feel like they were present at the discovery of Tutankhamun's tomb. Mr Corzine has departed, feared ousted, from Goldman, and is trying to become a Democrat senator. Herb Allison, who represented Merrills, lost his place in the bank's pecking order and has left. Mathis Cabiallavetta, the former golden boy of Swiss banking, took the blame for UBS's $700m exposure to LTCM and fell on his sword. It was Mr Meriwether, after all, who was unfairly scapegoated by Salomon despite exposing the Treasury bond scandal of 1991. Perhaps it is he who is cursed.

Eric Rosenfeld, Mr Meriwether's right-hand man, might agree. He too was present at Mr Scholes' wedding, at least in body, his mind being preoccupied with the prospect of selling his beloved wine collection to make good his debts. Having been forced to sell his hedge fund for a pittance, he had to lose his cellar as well. The buyer? One Conrad Volstad.