Federal Reserve Intervention and Legacy

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Less, your call is important to us, and more, how can we help? It's getting more of what you want, and less of what you don't. That's how TD's making banking more human You caught it You take me back to the nineteen nineties baby and then the seventies and then the nineties. Okay Robert Smith, this is a story about some of the smartest people in the world incredibly successful in their fields. They decide to come together, start a new thing, and they are so successful. They make billions of dollars They win the Nobel prize as they're making billions of dollars. and then The next year They get destroyed And in fact, they get destroyed so hard that they almost take the global economy down with them. I'm Jacob Goldstein. I'm Robert Smith, and this is business. I show you about the history of business today on the show, the story of long term capital management. Wh, You are so amppt for this. The mid nineties. The Cold War has just ended. free market capitalism is tririumphant and the economy was fantastic in the nineteen nineties. bestest economy, my favorite economy. And the people who started long term capital management looked at the economy, not just in the US, but around the world and they said yes. Yes. This is the moment we've been waiting for. We are going ride this. global capitalism wave and they did What they did not know was that that wave was about to Let's start before the nineteen nineties. Let's, let's, let's start in the nineteen eighties, the early eighties, go, go, go Wall street with a bond trader named John Merryweather Merryweather had grown up Working class south side of Chicago golf caddy as a kid. That was like his, you know, path old school, got his MBA at the University of Chicago. And in the mid seventies he went to work at Solomon Brothers. And Solomon Brothers was about to become The heart of nineteen eighties Masters of the Universe Wall Street Yeah Bonfire of the Vanities was based on Solomon Brothers. Michael Lewis in Lyarars Poker wrote about Solomon Brrosers. It was where he worked right out of college in the eighties. The key thing to know is at this time The kind of legendary tritors at Solomon Brothers were like very rough. They were street smart. They ate cheeseburgers for breakfast. They traded, you know, based on their cheeseburger filled guts And Michael Lewis wrote beautifully about these guys in Lars P pooker, most famously about a trader named Louis Raneri Louis Ranier started out in the mailroom. He was from Brooklyn, He worked his way up. And Robert, I want you to read one sentence from Lars Poker. that describes the life of a guy who worked with Riner and just captures this culture At Solomon Brothers, he traded bonds while being hollered at by six salesmen, eating a morning cheeseburger and watching Ryeri hold a bit lighter under the balls of a fellow trader pared for that This is this is Solon Bothers at this time. You don't see the lighter coming John Merryweather was not kind of guy. He was working class, but he was calm. He was even tempered. He didn't yell didnidn't hold big lighters under his colleagues' balls. But he did love to take risks. He was a traitor at heart. And he was really good at it. And he got promoted and he started running a desk, which meant he had to hire people to come work with him, hire traders And this is when He has his big idea For the past decade or so by this point, this is the early eighties, professors at places like MIT and the University of Chicago had been developing these really mathematical theories of finance about prices, right? Some of this had filtered into Wall Street, but not much. It was an academic endeavor. They had found datas and they were tracking the stock market. they knew there was money involved But they were doing it to pass their dissertations, not necessarily to like blow up the market. Yeah. and still the culture on Wall Street was this very kind of burgers for breakfast culture. not an academic culture But Merryweather's idea was basically, oh, maybe these Nerds know what they're talking about. you know, like maybe they could actually come to Wall Street. we could Do a bunch of math and make money And so he decides to test this theory, starts hiring a bunch of you know, guys with PhDs from MIT. and they come work with him at Solomon Brothers. He's like, stay away from the guy with the big lighter Yeah Unsurprising now. Now if you have a PhD from MIT, the easiest thing to do is not to be a professor, but to go work at Jane Street or some quant fund. Yeah, they're actually recruiting at MIT in Stanford and Harvard. A banker who worked with Merryweather said these guys that Merry Weather is bringing in these academics were considered freaks. He give here's a line Those guys would be playing with their slide rules at Bell Labs if it wasn't for John. Side rules. Slide rules. Three things about that quote Th guys would be playing with their slide rules at Bell labs if it wasn't for John. One It comes from Roger Loewenstein's book When Genius Failed. Excellent, excellent nonfiction book about The rise and fall of long term capital management, the key source for today's show Tw sllide rules were what people used to do complicated math before graphing calculators came along. scientific calculators. I had one. Yeah. You would like actually move little little slides and yeah a little little clear window. love that. And three, Importantly, this quote was an anachronism even in nineteen eighty three because they would not have been playing with slide rules. They would have been playing with computers The rise of the computer is what empowers these people to do real work. I'm going to give you a number four too, because we're starting to see the shift in the economy in this quote. They're not at Bell labs anymore. They're not working for American manufacturing and American invention They're working for American finance. This is when we're seeing this big shift in the economy. Yes, financialization. financialization, the rise of Wall Street. Yes. And in fact, it's no coincidence that Jim Simmons, who you did a show about, who is a math PhD whoo is a math PhD is starting his fund Rennaissance technologies right around the same time. Merryweather brings the nerds to Wall Street and they work with him on what's called the arbitrage desk. Robert Smith M sweet free money Arbitrage is this very specific idea in finance and it s very big idea and very simple idea, I would say, which is If you can buy and sell The same thing at different prices. You can make money with almost no risk So let's say Silver is trading in New York at one hundred dollars and is trading in London at one hundred and one dollar. It's a very hardot price for silver. It's a very exciting moment. Yes. you could buy the silver in New York for hundred dollars and simultaneously sell it in London for one hundred and one dollars. know you don't have to ship it And then you make a dollar profit Yes, no work whatsoever. Yes Now arbitragees like this tend to be hard to find because people arbitrage them away. When you buy the cheap one and sell the expensive one, you cause the prices to converge. Yeah. at one hundred dollars fifty cents The kinds of arbitrages that Merryweather and his nerds are finding are a little more subtle, but they exist in the world And these guys come in and indeed start making money, a lot of money. In some years they account for most of Solomon's prophets. and might have been the end of the story. They might have just got rich on Wall Street But for one In nineteen ninety one, so they've been at this for a while, they're doing well Merryweather gets in trouble cause a guy who worked for him rigged treasury bond auctions and actually told Merryweather about it and Merryweather told his boss, but they didn't do anything. They said on it. story comes out They lose their jobs. We talked about this in the Warren Buffett show because Warren Buffett was a huge investor in Solomon Brothers had to come in and run the company from Omaha. with all of these New York traders just to fix the reputation. Yes. So Merrywather, I think he resigned under pressure. I don't think he actually got fired, but he's out. he's out. So he decides, not long after that He wants to getet his band of nerds back together But not working for somebody else, not at a Wall Street firm He wants to start M. Wasn't his reputation bad Well, will know, he didn't get fired for losing money. got fired for an ethical lapse. and making a lot of money Make a lot of money. So O contrare, Ethhical Labs plus make a lot of money Perfect. And so we decided to start a hedge fund. In nineteen ninety three, hedge funds were not that popular. But there was this idea, which was you could have a fund that was not correlated to the market. And this was very useful because you would make money on stocks, but you worried about losing money. So you'd put a fraction of your wealth into a hedge fund and they would do sophisticated mathematical things to make sure that if the market were to crash, you wouldn't lose all your money. That was the hedge part. That's the hedge.. They make different kinds of bets. so it's not just market goes up, you make money, market goes down, you lose money This was the original idea. Headphones had been around for decades by this point Tim Merryweather comes along and in the ninet days not all hedgeunds are even hedged The main thing they are is special funds for rich people and institutions that charge very high fees And Merryweather decides he's going to launch Biggest hedge fund And in order to launch the biggest hedge fund ever and to charge higher fees than usual, which is also part of his plan, he needs to nerd up He needs to go even nerdier than before And he goes and recruits two professors, two super nerds We're going to make his dreams come true They are Robert Merton and Myron Sholes. Merton was a Harvard professor who was sort of the father of the finance math nerds And Schooles, Scholz was at Stanford And hiring shhoals was like I couldn't quite nail this one. It was like hiring Dr. Bandaid for your for your hospital or I don't know it, because School's name was on this famous equation that was widely used in finance. Scholz and another guy Fisher Black had come up with black shoals An equation that I know is dear to your heart. Yeah, if you know anything about finance math, you would know the Black shoals formula. did was solve this classic problem in finance, which is how to price an option. So an option is a contract between two people that essentially says, I have the right to buy something you own in the future. att a certain price. At a certain price. So Jacob's you know all in on SpaceX and I'm a little bit wary. So I say to him, I want the right to buy SpaceX at two hundred dollars in six months That's a normal contract. But how much should I pay Jacob for that right to buy it in the future. The right, but not the obligation, right Yeah. And so people had used their guts. They essentially guessed what this was worth And what Scholz and Black and Merton did was come up with this way to essentially price the future in the present by creating a little insurance portfolio theoretically. Yeah The way you predict future risk now is through essentially an insurance contract.. So now Merryweather has Merton and Soolals He also hires a guy who had worked at the Fed. this incredible team And history in a really profound way on their side Think about this moment. it's nineteen ninety three Communism , You know, the Soviet Union just just fell apart Cold War is over and it's clear, right Free market capitalism won, command and control, communism lost. Even Russia at this point is becoming a market economy. And there's this famous kind of controversial book that has just come out around this time that kind of nails this moment. book with the title that people love to mock The title was The End of History was by a professor named Francis Fukuyama. And let me just say he didn't actually mean the end of history the way people who mock it say right? Things would still happen. thingsings would still happen. His argument was there has been this long arc of humanity figuring out how to organize people in economies. you know monarchial feudalism. and we had communist dictatorships And now in the nineties, we have arrived at a winner. Free market capitalism. and liberal democracy. And if you think all the other countries in the world are going to become more like the U.S, more efficient then you can make bets on them This is the world that Merton and Scholz have been doing their math. for the rational, so called rational, if you like world, where the market becomes more efficient, where prices more and more closely reflect fundamentals This is their moment. The world is breaking their way. And so when Merton and Scholes and Merryweather go out to pitch their fund the world wants in Italy's central bank invests. The biggest investment bank in Brazil invests. Money is coming in from Japan, from Taiwan, from Kuwait, from Wall Street Phill Knight, founder of Nike invest, Michael Ovtz. Ovit, Ovz, don't know. Ovt. Ovit, Hollywood super agent invests In all, Merryweather raises over a billion dollars, which was mon time time biggest hedge fund ever And in February of nineteen ninety four, they launched. Long term capital management becomes a thing. They got an office in Greenwich, Connecticut, of course. They got like forty people and they got a bunch of computers And they are ready to start making money We're going to run an ad now If you don't want to hear ads, you can join Pushkin pllus pushkin. fm We'll back in a minute Did you ever notice how you spend hours shopping online? only to pause right before you hit byy now tiny hesitation. the one where you wonder if it's trustworthy. can make or break the sale. Now, with AI changing the way we discover and compare things, that split second trust question matters more than ever That's where PayPal comes in. For more than twenty five years, PayPal has been a leader in online payments. And now they're at the forefront of agentic commerce, making it work for businesses, letting them maintain control of their brand and their customer relationships So even as the way we shop changes, the moment that matters most still feels familiar and deeply dependable built for payments, Gth and eentics buuilt for all business. Visit payPaloppen. com to get started. Things are feeling a little less human these days, aren't they But isn't the whole point of progress to make things more human That's why, at TD, when we design a product, whether it's getting you paid early or making debit card replacement easy, we ask one simple question. How does this help people That's how we're making banking more simple, more seamless, and more intuitive But most importantly, that's how TD iss making banking more human. Sonanics Fest NYC returns to the Jabbitz Center july sixteenth through the nineteenth for the biggest sports event weekend of the summer. 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US government debt thirty year treasury bonds that had been issued just a few months earlier So this is basically the same thing There was an unusually large gap between the prices of the two of them for sort of kind of regulatory reasons about the way Wall Street had to work The thing is, it was clear that this gap should close over time It was bigger than made sense. So this is perfect for the nerds. It's an irrational gap on really safe assets. They don't have to bet on whether you, the treasury market is going to go up or down. They just have to bet that this irrational price gap is going to close. And it almost certainly will close. This is the age of rationality. Of course, it's going to close and they can help it Only problem is that the gap between the prices was really small. It was like one and a half percent So even if the gap closes entirely and it might not do that, the most they could make is ish one and a half percent. So too low. That's too low. Yes, you're notre you're not starting this great hedge fund with a billion dollars for a return like that. So you have an investment that you're very confident in. It in turn. Yeah. What do you do You lever up. Barren money, borrow massive amounts of money because when you borrow money, you can turn a tiny percentage increase into a large percentage increase Yes, let's do the math. Okay, give it to me Okay, so if I have a million dollars and it's going to return one percent., that's ten thousand dollars B no. That doesn't even buy me a maserati. No. I want my maser. buy you a bad car So I take my one million dollars, I go to a bank and say, give me nineteen million more dollars. Now I have twenty million dollars Same investment On now I make hundred thousand dollars. I get my maserati. And that's a twenty percent return. I pay back the nineteen millionure. And by borrowing that money I can make myself rich even on tiny opportunities. This is the game Still is the game. St is not a historical thing. This is what happens today. So they do this They borrow something like twenty five dollars for every dollar they have. Yes. And they make a billion dollars bet on this treasury arbitrage play. and it works. And very quickly, they make fifteen million dollars in profit, putting up very little of their own money It's working It's important to know that they're not the only ones who see this gap. You know, the quants are emerging by this point. There are lots of nerds following in their footsteps. And so as other traders are getting in on this kind of bet the spreads are closing and the traders at long term capapital have to look farther out into the world and make bets that are a little bit more speculative One big one they do early on is on Italian bonds So I don't want to give a hard time to the Italian economy, but let's just say they've had a lot of problems, especially at this point, a lot of different governments. And so Italian bonds are a little bit riskier than the other countries of Europe or U.S. bonds. Yes. And this is before the euro, right? So even more so trader at Long term Capital is convinced that the market is overestimating a particular risk. And again, this isn't like some wild speculation. He thinks the market is overestimating the risk that Italian companies will default on their bonds relative to the risk that the Italian government will default, right? So it's still a spread trade, right? a convergence trade But you know, it's interesting that there is this principle in behavioral economics that says People Overestimate The odds that bad things will happen. So in the stock market, you hear news about all time highs or the stock market crashing. Most days the stock market is boring You know, the price at the end of the day is very similar to the price at the beginning of the day. You know, we worry about Italian bonds or Italian company bonds. Oh, no, they're going to default. But most of the time They don't But weirdly as humans, we think about the bad thing that can happen and that's the price we put on it. So long term capital decides to take the other side of that bet to decide no, the world is going to continue to just be fine. Yeah, it's be boring. They make this bet. Italy, in fact, did not default. and long term capapital made something like six hundred million dollars in two years on that trade So the firm is doing the thing that they said they would do They're making these trades that profit, you know, whether or not the market goes up or down, that things will tend to converge over time. They're borrowing a lot of money to do it And it works So well. it works In fact, better than they thought it would In nineteen ninety five, long term capapital made a fifty nine percent return took a bunch of fees out of that and they returned to their investors forty three percent In one year, take all my money Take all my maniacs. Yeah, yeah, please One interesting thing about this moment is The people running the firm Merton and Scholes and the rest of them. They knew that this was extraordinary. This was more than they expected. And I don't just mean that in a kind of hand wavy way. They weren't like, o, that's more than we expected. It was more than their math told them was likely. And at this point there are trraders who are not PhDs in the firm who are, you, popping the champagne and saying, we're geniuses., you know, they're like, we're going to do this again and again and again. But the math guys in the room are looking at this saying, this is off our calculations. This is better than we thought, which is just as bad as worse than we thought. Well it's not it's not actually from a mathematical perspective. have done all the m. And in fact You know, all firms tell their investors, we might lose money, right? Your lawyers make you say, we might lose money But there is this amazing investor letter. It's actually an addendum to the investor letter that the firm sends out. The addendum is written by Merton and Shoolz. Loewenstein talks about this in his book And they don't just say, yes, our firm might lose money. They put numbers on how much they might lose. So for example, they say Yes, there is a twelve percent chance the fund will lose at least five percent of its money in any given year This is their worldview that outcomes are mathematically knowable in a probabilistic way. And this is the world v that is spreading You know, this is kind of the end of history worldview, the triumph of free market capitalism. And in nineteen ninety seven, this worldview is validated in the most validating way possible When Merton and Scholals win, The Nobel Prize Its very rare for an investment trader to win the Nobel Prize. Yes. like they're making billions of dollars for their firm and many millions of dollars for themselves. And by the way you're a genius. way, here you go And you know, the prize is specifically for that work figuring out how to price options, But the committee, there's this phrase from the committee that is important here. The committee, the Nobel Committee says, their work facilitated more efficient risk management in society. which is a beneficial thing for the world You know, there's a lot of risk out there. And if you don't know how to price that risk That's concerning. Things can blow up all the time. But if you have formulas that allow us to figure out exactly how much risk somethinghing is taking and how to price that risk Everyone can calm down. Part of the calm nineties we're talking about. The world is better when prices more accurately reflect fundamentals I should mention, by the way, black, fish are black of black shos would have won as well, but he had died by this point and you can't win the Nobel posthumously So now Long term capital has extraordinary returns And on top of that They just won the Nobel prize. The line forms to the right. just be calm all the way around their building in Green's, Connecticut. P want to give them money, clearly. You can't take more money at this point. This is a problem. This is a classic hedge fund problem where, you know, they're not just putting money into the stock market in these giant liquid markets. They're making these weird arbitrage bets on bonds in Italy. and there's only so much money you can put into those bets before it starts to move markets. O at least this is what they tell their investors In the fall of nineteen ninety seven, around the time that Mertin Schls win the Nobel Prize. Here, Robert, read from this letter that Merryweather sends to investors around this time The fund has excess capital This has occurred primarily because of a substantial increase in the capital base from the larger than expected past realized rates of return and high reinvestment rates elected by the funds investors. Oh, we're too good. We're too good at our jobs. We just made too much money. is what they're saying. They're saying that, and what they decide to do is force the investors to take back their money. And a lot of the investors were like, no, don't give us our money back. K. And of course, the partners keep their own money in, crucially. But in late nineteen ninety seven, long term capital does in fact pay out two point seven billion dollars to its investors Now the next thing that is amazing The fund does not trin its bets, does not say, oh, now that we've given this money back, we're going to, you know be a little bit more modest. What they do is they borrow more money, they increase their leverage and keep the same bets going It didn't worked so well Why not double down? Why not double down? So now a bigger share of the fund is the partner's own money It's levered up even more. So If it works, if they keep making money, the partners will go from reallyally, really rich. to really, really, really, really rich. By the way, we haven't mentioned the other side of leverage, which is the market goes against you, instead of losing a little You lose a lot What is going to happen after the ad brereak? They're Nobel Prize winning geniuses. They're going to be rich forever. Wils Did you ever notice how you spend hours shopping online, only to pause right before you hit by now. 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It lets you choose which spend categories earn unlimited three percent cash back, like on dining, groceries, or gas. It's how TD is making banking more human Terms and conditions apply Ctd. com slash cash for details Sest NYC returns to the Javbit Center july sixteenth through the nineteenth for the biggest sports event weekend of the summer. S stars like LeBron James, Tom Brady,raron Judge, John Cena, Jaylin Brunson, Serena Williams, and hundreds more, featuring more than five hundred athletes and celebrities, live shows. Eclusive merch, rare collectibles, Sonatics games with two million dollars in prizes, A full tailgate zone, and New York City's largest indndoor FIFA World Cup fininal watchatch party. Synanics Fest is the world's number one sports fan festival. G your tickets Betxpest d. com. That's betxpest. com onn the roller coaster The cars have just gone up the hill at the beginning of the roller coaster.. It's to the very, very top. And do you know what we're gonna talk about now, Bond spreads. Okay Let's do bond spreads. If you have two different bonds, they may pay different interest rates. If you have a very safe bond, like US government bond, it may pay four percent. If you have a risky bond, it may pay eighteen percent to compensate for the risk. eighteen percent is crazy. I know. So theread risky bond. The spread is the gap between them So in this case, fourteen percent, eighteen minus four The key thing to know is the magnitude of the spread is a measure of fear, really, right? The wider the spread, the more worried investors are. When they're really confident about the economy, the spread will be narrower because they think everyone's going to pay out the bonds. The risk bond isn't that risky. but if the economic conditions start to get worse, you start to worry about your high risk bonds, your demand a higher interest rate and the gap idens widens and people flee to the safe bond, which makes that interest rate even lower yes So it's the beginning of nineteen ninety eight. In a lot of parts of the world Bond spreads are wider than usual.'re not insanely wide. It's not like financial crisis wide, but there They're wide You know, there are reasons for this. In nineteen ninety seven, there was the Asian financial crisis that flowed through Thailand, Indonesia, South Korea. So investors are still worried about this, and this is reflected in wide bond spreads And the partners at long term capital, and more importantly, their financial models thought Global bond investors were too worried They thought bond prices would converge spreads would fall, things would go back to historic norms. And if you zoom out to that broader historic arc we were talking about earlier, this makes sense. you know Hall of the Soviet Union, triumph of the free market. progress of rational economic actors, all of this points in the direction of a smoother, less volatile calmer market and lower bond spreads. And the economy in the US is doing tremendously well. We have the internet finally, there's all these dot com stocks. It looks like a new age in economics. Around the time we balanced the budgets,'s running a circuswhere around here So Long term capital puts on bets all over the world, that volatility will go down, that spreads will converge in Europe and in Latin America. And they're also putting on bets in Russia in the new the lest frontier. And the Russian economy was kind of a mess by this point, People were starting to worry that Russia might default on its debts There was this thing people said at the time, which was, no nuclear power has ever defaulted. meaning no big, serious country has ever defaulted. which kind of nuclear power is kind of weird, it was a thing people said. And you know, the International Monetary Fund, the IMF had been really active in countries around the world helping them stave off defaults. And so the tradors at long term capapital look at Russia and they think, no, these fears are you know one more example of irrational fears They figure Russia is going to pay its debts, spreads will converge. And also they do hedge some of their bets for additional safety do love though that they're kind of optimist. I know it's the data and it's backed by the computers. But what they are saying is that the world is going to be a calmer, better place. It's kind of a beautiful thought I wouldn't borrow a bunch of money and put billions of dollars on it, but yes, yes. I mean, in a certain way, not exactly, but kind of like You and I both just do the boring retirement thing of just buy index funds mostly of stocks. And that's a version of that, right? We're just going ride a growing economy because that's what has happened. But we don'torrow bunch money to do it. We don't Long term capital is betting that around the world, spreads are going to converge This is not what happens in the spring and early summer of nineteen ninety eight spreads start to get a little bit wider. In June of nineteen ninety eight longong term capital loses ten percent Biggest ever one month loss, not disastrous bigig in July, their returns stabilize. And then comes August. August seventeenth The thing happened. That was not supposed to happen Russia Russia said, we are not going to pay some of our debts And also the Russian banks where long term capital had put their hedges Like we're not going to pay those foreign investors. We're not going to pay out those on those contracts Who would have thought you can't trust the Russians? Kind of surprisingly, it actually takes a few days for it to hit global markets. Robert Smith, I have Pasted here a paragraph from a nineteen ninety eight Wall Street journal story for you to read. It was august twenty first, a sultry Friday, and nearly half the partners at Long Term Capital Management LP were out of the office outside the fund's glass and granite headquarters, a fountain languidly streamed over a copper osprey, clawing its prey I said this I said this to, you and I have like a running thing about newspaper stories with like gratuitous descriptions of place. Number one, it means that the reporter did not get inside the building. So the reporter's describing whatever they can, but number two, it means settle in for a long story of hubris Yes. I mean, if you are a financial firm and the Wall Street Journal is describing the fountain outside your office You are in terrible trouble. somethinghing very wrong has happened In this case, what has happened on this sultry August day is that investors all around the world, all around the world are terrified by what has happened in Russia, and they are reacting by selling risky bonds and buying safe bonds, but not just in Russia. They're afraid of risky bonds around the world. Any country that could conceivably be related to Russia in some way, they're like, we gott to get out of there. We gott to get out of there. And you will recall, yes, that when this happens, it makes bond spreads get wider And this is the opposite of the bet that long term capital has made all around the world and they're widening in a more correlated way than long term capital's models would have predicted, right? Like sure, okay, maybe they'll widen in Russia, but they hadn't guessed that they would widen everywhere all at the same time in this way, is why they spread their bets around the world because you're thinking, okay, one country, this could go wrong, two countries, it could go wrong. But other countries halfway around the world would not react the same way. wouldn't be rational. And so because the world is reacting in this way, because these things are happening, long term capital getting destroyed. Their models had predicted that the most they could lose in a single day was thirty five million dollars. On that sultry Friday, they lost More than five hundred million dollars. Time to reboot the computer. Something's wrong here. Unplug it, unplug it. Turn it off turn those machines back on. So it's late August in Connecticut Of course all the rich guys, the partners are off on vacation and the Traders at the office are picking up the phones and calling them because that's what you had to do in the nineties. O their giant cell phones. Yeah. They get Merrywather at a dinner in Beijing S other guy was in Sun Valley, Idaho, another one was in Italy. They were they were on top By Sunday morning, two days later, they are all back in the office in Connecticut trying to figure out what to do. And they think Okay This is going to fix itself. L there's no fundamental reason why spreads are doing what they're doing. It's not like there's a war and economies have you know been blown up and destroyed. Things are going to go back to normal. and when that happens, we'll make more money All we need is some cash, some capital to ride this out. becausecause remember when you've borrowed a lot of money against a little capital, people are going to start asking for the money back, you're going to need some money essentially in the bank to ride out the storm. But if you have a pile of money that you can pay that back, that's fine. You can keep going and keep going and eventually make Untold billions. Yeah. You can make your money back in more This is their plan. And around this time, Merryweather calls this old Wall Street friend of his for advice, maybe some contacts for raising money The guy's name is Vinny Matone Vinny is the old school style trader. you know, the cheheeseburger for breakfast kind of guy. And and Loewenstein in when Genius Hiled has a beautiful description of this scene of of Vinny coming to talk to Merrywetather going to be good Vinny wore a gold chain and a pinky ring and he showed up at long term in a black silk shirt Op at the chest. Where are you? Matone asked bluntly. We're down by half, Merryweather said You're finished, Matone replied For the first time, Merryweather sounded worried. What are you talking about? We still have two billion dollars. We have half. tonone smiled sadly When you're down by half, people figure you can go down all the way They're going to push the market against you You're finished I like to think of Vinnie Matone as this Street smart Yoda telling Merryweather that the force is not with him. It's beautiful because Long term capital management was depending on computers and logic and this optimistic view of the world And Vinny The street smart guy is like what you didn't factor in is the fact that this is a competitive game And much like the Ospry in the fountain outside of your office, other investment firms are going to grab you out of the water and consume you. And so it's just such a beautiful moment that Vinnie knows the way the world really works outside computers. Merryweather isn't ready to give up though. On september second, he sends this letter to Long term Capital's investors tells them that the fund was down forty four percent in August. One month month. It's a very bad month. But he says, you know, spreads are going to close again Our strategies are sound. This is in fact a good time to invest. And he makes this move in this letter that at a certain level, I am just in awe of. I can't believe he did it. It's fantastic. So Robert here, re read this paragraph from the letter Since it is prudent to raise additional capital, the fund is offering you the opportunity to invest in the fund on special terms. If you have an interest in investing, please contact Richard Leahy at Long term Capital Management two hundred three five five two five five one one for further information. Pull now. All right. operators are standing by. Where's my phone? Where's my phone Actually have you called this phone? put it on speaker. Okay, well One, two, o three Oh say I'm trying to reach. I want to invest. What are you going to say if they answer The number you dialed is not in service Boiler alert Robert, the investors did not call now. And in fact, the letter leaked to the press before even all the investors had got the letter. Some of them found out about it by reading about it in the news. And now In case they hadn't before, everybody knew that long term capital management was screwed. knew, like Vinny said They were going to be screwed And they called it the LTCM death trade where everybody is getting out ahead, right? Be think about it. Th are thinly traded markets. Long term capital has huge positions you know they're going to have to sell. So even just to protect yourself Like if you own anything that they own, you want to sell before they sell because they're going to drive the price down Everybody is selling the stuff that they own. So the prices are falling, right? So this, in addition to the market behavior, is compounding long term capital's troubles On a single day, september twenty first They lose Again, more than five hundred million, like that bad day in August, five hundred fifty three million dollars more. And they still have all this leverage. In fact, in a way, your leverage ratio goes up the more you lose, right? because they still owe all this money, their capital base is shrinking. And now the lenders are afraid that long term capital is not going to be able to pay them back. So they start saying, no, you have to give us our money back, or we're not going to roll over these short term loans that we've been rolling over. And if you're not rolling over the loans, you have to sell even more. and the more you sell, the more loans you have to pay off. And so that's the death spiral. That's the death spiral. And then there's if we widen the circle, there is now a bigger concern because long term capital is so big and so intertwined with all these other Wall Street firms, there is a bigger fear, which is If they blow up and can't pay back their debts all of these other banks that they owe money to might not be able to pay their debts And then we'll have a financial crisis. We'll have all of these firms linked to each other going down and potentially hurting the whole economy bringing down the whole economy And this is super important because this is how crises happen Nobody really cares about Nobel Prize winners losing all their money. No they should be able to likeike that's we want firms to fail that. And even the banks that lent the money, they took a risk and they might lose money on this deal But the situation is you don't know the full list of everyone who lent money to long term capital And so when you're out in Wall Street and you want to make a deal, you have to ask yourself constantly, wait a minute. is the person I'm about to make a deal with? Are they exposed to this?. Are they exposed to someone who's exposed to this? It can slow down all investment at once because you just don't know where the risk is. This is the problem. Yes. This is why in the eighteen hundreds, there were panics every few years because this would happen again and again. stop it from happening or at least reduce the risk of it happening. America created a central bank, the Federal Reserve And as long term capital is about to blow up in September, the Federal Reserve does its job. They say, oh wait We better sure this doesn't cause a financial crisis. Yes You know, there is a branch of the Fed in New York that Dals with Wall Street. A guy we used to work with said the New York Fed is actually more baller than the main Fed headquarters in Washington, the Bard of governors. And they have a special conference room there. just for moments of crisis. And they invite everyone into this conference room. Yes. It's Wednesday, september twenty third. they use the special crisis conference room which is not a special crisis conference room. And they call all the heads of the big Wall Street banks to a meeting And the Fed says to all these bankers, look You're all doing business with long term capital. You're all screwed if they go under Figure something out. We have f, we're not to put money in. We're not going to bail you out You're all in this together, work together to figure it out Kumbaya, just together. a bunch of Wall Street bankers love to hold hands and help each other out. Hyper competitive. they want to stab each other in the back. This is their normal day. And now the Fed and this does happen occasionally. the Fed is saying, hey, for the good of everyone, can we set aside our immense greed and hatred of each other on this day. and just be a little more long term greedy, right? Like it is in your greedy interest for this not to blow up. And so the bankers sit in this room and over the next several hours, they actually come up with a plan. They're going to put in three point six five billion dollars into the fund of their own money, of the bank's money