P(x) = 1/1,000,000,000,000,000,000,000,000

In the first months of 1998, markets were smooth. ... The mood at Long-Term was relaxed, too. Though the fund's leverage was up, and though the partners had taken out huge personal loans, their exposure seemed tolerable. ... According to their models, the maximum that they were likely to lose on any single trading day was $45 million—certainly tolerable for a firm with a hundred times as much in capital. According to these same models, the odds against the firm's suffering a sustained run of bad luck—say, losing 40 percent of its capital in a single month—were unthinkably high. (So far, in their worst month, they had lost a mere 2.9 percent.) Indeed, the figures implied that it would take a so-called ten-sigma event—that is, a statistical freak occuring one in every ten to the twenty-fourth power times—for the firm to lose all of its capital within one year.¹

Let's see if I have this right. Long-Term Capital Management failed in 1998 due to a combination of the following reasons:

1) A coincidence of unusual and unforeseen exogenous events, capped by Russia's default, which led to severe and ongoing market disruptions and a convergence in correlations (and covariances) of returns across different markets and different risk classes

2) Personal greed on the part of the fund's principals

3) Credulous and scale-independent application of supposedly sophisticated value-at-risk models

4) Massive up-risking of LTCM's portfolio into non-core trade positions when returns in its core business diminished due to increased competition

5) Excessive leverage, both on-balance sheet and off, facilitated by short-sighted, uninformed, and greedy prime brokers

6) De facto coordinated attacks by other market participants (including its prime brokers) when LTCM got into distress

7) Institutionalized arrogance and hubris

LTCM did not blow up because its principals were stupid or inexperienced, in a conventional sense (pace Nassim Taleb). Say what you will, you cannot accuse people like Meriwether, Hilibrand, Scholes, Rosenfeld, and Merton of being stupid or inexperienced. It also did not blow up because they had bad ideas, per se. Leveraged arbitrage—which, cutting through the crap, is what LTCM did, at least until it got greedy (or desperate)—is a time-tested trading strategy.

It failed due to the human element: vanity, hubris, greed. Oh, plus an unlooked-for exogenous event or two.

Nowadays, with orders of magnitude greater capital invested with hedge funds committed to chasing down ever more fleeting market opportunities, it strikes me that the pressure on hedge funds to deliver returns is no less than it was for LTCM in 1998. Plus, the last time I looked, no-one had repealed human nature, or its foibles. Finally, the nature of unlooked-for exogenous shocks is such that—*ahem*—they are unlooked-for.

So explain to me, all of you strident hedge fund apologists, why "It's different this time."

Go ahead: I'm listening.

¹ R. Lowenstein, "When Genius Failed: The Rise and Fall of Long-Term Capital Management," Random House, 2001, pp. 126–127.
© 2007 The Epicurean Dealmaker. All rights reserved.

Call for Entries

TED has reached a milestone, of sorts, with the publication yesterday of our fiftieth¹ post on this site. In celebration, we will shortly inaugurate a new topic category tentatively titled "classics" or "the canon" or somesuch other modest sobriquet befitting the weight and importance of our most significant writings. We intend to leaf back fondly through our output and anoint those pieces particularly worthy of permanent preservation² with said modest sobriquet, the better to allow the forgetful, the uninitiated, and the just plain unwashed among you to find our most earth-shattering work.

We, of course, have our own candidates in mind for this honor. But, in a gesture of remarkable yet characteristic noblesse oblige magnanimity³, we have elected to solicit opinions from you, our Dear Readers, as to which entries you think best deserve canonization. (I know, I know, you don't deserve me.)

Therefore, take pen, pencil, or keyboard in hand, and write to me posthaste at epicureandealmaker [at] hushmail [dot] com with your suggestions. The person who provides the most interesting list (i.e., the one closest to my own) will win a prize of staggering generosity of a yet-to-be-determined nature. Runners-up will receive a handsomely framed specimen of bupkus.

All entries, bribes, and other monetary "gifts" submitted will become the sole property of The Epicurean Dealmaker, to do with as I see fit. Particularly egregious examples of mendacity, stupidity, or cupidity will be forwarded to Equity Private at Going Private, who has been strictly charged to shame and excoriate you in public in the most humiliating and sardonic way possible. (You have been warned.)

Every effort will be made by this establishment to return the electrons, photons, and neutrinos comprising contest entries to their natural habitat after the competition. No assurances can be given, however, as to the treatment of any Higgs Bosons we might or might not find in our inbox.

The entry deadline is Monday, May 21, 2007 at 1700 hours, New York time, unless all six of you are out of town, in which case we will close the contest when we damn well see fit.

Get cracking!

¹ Clever readers will note that fifty posts have not yet been published here. (I have been holding some particularly devastating ones in reserve.) Extra credit and a personally autographed centerpiece from Steve Schwarzman's sixtieth birthday celebration to the first reader who writes in with the correct number that have appeared on this site.
² "But wait!," you exclaim, "Surely all of your precious pieces are worthy of elevation to the literary and philosophical Pantheon, are they not?" Yes, yes, child, of course. But we needs must make some distinction amongst our beautiful children, no?
³ [Edit as of 1950 hours, 9 May 2007:] Sorry. While my Noblesse is certainly frequently obliged among you little people, I knew there was a better word for what I was aiming at when I wrote this piece. Who knew it was a solid, five syllable word of impeccable Anglo-Saxon pedigree? I think Hemingway called these "ten centers."
© 2007 The Epicurean Dealmaker. All rights reserved.

A Tedious Argument of Insidious Intent

My Devoted Readers may have trouble believing this, but it can get a little lonely here on occasion in the volcano lair. This blogsite as yet does not attract the sort of voluminous and incisive correspondence that certain reclusive, sardonic, and reputedly attractive private equity memoirists receive. (I am not surprised: who would not rather suck up to a potential fee-paying client—no matter how sardonic—than a logorrheic investment banker?)

Every now and then, however, the little red flag on TED's virtual mailbox pops up, and we get to indulge in a little epistolary back-and-forth with one of you. Today, for instance, a kind reader wrote to reassure me that, pace my recent worrying in these pages, (s)he has no trouble understanding my writings. However, citing what (s)he obviously considered a particularly egregious example of what I might characterize as literary overreach, (s)he remarked:

Strunk & White (probably too provincial for your Cosmopolitan grammatical palate) advise writing in nouns and verbs, not adjectives and adverbs. Otherwise "turgid and elephantine" prose results. It would be dishonest of me to say that phrase has never crossed my mind whilst reading your posts.

("Strunk & White," for those of you in the audience who are numerate yet illiterate, was not a predecessor firm to legendary white shoe investment bank White Weld, later subsumed into Merrill Lynch. It rather refers to that wonderful guide to writing in the English language, The Elements of Style, by William B. Strunk Jr., with revisions, an introduction, and a chapter on writing by E.B. White. Highly recommended for all current and aspiring belle-lettrists.¹)

I can certainly appreciate why some might agree with my nameless correspondent's characterization of my outpourings as "turgid and elephantine." I, however, prefer to view them as "turbid and orotund."

In any event, I cannot fault my correspondent's taste in style manuals. In fact, after I concluded our exchange, I took down my dogeared and dusty copy of S&W to leaf through its pages of wisdom yet again. Of course, the book naturally fell open to what is perhaps S&W's most famous dictum, Principle 17 of the Principles of Composition:

"Omit needless words."

For the nonce, I have decided to take that advice.

Okay.
















¹ Whatever you do, however, do not buy the awful 2005 edition of S&W with the hideous pink cover and the insipid illustrations by Maira Kalman. Illustrated Strunk & White? The mind reels.
© 2007 The Epicurean Dealmaker. All rights reserved.

All Rights Reserved

If—and the thing is wildly possible—the charge of writing nonsense were ever brought against the author of this brief but instructive poem, it would be based, I feel convinced, on the line (in p. 18)

"Then the bowsprit got mixed with the rudder sometimes."

In view of this painful possibility, I will not (as I might) appeal indignantly to my other writings as a proof that I am incapable of such a deed: I will not (as I might) point to the strong moral purpose of this poem itself, to the arithmetical principles so cautiously inculcated in it, or to its noble teachings in Natural History—I will take the more prosaic course of simply explaining how it happened.¹

Selective market research by Yours Truly among my cherished readership has led me to the unfortunate conclusion that—on any given day—no more than two of you can figure out what the hell I am talking about in these posts.

I have developed a number of hypotheses for why this might be the case, which I am happy to share with you while I continue to formulate a fully fashioned theory to explain the data:

1) On any given day, no more than two of you are Not Complete Idiots

2) The University of Central Iowa was fresh out of CliffsNotes^® ("rip it™ and cram it: Fuel your brain with rip it™. Learn fast with CliffsNotes™") when you took the introductory lit course "Classic Novels by Dead White Males" freshman year

3) You have not seen a dictionary since your grandmother gave you a Websters Condensed edition in fourth grade, and you are not sure you would know how to use it if you stumbled across one

4) MSN Explorer cannot properly display words containing more than two syllables or ten letters

5) My writing is too obscure

Naturally, I included that last one only in the interest of theoretical completeness, and I am inclined to discard it out of hand as being nonsensical. Something tells me, however, that there may be a germ of truth in it, no matter how painful that fact may be to me.

Unfortunately, even if I wanted to there is no way I could dumb down my writing style to a level appropriate for regular watchers of American Idol—

"Fish gotta swim, birds gotta fly,
I gotta love one man 'til I die"

—but I can perhaps assist my readers in their enjoyment of my Terpsichorean prose with a little more background. In that spirit, I have offered below some glossarial guidance on the blog topics regularly addressed in these pages. To the extent new topics are added in the future, this list will grow as well. Please, use this list responsibly.

TOPICS ADDRESSED IN THESE PAGES

ad hominem — Scurrilous slander, vile calumny, and cheap shots levelled at those among the Great and Good deserving of such treatment (i.e., most of them). A perennial favorite of our readers, and one guaranteed to continue ad infinitum, given the reliably ludicrous and pathetic behavior of said G&G.

bon mots — Memorable quotes and other tidbits authored by persons not formally employed by TED or its Cayman Islands affiliates.

Folly — A catch all topic, which should be self-explanatory to anyone with more than a third grade reading level.

fourth estate — Affectionate gibes and tender pokes at the follies, pretensions, and general misdeeds of our fellow bloggers and friends among the financial press and mainstream media. Always good for a cheap laugh.

ghost in the machine — Discursions on financial bubbles, the madness of crowds, animal spirits, and other evidence that the relationship of rationality to human behavior in the business and financial spheres is tenuous, contingent, and highly suspect.

gray flannel suits — Dispatches from the bowels of Corporate America, in all its craven, sclerotic, and bombastic glory. Proven to be an effective antidote to overdoses of Fortune, BusinessWeek, and other corporate panegyrics.

over there — Our intrepid reporters scour the globe for proof that countries other than the United States are also blighted with stupid, deceitful, and foolish morons cluttering the business, financial, and economic landscape. We have warehouses full of supporting evidence, which only await translation for publication.

philosophy — The occasional descent into mawkish self-regard, gratuitous pontificating, and specious sophistry you would normally expect from a website named after a long-dead Greek philosopher.

private equity — What, have you been asleep? Fail to renew your subscription to all newspapers and magazines other than Hello!? I fear this topic will continue to balloon in number of posts contributed as long as the current (May 2007) boom in PE fundraising and investment continues. After the bubble bursts, this topic should fade into justified obscurity on the dusty back shelf of the archives room, where it belongs (and where many of its practitioners would prefer it had remained).

selling short — Shits and giggles about hedge funds and their peccadilloes, large and small. Most of these guys have more money than Henry Kravis and less time to have gotten used to it. A promising topic, from which we at TED expect a lot in the future. Timmberrr!

The Life — Inside dirt on investment banking and other such whores financial service providers. Sort of like The Godfather, but with classier cufflinks.

¹ Lewis Carroll, "The Hunting of the Snark: An Agony in Eight Fits," Chatto & Windus Ltd., 1981, p. v.

© 2007 The Epicurean Dealmaker. All rights reserved.

You Know Much That Is Hidden, O Tim

Deal Journal at WSJ.com interrupted UBS investment banking satrap Huw Jenkins at his Supervisory Board-mandated yodeling and alpenhorn practice earlier today to discuss the Swiss chocolate maker watch manufacturer universal bank's credit policies, which have been faulted for the inability of the firm to punch as many leveraged buyout tickets as its competitors in the current deal frenzy.

The interview was apparently kept short, but a smiling Jenkins did drop a minor bombshell of sorts:

The company already has taken steps to make improvements amid widespread griping within its banker ranks, by hiring McKinsey & Co. around the end of last year. That sped up the lending process by giving more decision-making power to people within the investment bank and increasing their client-funding capacity, some inside the firm say.

McKinsey? Fuck me. That's a sorry-assed commentary on UBS's internal management capabilities when they have to ask a bunch of pencil-pushing Powerpoint witch doctors from McKinsey to tell them how to run an integrated banking and lending practice. That's what universal banks do.

No word yet as to whether McKinsey will give the UBS Credit Committee seminars on how to go to the bathroom without pissing on their shoes.

I know what Long or Short Capital would recommend: Short UBS in size. More aggressive traders can leverage their short with barrier put options on Lindt chocolate and cuckoo clocks.

© 2007 The Epicurean Dealmaker. All rights reserved.