Before he died, Albert Einstein requested that his whole body be cremated as soon as possible after death, and his ashes scattered in an undisclosed location. He didn’t want his mortal remains to be turned into a shrine, but his request was only partially heeded. Einstein’s closest friend, the economist Otto Nathan, disposed of his ashes according to his wishes, but not before Thomas Harvey, the pathologist who performed the autopsy, removed his brain. Family and friends were aghast, but Harvey convinced Einstein’s son Hans Albert to give his reluctant permission after the fact. The eccentric doctor kept the brain in a glass jar of formalin inside a cider box under a cooler, until 1998, when he returned it to Princeton Hospital, and from time to time, he would send little chunks of it to interested scientists.
Most of us will never be victims of brain-theft, but Einstein’s status as the archetypical genius of modern times singled him out for special treatment. An ordinary person can live and die privately, but a genius – and his grey matter – belongs to the world. Even in his lifetime, which coincided with the first great flowering of mass media, Einstein was a celebrity, as famous for his wit and white shock of hair as he was for his science. Indeed, his life seems to have been timed perfectly to take advantage of the proliferations of newspapers and radio shows, whose reports often framed Einstein’s theories as being incomprehensible to anyone but the genius himself.
There’s no doubt that Einstein’s contributions to science were revolutionary. Before he came along, cosmology was a part of philosophy but, thanks to him, it’s become a branch of science, tasked with no less than a mathematical history and evolution of the Universe. Einstein’s work also led to the discovery of exotic physical phenomena such as black holes, gravitational waves, quantum entanglement, the Big Bang, and the Higgs boson. But despite this formidable scientific legacy, Einstein’s fame owes something more to our culture’s obsession with celebrity. In many ways, Einstein was well-suited for celebrity. Apart from his distinctive coif, he had a way with words and, as a result, he is frequently quoted, occasionally with bon mots he didn’t actually say. More than anything, Einstein possessed the distinctive mystique of genius, a sense that he was larger than life, or different from the rest of us in some fundamental way, which is why so many people were desperate to get hold of his brain.
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Many people have wondered whether genius is a physical attribute, a special feature that could be isolated in the brain, and Einstein’s grey matter is considered a fertile experimental ground for testing this claim. Unfortunately, as the psychologist Terence Hines has argued, the published studies that were carried out on Einstein’s brain are flawed in important ways. In each case, researchers compared parts of Einstein’s brain to people assumed to be ‘normal’, but in most of these studies the scientists knew which brain sample was Einstein’s. They set about looking for differences – any differences – between Einstein and the control brains and, when you approach science in this way, it’s very easy to find differences.
After all, there was only one Einstein, just as there’s only one ‘you’ and only one ‘me’. The only way to be sure that Einstein’s brilliance was due to his anatomy would be to analyse his brain alongside many other people like him, in contrast to people unlike him. Otherwise, it’s impossible to tell the difference between the unique physiological characteristics of his genius and random variation between individuals. But that doesn’t mean we can’t investigate his genius. For while we might not have good studies of his brain, we do have the story of his life, and the contents of his mind, in the form of his research.
Einstein is often remembered as a harmless, other-worldly figure, detached from mundane problems. Certainly he had his eccentricities: he wore sweatshirts that grew rattier over the years, because wool sweaters made him itch. He didn’t like socks, and sometimes wore women’s shoes on vacation. But the conventional narrative of Einstein as tweedy eccentric ignores his radical politics and occasionally troubled personal life. After all, Einstein was a socialist and advocate for one-world government and, until Hitler rose to power, championed demilitarisation and pacifism. He was also passionately anti-racist, hosting the African-American contralto Marian Anderson at his house when Princeton hotels refused to serve her in 1937, and after.
if we expect a genius to be somehow fundamentally different from the rest of humanity, studying Einstein’s life and opinions will disappoint
But Einstein was no saint. He cheated on his first wife Mileva Marić with his cousin Elsa Einstein, whom he later married and cheated on in turn. He was known to write sexist doggerel in letters to his friends, and he had difficult relationships with his children – though he could be extremely kind to other people’s children, and even helped youngsters in his neighbourhood with their homework.
In other words, Einstein was – like all of us – a bundle of contradictions, someone who behaved well sometimes and badly at others. As a world-famous scientist, he had a louder amplifier than an ordinary person, but if we expect a genius to be somehow fundamentally different from the rest of humanity, studying Einstein’s life and opinions will disappoint.
Which leaves us with what established Einstein’s reputation: his science. Like Isaac Newton before him, Einstein sometimes had trouble recognising the implications of his ideas, to the point where it’s likely that he would have trouble recognising the way general relativity is researched and taught today. In 1939, he published a paper intending to show that black holes didn’t and couldn’t exist. The term ‘black hole’ wasn’t around back then, but several physicists proposed that gravity might cause objects to collapse on themselves. Einstein’s usually excellent intuition failed him in this case. His calculations were technically correct, but he hated the idea of black holes so much that he failed to see that, with enough density, gravity overwhelms all other forces, making collapse inevitable.
To be fair to Einstein, general relativity was still an esoteric theory in 1939. Very few researchers used it, and the observational methods required to show that black holes exist – radio and X-ray astronomy – were in their infancy. But black holes weren’t Einstein’s only weakness as a scientist. He was also justifiably modest about his mathematical ability. He relied on others, including his first wife Mileva and his good friend, the physicist Michele Besso, to help him work out thorny problems. Today they would receive co-author credits on Einstein’s papers, but that wasn’t the practice at the time.
Thanks to the diversity of human experience and human talents, we know that genius isn’t a monolithic quality that appears in identical form everywhere we find it.
And as is always the case with scientific geniuses, Einstein’s theories would exist even if he had not. Special relativity, general relativity, and the photon model of light might not have been developed by the same individual, but someone would have sussed them out. Henri Poincaré, Hendrik Lorentz and others worked out much of relativity before 1905, just as Gottfried Leibniz independently worked out the calculus in parallel with Newton, and Alfred Russel Wallace developed natural selection in isolation from Charles Darwin. Historians of science once subscribed to a ‘Great Man’ theory, but we now know that transformative ideas emerge from the work of many talented individuals, instead of emerging ex nihilo from one brilliant mind.
Nor was Einstein the only physicist to make brilliant discoveries in the early 20th century. Marie Curie, Niels Bohr, Erwin Schrödinger and Werner Heisenberg all accomplished the same, and so did many others. Were they lesser geniuses than Einstein? Curie won two Nobel Prizes and contributed directly to research that led to several others, yet she isn’t considered the archetype of genius – despite having crazy hair to rival Einstein’s. But of course there are two unfortunate biases against Curie: her gender and the fact that she was an experimentalist, not a theoretician.
This difference is instructive. Thanks to the diversity of human experience and human talents, we know that genius isn’t a monolithic quality that appears in identical form everywhere we find it. Einstein’s genius was different from Curie’s, and scientific genius is different from musical genius. Celebrity, on the other hand, tends to follow more predictable patterns. Once a person becomes famous, they tend to stay that way. Had he lived in another era, Einstein might have been a decent physicist, but he wouldn’t have been the Einstein we know. But because he lived in a special sliver of time, after the lights of fame had begun to shine bright, and before science came to be seen as a team sport, he has become our genius.
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is a science writer and speaker specialising in physics, astronomy, and the culture of science. His writing has appeared in a wide variety of publications. He lives in Cleveland, Ohio.
When Genius Failed: The Rise and Fall of Long-Term Capital Management
Ron J. Feldman | Assistant Vice President
Published December 1, 2000 | December 2000 issue
By Roger Lowenstein
The book suggests that the lenders were clueless as to the nature of the LTCM's assets and strategies and equally ignorant as to LTCM's total indebtedness. Rather, the banks relied on the brand name that LTCM had established through its roster of partners.
Skip the movies and computer games, the story of Long-Term Capital Management (LTCM) is a fable.
My version of the story, based on Roger Lowenstein's When Genius Failed: The Rise and Fall of Long-Term Capital Management, would read as follows: Sorcerers (Mathematically oriented bond traders led by John Meriwether) make the humans they serve rich (the investment banking firm Salomon Brothers). After this accomplishment, they find themselves fired and underappreciated (following a scandal involving a Meriwether employee). The magicians create a new organization (LTCM in 1993) with more powerful magic (quantitative models to discover and exploit price discrepancies in financial markets). Using their powers and the skills of their wizard high priests (Nobel Laureates Robert Merton and Myron Scholes), the geniuses build an even greater machine and accumulate a bigger pile of gold ($1 invested in LTCM in 1994 was worth $4 in 1998).
As they lord over mere mortals (the investment banks that provide LTCM with day-to-day funding), the magicians gain even more confidence that their guiding principles (financial markets are efficient) and methods (quantitative models) are infallible. But the incantations that worked at first ultimately fail when subjected to the foibles of the human world (LTCM almost goes insolvent in 1998 after Russia defaults; the firm lost about $3.6 billion in five weeks and suffered losses over $500 million on a single day). The arrogant sorcerers take financial hits and lose some of their luster (one LTCM partner saw his net worth drop from $500 million to -$24 million). The humans who had contact with the magicians get burned (the investment banks end up bailing out LTCM by buying the firm for $3.5 billion). Finally, the gods who intervened during the crisis (the Federal Reserve Bank of New York) faced skepticism from previously fawning acolytes.
Good story, bad moral
LTCM is a great story/fable populated with memorable characters. Lowenstein does a nice job in pacing the story and I recommend reading the book for these reasons alone. There is a certain pleasure reading about the demise of the haughty and rich (or least people characterized that way). The book fails, however, in communicating a convincing moral. Lowenstein views the LTCM failure as a warning about applying high-tech, financial models and theories of efficient capital markets to financial markets that "are not always reasonable." There is also a general suspicion about the stability and effectiveness of financial markets that lurks throughout the book.
I did not buy it. Lowenstein seems to have fallen into the trap of confusing the failure of a firm with the failure of markets. As others have also noted, the decline of LTCM appears with 20-20 hindsight to be based on large, but surprisingly run-of-the-mill judgments, bets and strategic decisions that went wrong. Nothing in the book convinced me that the general methods (for example, using models) that informed those judgments, bets and decisions were systematically flawed. In fact, the one potential systemic failure that the book hints at relates to ill-conceived government policy.
Some lessons (re)learned
Here are the "lessons" I took from Lowenstein's story.
Absent effective barriers, above-normal profits in an industry will attract entrants and imitation, which drives down returns. LTCM's initial returns were astounding. When the average bond investor lost money in 1994, LTCM generated returns of 20 percent, after subtracting out extremely high fees. In 1995, the return after fees was 43 percent; returns were 59 percent before fees. I had assumed that entry of firms into LTCM's markets and imitation by existing competitors would be limited, given popular accounts of LTCM's hard-to-replicate genius and ultra-secretive culture.
However, Lowenstein provides numerous examples suggesting that LTCM's strategies, models and even specific trades were either commonplace pre-LTCM or were quickly copied after their success. This did not bode well for LTCM as it meant competition, from new entry and imitation, would seriously erode profits. As one LTCM partner puts it in the book, "Everyone was catching up to us. ...We'd put on a trade, but when we started to nibble, the opportunity would vanish." Of course, if LTCM's techniques were not so special, one wonders how they were able to generate such large returns in the first place. At least one answer appears to be quite basic: lots of leverage.
Returns and losses are magnified by leverage. Consider the home buyer who has enough idle funds to pay cash for her $150,000 house. The next year she puts the house on the market and discovers it has appreciated $5,000. She has generated a return of 3.3 percent (5,000/150,000). Her brother bought a similarly valued house that had similar appreciation. But, he could only put $10,000 toward the purchase and had to borrow the rest. The return on his investment? A whopping 50 percent (5,000/10,000). The difference in this case was leverage. Borrowing allows the brother to put up little of his own money, or equity, thereby magnifying the gains on the asset when it grows in value. Of course, if the value of the house had fallen by $10,000, the brother would have been wiped out completely, while his sister would have lost only 7 percent. In this case, the brother had a leverage ratio (equity to assets) of 1 to 15.
Long-Term Capital's leverage was closer to 1 to 30 as early as 1995. A partner at LTCM described their technique as scooping up loose nickels created when prices in financial markets got slightly out of balance. However, it was only through leverage that such small bets created huge returns. And, as the house example demonstrates, such leverage left the firm extremely but knowingly vulnerable to an unfavorable shift in prices.
Brand names as substitutes for research. In addition to leverage, Lowenstein points to low financing costs as another source of supernormal profits for LTCM. Specifically, investment and commercial banks thought they would profit by providing short-term funding to LTCM at very favorable rates and terms. The banks, for example, lent money to LTCM without requiring much collateral, effectively driving down costs for LTCM and putting the lenders at greater risk of loss. Why would the banks make such loans? Little risk taking by LTCM is not the answer. Indeed, the book suggests that the lenders were clueless as to the nature of LTCM's assets and strategies and equally ignorant as to LTCM's total indebtedness. Rather, the banks relied on the brand name that LTCM had established through its roster of partners.
The group included economists who had pioneered financial tools that all the banks used, a former central banker with first-hand knowledge of monetary policy formulation and foreign governments, and a team of traders who had made significant profits for one of the banks. Just as consumers might look to a brand name for a sense of quality rather than investigating a product thoroughly, the banks considered the externally observable quality of LTCM's staff as a substitute for gaining inside information on firm operations. This proved to be a very poor decision and explains how LTCM was able to grow quickly and profitably. But, miscalculated decisions are just that and not evidence of failing markets. Indeed, I could probably tell an equal number of stories where relying on a brand name (for example,Warren Buffett) would seem like the stroke of genius.
Losing focus from your competitive advantage can be costly. LTCM compounded its problems by shifting away from areas where it benefited from comparative advantage. In response to the rising competition, partners in the firm moved from bond markets where many had spent their entire careers and had developed significant expertise, to stock markets where they had much less experience. For example, the firm made sizable bets on the completion of certain mergers, even though these markets did not lend themselves to LTCM's analysis or skills. Ultimately, the shifts into equities did not go well for LTCM and contributed to its failure.
A calculated bet not market failure
In this context, the fable of LTCM is not a condemnation of new financial technology or of financial markets as a whole. Rather, we have a firm with access to easy money, facing increasing competition over time, shifting to markets it does not know well and relying on a strategy that leaves the firm extremely vulnerable to adverse price moves. Wrapped up in such a neat package, it would be surprising if LTCM did not fail! In his descriptions of these events, Lowenstein provides enough evidence to weaken his claim that LTCM was a firm where model devotion ran amok. From Lowenstein's descriptions it sounds as if the LTCM partners knew where their models were vulnerable.
They understood that future experience may not reflect the past. They understood that losses that occur infrequently could be larger than standard modeling assumptions project. They knew they were buying illiquid assets that would lose substantial value when sold quickly. Indeed, it would be amazing and unbelievable if the folks at LTCM were unaware of such concerns. By 1995, articles describing the deficiencies in the modeling approach used by LTCM to estimate exposure had even reached my humble cube (see, for example, Paul Kupiec, "Techniques for Verifying the Accuracy of Risk Measurement Models," Board of Governors of the Federal Reserve System, Financial and Economics Discussion Series Working Paper 95-24, May 1995).
In fact, Lowenstein describes LTCM as a firm whose comparative advantage was in "reading," not blindly following, the output of their models. In that vein, he also mentions detailed debates on specific trades and strategies that occurred over many weeks. Ultimately, it appears as if LTCM thought their predictions of future prices, warts and all, were better than alternative forecasts. As one LTCM partner summarized the firm's strategy, "What we did is rely on experience. ... If you're not willing to draw any conclusions from experience, you might as well sit on your hands and do nothing." While LTCM might have been better off "doing nothing," their failure seems to be a calculated risk that financial markets should encourage rather than an indictment of such risk taking.
Future policy lessons?
Lowenstein's story gives the Fed a small operational role in the resolution of the LTCM crisis, relegating the New York Fed to an administrative role (for example, sponsoring meetings of those owed money by LTCM). The Fed did nothing to directly bail out LTCM, according to the author. But, the Fed, putting a very high value on limiting market turbulence, did lend its prestige to the effort to resolve the crisis. Lowenstein argues that absent the Fed's coordination effort, those that funded LTCM and the partners themselves would have come out worse. Unlike the banking crises of the 1980s and 1990s, where regulators allowed insured institutions to double up their losses after they became insolvent, the markets were proving themselves unrelenting in trying to shut down LTCM. Lowenstein correctly notes that by halting that process and encouraging protection, the Fed's behavior could have long-term costs.
By sparing creditors, equity holders and managers some of the pain of loss, we are more likely to see a repeat of the behavior that produced the LTCM crisis in the first place. Indeed, the expectation of future bailouts could have played a subtle role in the growth of LTCM in the first place. Did the favorable financing of LTCM go beyond reliance on the LTCM brand name and reflect the brand name and potential support of the U.S. government? Will LTCM's resolution make the too-big-to-fail problem even worse? Perhaps with time we will have a clearer sense if the benefits of the Fed's role in the LTCM resolution outweigh potential costs. For now, enjoy Lowenstein's fable but come up with your own more satisfying moral.