Financial books rarely generate much of an advance buzz, but When Genius Failed: The Rise and Fall of Long-Term Capital Management, published this month by Random House, appears to be doing just that.

Roger Lowenstein, a former Wall Street Journal reporter and the author of a best-selling biography of Warren Buffett, has written the definitive book on the scandal. Well-thumbed photocopies of the galleys have been circulating for months in many of the Wall Street firms involved in the bailout.

The book's eminent publication also seems to have inspired John Meriwether to emerge from his Connecticut bunker, granting his first post-meltdown interview to the Wall Street Journal on August 21. "One can speculate that LTCM's sudden urge to go to the mountain of confession was motivated by the fact that their mistakes were going to be laid out in public anyway,” says Lowenstein.

Meriwether, who claims to have lost more than 90 percent of the $150 million in his personal piggy bank, has formed JWM Partners, a new hedge fund that is trying to raise $1 billion. So far, however, he has reportedly attracted only $375 million. In the Journal interview, Meriwether claims that at LTCM he didn't realize others were making similar investments and thus didn't see a liquidity crisis brewing. "We believed that diversity meant safety—it worked in 1994 and 1987, but it failed us,” he explains. "We didn't fully understand that a variety of people had become more involved in these types of activities, and more important, their behavior in a time of panic. It led to a complete breakdown of the fundamental thesis of how we evaluated risk.”

Blaming liquidity for LTCM's problems troubles Lowenstein. "Anyone who ever lost money always blames liquidity,” he says. "On the day you try to sell, there's never enough liquidity at the price you bought. Otherwise you wouldn't have a loss. And blaming it all on liquidity also makes it seem ephemeral. None of those spreads have come all the way back, and most of them are significantly wider than when they were put on. If something goes on for more than two years, there's something more than liquidity involved. The world's perception of risk in 1998 was simply too rosy.”

Lowenstein is also bothered by Meriwether's claims about diversification. "In virtually every trade, they were betting that risk premiums would decrease,” he says. "When people fled from risk, they didn't care which market they were in. Diversification didn't protect them, because they weren't really diversified.”

In researching the book, Lowenstein secured the cooperation of individuals employed by virtually all the major players in the bailout. Sources at Goldman Sachs, Merrill Lynch, JP Morgan, Bear Stearns and even The Federal Reserve Bank in New York were forthcoming. He also had sources at LTCM, and managed to get two on-the-record interviews with LTCM partner Eric Rosenfeld before the firm decided to stop formally cooperating. "I continued to harass him with e-mails and questions, and he generally continued to answer many of them on a sporadic basis,” says Lowenstein. "But J.M. never answered my calls.”

The book makes a number of public-policy points. Lowenstein, for instance, doesn't think derivatives disclosure is sufficient. "Disclosure doesn't serve the purpose it's intended to serve,” he argues. "If you look at the financial statements of the derivatives dealers, you get a pretty good sense of their debt, but if you look at their exposures in derivatives market, you wouldn't have a clue.” He also thinks lending limits on institutions accepting federally insured deposits should be supplemented with limits on derivatives exposure.

At the moment, however, Lowenstein is quite happy with Meriwether's recent apologia, given that he's about to set out on a multi-city book tour that includes appearances on television and radio. "Any publicity about an author's subject is good news,” he says.

By now, everybody knows that Richard Cheney owns some restricted options on his former employer Halliburton's stock. The potential conflict of interest this represents for a potential Vice President of the United States, and how to hedge away that conflict of interest, has been covered in some depth by the Wall Street Journal and the New York Times. It was also the central point of discussion of every Sunday morning news show on the weekend of August 27.

The timing of this discussion could not be more relevant to "Cashing Out” (see Page 16), our cover story. The immediate question to ask, though, is, Does anyone in the financial press really understand the true hedging and tax issues?

In the August 23 Journal article, reporter Jeff D. Opdyke proposes that a properly structured synthetic short might do the trick. He suggests Cheney buy put options and sell call options to create a synthetic short-against-the-box, although it's unclear what strikes he has in mind. He notes, correctly, that having strikes too close together might trigger a tax liability issue because strikes on a synthetic short sale or structured collar set too close together can be deemed a "constructive sale.” Keeping those strikes at least 15-20 points apart, however, would probably not cause a taxable event.

What the reporter completely misses, however, is that Cheney does not own a future long position, but a Halliburton call option position. A long call hedged with a synthetic short sale (no matter how constructed) inevitably creates a third factor in the equation: a synthetic put. By entering into such a hedge, Cheney could actually benefit if the stock of Halliburton fell below his long call strike.

The usually astute Floyd Norris of the New York Times, meanwhile, got all hung up on August 26 talking about the tax implications of doing a forward sale of stock to hedge an option position. Norris spends multiple paragraphs explaining how this might result in ordinary gains vs. capital losses, or vice versa, in various different stock-price environments.

However, a simple swap transaction, as opposed to forward sale, would get around this entire problem since swaps held to maturity are always taxable as ordinary income. Like Opdyke, Norris also fails to understand that a long option hedged by a future sale or swap still creates a synthetic put position.

Norris, moreover, discusses the entire cash values of the options as if they had no time value and misses a very important point: If Cheney were actually to sell these call options in the open market now, he could benefit from the time value they implicitly contain. This, in fact, might more than offset any tax liability created. For example, Norris gives only a $13.50 value to a December 2002 option struck at $39.50, when a fair market bid for such an option is currently closer to $24.25. Similarly, Norris gives a zero value to Cheney's December 2000 $54.50 strike, while in actuality the option is currently worth approximately $5.38 on the American Stock Exchange.

Cheney's problem boils down to this: The easiest way to offset the risk of a long call on a stock risk is simply to sell another call. If he did so now, on either an over-the-counter or exchange-traded basis, Cheney might actually capture more money for his options than he would by allowing their implied time value to dwindle to zero. There's no real need for a collar or synthetic short sale at all.

"By simply selling a call to a third-party bank, Cheney would take his effective position to zero,” says financial structuring expert Robert Gordon, president of Twenty-First Securities. "Conservatively, he would likely have to consider this as a constructive sale and pay tax between his basis price for these options—zero—and his received premium. But that might be financially better for him than watching their time decay slowly diminish.” If Cheney did a collar around the position, he might be able to avoid a taxable event until exercise—if the options strikes were spread far enough apart—but then he'd still have an exposure up and down to the respective strike levels until that time.

Gordon thinks simple is better: just sell the calls into the market. Yes, a taxable event would transpire, but not without capturing the added time value of each option. Presuming the oil market tops out soon, Cheney might actually end up doing better selling his calls now as opposed to having stayed at Halliburton any longer.

The only small problem involves collateral. Gordon admits Cheney might need to work out a deal with Halliburton to allow him to pledge his long restricted options as collateral against his short call position sold to a Wall Street investment bank. Halliburton would have to promise any investment bank that it recognizes the pledge against these options, although technically the actual options may not be immediately pledgeable or transferable. Alternatively, if the Halliburton-issued stock options were not deemed good collateral, Cheney would simply have to leave enough other collateral with an investment bank to guarantee his short call positions. Cheney certainly has enough assets that this shouldn't be a big headache: a bunch of T-Bills sitting in an account somewhere would do.

• Myron Scholes, winner of the 1997 Nobel prize for economics and a professor of finance, emeritus, at the Stanford University School of Business, has been appointed to the Chicago Mercantile Exchange's board of directors for a two-year term.
• Barclays Capital has named Steffan Dahmer, formerly head of credit trading at DG Bank, director and head of European Pfandbriefe trading. The bank has also named Thorsten Polleit, formerly chief economist in AMB Amro's German division, a director in charge of German economics and strategy and head of the Pfandbriefe research group.
• David Platter has joined Bear Stearns & Co. as a senior managing director and head of the financial institutions group. He had been a managing director in the financial institutions group at Donaldson, Lufkin & Jenrette.
• Axiom Software Laboratories has appointed Toru Tanaka, former head of risk management at Fuji Bank, head of its new Tokyo office.
• David Pavlini, former senior vice president at Exco, has been named vice president and head of the G-7 currency options desk at Prebon Yamane.
• TheBEAST.com has hired Sharon Premoli as executive vice president of strategic business development. She had been a consultant for Instinet Corp. in London and New York.
• Dan Lintz has joined Henwood Energy Services as managing director of business information and e-business. He had been director of e-commerce consulting at MIS 2000.
• TradingLinx.com has named Stephen Ficara, a former vice president in global capital market operations at Deutsche Bank, a vice president and head of its operations team. The firm also named Joel Gallo, a former vice president of investment administration and technology, a director.
• Michael Radin, formerly a senior vice president at SunGard Treasury Systems, has joined TreasuryConnect as senior vice president for business development.
• Algorithmics has named Paul Smetanin, former global head of market risk management at ANZ Bank, senior director in charge of product marketing.

I read "Get Ready for Single-Stock Futures” (July 2000) with much interest. I just wanted to add a few comments.

Single-stock futures are unlikely to attract the kind of institutional interest suggested by some of those who commented in the article. Stock options are a good place to look for information on how stock futures might do. Stock options are primarily a retail instrument. Institutional investors primarily use stock-index options (and stock-index futures). This is because they think more broadly in terms of portfolios than individual stocks. Also, they are benchmarked to indices so they do most of their hedging and asset allocation at the index level. I know this because a few years ago I did a consulting project that required that I interview a number of professionals on this subject and virtually to a person, they gave me that response. So it is unlikely that institutions will use single-stock futures much.

One exception, however, is hedge funds. They do speculate on individual company performance and I was quite surprised they weren't mentioned in the article.

But in the end, it will be individuals who use them, probably the same kinds of individuals for whom Internet day trading isn't exciting enough. That could spell danger and surely will not increase liquidity. Of course, hedge funds will help in that regard.

I'm not in favor of prohibiting these instruments, but we should not naively expect that the big institutions will embrace them. While I hope they do, I have my doubts.