octubre 16, 2004

How Meriwether started his team

As I explained about Meriwether in a previous post, the founder of Long Term Capital Management started most of his team at Salomon Brothers.

Meriwether had become a partner at Salomon by being a savvy trader, particularly in one instance. A different firm had taken a position that was nearly certain to pay off in the long run, but was declining and thus threatening the firm's leverage. Meriwether saw that the trade had to pay off in the long run and convinced the Salomon bosses to make the trade, for tens of millions at a time when total firm capital was only $200 million.

As Keynes said, "in the long run, we're all dead." And in fact, the trade continued to lose money for the next few weeks. The Salomon partners watched the downward progress of the trade. Meriwether insisted that they would eventually make money. The managing partner replied, "We better, or you'll be fired."

The trade eventually won money, and Meriwether became partner the next year.

Meriwether understood -- or so Lowenstein imputes to him -- that the heart of trading is gambling. It's simply finding bets where you have a positive expectation, and then rolling the dice. Successful gamblers look for bets where they have an edge, and then they exploit them as much as possible.

Meriwether's genius is that his edge was hiring the best. At a time when he was at the top of his field, he decided to recruit people even better than him. He hired academics who studied the subjects, but who no firm had ever thought to hire. He assembled a team that were the best. Two of his team -- Merton and Scholes -- eventually won a Nobel Prize for economics for the Black-Scholes theorem (which they had invented pre-Meriwether's recruitment of academics).

Meriwether liked to say that he never hired anyone who wasn't smarter than he was. Per Lowenstein:
One time, a trader named Andy who was losing money on a mortgage trade asked for permission to double up, and [Meriwether] gave it rather offhandedly. "Don't you want to know more about this trade?" Andy asked. Meriwether's trusting reply deeply affected the trader. J.M. said, "My trade was when I hired you."

Meriwether saw that trading at the time was dominated by intuition. As most gamblers -- and casinos! -- will tell you, intution can sometimes be very costly. Meriwether helped end the days of the intuitive bond traders. His vision helped turn trading into a model-based, rigorous analytical field.