Now that everyone is making gold with the stock market, cryptocurrencies or even NFTs, it is worth remembering financial operations that went really wrong, those capable of shaking the world economy.
Let’s take a look at three of the worst investments in history and see what lessons we can draw to avoid repeating the same mistakes.
The billion-dollar gamble
John Meriwether created his hedge fund, Long-Term Capital Management, staffing it with some of the brightest minds on Wall Street. The fund used complex equations, computer programs and pricing models to make the trades, as recorded in a Federal Reserve History retrospective, “Near Failure of Long-Term Capital Management.”
Going into 1998, LTCM believed it was going to be a slow and quiet year, so the fund placed large short volatility positions. Large, to the point of leveraging $4.8 billion in assets to effectively control $1 trillion in financial instruments.
However, in late August, Russia defaulted on its sovereign bonds, which sent financial markets reeling. Volatility soared and only a bailout by the Federal Reserve could prevent LTCM’s bad bets from wiping out the global financial system. In total they lost $4.6 billion.
Lesson: While the market may seem predictable there are always events that can throw the best of algorithms out of whack.
In December 1994, Nick Leeson was a little-known trader at Barings Bank, the oldest commercial bank in the UK, where even Queen Elizabeth II had an account. Within months, the bank was no more, having collapsed due to Leeson’s poor trading.
It all started in 1992, when a colleague supervised by Leeson bought 20 futures contracts when she should have sold them. That cost Barings about $40,000 – a paltry sum for a bank of its size – but Leeson discovered that, in his dual role as trader and head of trade settlement, he could hide the losses in an unused error account.
Soon, Leeson began funneling his own trading losses into that account. Over the course of the next three years, Leeson traded a lot-and badly-until he accumulated an incredible $1.3 billion in losses in the error account, according to an article in the London Telegraph. That amount was twice the amount of capital Barings had at its disposal. When auditors discovered the losses, the venerable bank was forced to close.
Lesson: Own up to mistakes as soon as possible and don’t obsess about recouping the losses on an investment.
The irresistible force
In 2006, Brian Hunter was a star trader at Amaranth Advisors, a hedge fund specializing in natural gas trading. Hunter’s analysis told him that prices would rise in the following winter, and he began buying natural gas futures heavily.
But in early September, gas prices broke price support and proceeded to fall another 20% over the next two weeks. By the end of the month, Hunter’s position was negative $3 billion.
Hunter redoubled the bet, but the winter continued to be mild and prices fell further, ultimately creating margin calls that the company could not meet. In the end, the fund lost more than $6.6 billion of investors’ money, and its assets were liquidated.
Lesson: No matter how big you are and how much money you have, the market is even bigger. The trend is always your friend.