any way we can save J.M.?” Meriwether, of course, was the firm’s top moneymaker and known as impeccably ethical. His traders heatedly defended him, pointing out that J.M. had immediately reported the matter to his superior. But pressure mounted on all involved in the scandal. McIntosh, the partner who had first brought Meriwether into Salomon, trekked up to J.M.’s forty-second-floor office and told him that he should quit for the good of the firm. And almost before the Arbitrage Group could fathom it, their chief had resigned. It was so unexpected, Meriwether felt it was surreal; moreover, he suffered for being front-page news. “I’m a fairly shy, introspective person,” he later noted to Business Week.15 The full truth was more bitter: J.M. was being pushed aside—even implicitly blamed—despite, in his opinion, having done no wrong. This painful dollop of limelight made him even more secretive, to Long-Term Capital’s later regret. Meanwhile, within the Arbitrage Group, resurrecting J.M. became a crusade. Hilibrand and Rosenfeld kept J.M.’s office intact, with his golf club, desk, and computer, as if he were merely on an extended holiday. Deryck Maughan, the new CEO, astutely surmised that as long as this shrine to J.M. remained, J.M. was alive as his potential rival. Sure enough, a year later, when Meriwether resolved his legal issues stemming from the Mozer affair, Hilibrand and Rosenfeld, now the heads of Arbitrage and the government desk, respectively, lobbied for J.M.’s return as co-CEO.*
Maughan, a bureaucrat, was too smart to go for this and tried to refashion Salomon into a global, full-service bank, with Arbitrage as a mere department. Hilibrand, who was dead opposed to this course, increasingly asserted himself in J.M.’s absence. He wanted Salomon to fire its investment bankers and retrench around Arbitrage. Meanwhile, he made a near-catastrophic bet in mortgages and fell behind by $400 million. Most traders in that situation would have called it a day, but Hilibrand was just warming up; he coolly proposed that Salomon double its commitment! Because Hilibrand believed in his trade so devoutly, he could take pain as no other trader could. He said that the market was like a Slinky out of shape—eventually it would spring back. It was said that only once had he ever suffered a permanent loss, a testament to the fact that he was not a gambler. But his supreme conviction in his own Tightness cried out for some restraining influence, lest it develop a reckless edge.
Doubling up was too much, but management let Hilibrand keep the trade he had. Eventually, it was profitable, but it reminded Salomon’s managers that while Hilibrand was critiquing various departments as being so much extra baggage, Arbitrage felt free to call on Salomon’s capital whenever it was down. The executives could never agree on just how much capital Arbitrage was tying up or how much risk its trades entailed, matters on which the dogmatic Hilibrand lectured them for hours. In short, how much—if, sometime, the Slinky did not bounce back—could Arbitrage potentially lose? Neither Buffett nor Munger ever felt quite comfortable with the mathematical tenor of Hilibrand’s replies.16 Buffett agreed to take J.M. back—but not, as Hilibrand wanted, to trust him with the entire firm.
Of course, there was no way Meriwether would settle for such a qualified homecoming. The Mozer scandal had ended any hope that J.M. would take his place at the top of Salomon, but it had sown the seeds of a greater drama. Now forty-five, with hair that dipped in a wavy, boyish arc toward impenetrable eyes, J.M. broke off talks with Salomon. He laid plans for a new and independent arbitrage fund, perhaps a hedge fund, and he proceeded to raid the Arbitrage Group that he had, so lovingly, assembled.
* In practical terms, those who go short sell a security they have borrowed. They must return the security later—by which time, they believe, the price will have declined. The principle of buying cheap and selling dear still holds. Short sellers merely reverse the order: sell dear, then buy cheap.
* The Securities and Exchange Commission filed a civil complaint charging that Meriwether had failed to properly supervise Mozer. Without admitting or denying guilt, Meriwether settled the case, agreeing to a three-month suspension from the securities industry and a $50,000 fine.
I love a hedge, sir. —HENRY FIELDING, 1736
Prophesy as much as you like, but always hedge. –OLIVER WENDELL HOLMES, 1861
BY THE EARLY 1990s, as Meriwether began to resuscitate his career, investing had entered a golden age. More Americans owned investments than ever before, and stock prices were rising to astonishing heights. Time and again, the market indexes soared past once unthinkable barriers. Time and again, new records were set and old standards eclipsed. Investors were giddy, but they were far from complacent. It was a golden age, but also a nervous one. Americans filled their empty moments by gazing anxiously at luminescent monitors that registered the market’s latest move. Stock screens were everywhere—in gyms, at airports, in singles bars. Pundits repeatedly prophesied a correction or a crash; though always wrong, they were hard to ignore. Investors were greedy but wary, too. People who had gotten rich beyond their wildest dreams wanted a place to reinvest, but one that would not unduly suffer if—or when—the stock market finally crashed.
And there were plenty of rich people about. Thanks in large part to the stock market boom, no fewer than 6 million people around the world counted themselves as dollar millionaires, with a total of $17 trillion in assets.1 For these lucky 6 million, at least, investing in hedge funds had a special allure.
As far as securities law is concerned, there is no such thing as a hedge fund. In practice, the term refers to a limited partnership, at least a small number of which have operated since the 1920s. Benjamin Graham, known as the father of value investing, ran what was perhaps the first. Unlike mutual funds, their more common cousins, these partnerships operate in Wall Street’s shadows; they are private and largely unregulated investment pools for the rich. They need not register with the Securities and Exchange Commission, though some must make limited filings to another Washington agency, the Commodity Futures Trading Commission. For the most part, they keep the contents of their portfolios hidden. They can borrow as much as they choose (or as much as their bankers will lend them—which often amounts to the same thing). And, unlike mutual funds, they can concentrate their portfolios with no thought to diversification. In fact, hedge funds are free to sample any or all of the more exotic species of investment flora, such as options, derivatives, short sales, extremely high leverage, and so forth.
In return for such freedom, hedge funds must limit access to a select few investors; indeed, they operate like private clubs. By law, funds can sign up no more than ninety-nine investors, people, or institutions each worth at least $1 million, or up to five hundred investors, assuming that each has a portfolio of at least $5 million. The implicit logic is that if a fund is open to only a small group of millionaires and institutions, agencies such as the SEC need not trouble to monitor it. Presumably, millionaires know what they are doing; if not, their losses are nobody’s business but their own.
Until recently, hedge fund managers were complete unknowns. But in the 1980s and ’90s, a few large operators gained notoriety, most notably the émigré currency speculator George Soros. In 1992, Soros’s Quantum Fund became celebrated for “breaking” the Bank of England and forcing it to devalue the pound (which he had relentlessly sold short), a coup that netted him a $1 billion profit. A few years later, Soros was blamed—perhaps unjustifiably—for forcing sharp devaluations in Southeast Asian currencies. Thanks to Soros and a few other high-profile managers, such as Julian Robertson and Michael Steinhardt, hedge fund operators acquired an image of daring buccaneers capable of roiling markets. Steinhardt
