Some mistakes seem reserved for fools, which is what makes this one so unsettling. Twice in a generation, the most credentialed minds in finance, a circle that included Nobel laureates, watched fortunes dissolve in days, and both times the same quiet culprit stood behind the wreckage. It arrives dressed as opportunity. Finding out what it is, and why intelligence cannot stop it, means going back to a summer when a distant default shook the cleverest hedge fund in the world.
The Cautionary Tale of Long-Term Capital Management (LTCM)
In 1998, the board of Long-Term Capital Management (LTCM) included Myron Scholes and Robert Merton, who shared the 1997 Nobel Prize in Economics. When Russia defaulted on its debt in August 1998, the highly leveraged fund lost $4.6 billion in less than four months, and 14 banks put up $3.6 billion to rescue it. Warren Buffett, who once said that if he ever wrote a book it would be called Why Smart People Do Dumb Things, reduced the collapse to a single verdict: “To make money they didn’t have and didn’t need, they risked what they did have and did need. That is foolish. That is just plain foolish.”
What’s Leverage, and Why Is It So Dangerous?
The word that explains that verdict is leverage. It means borrowing to control more than the capital owned, so that $1,000 of collateral can buy $10,000 of securities. Buffett has relayed his partner Charlie Munger’s warning that only three things break a smart person: liquor, ladies, and leverage, with the first two added because they start with L
Buffett’s Million-Chamber Revolver Analogy
Surely clever people understand the odds? Buffett answers with a thought experiment. Handed a gun with a million chambers and a single bullet, he would not spin the cylinder and pull the trigger for any amount of money. No reward justifies even that one chamber. Leverage asks its borrowers to pull the trigger again and again.
The Math of Leverage: Why It’s a Recipe for Disaster
The chamber is not as remote as it sounds. At 50:1 leverage, a 2% adverse move can wipe out all equity or margin. Such moves are common: from 1928 through 2025, the S&P 500 fell 20% or more in 6 calendar years and 10% to 20% in another 14.
Modern-Day Examples of Leverage Gone Wrong
Twenty-three years after LTCM, the chamber came up loaded again. Archegos Capital, a family office run by Bill Hwang, used borrowed money to build concentrated positions in a handful of stocks. When they fell in March 2021, more than $20 billion of Hwang’s wealth disappeared in roughly two days. The lenders paid as well: Credit Suisse lost approximately $5.5 billion and Nomura approximately $2.9 billion.
The Psychological Toll of Leverage
Behind those figures sat a cost no spreadsheet captures. Buffett has described the downside of leverage, especially with other people’s money, as disgrace, humiliation, and facing the friends whose money was lost. For Hwang, the aftermath ended in an 18-year prison sentence.
The Takeaway: Stick to What Can Be Afforded
Both collapses lead to the same simple rule: invest only what can be afforded to lose. Berkshire Hathaway, now led by CEO Greg Abel, is worth $1.16 trillion and still held $365.5 billion in cash and Treasury bills at the end of June. Buffett’s principle explains the restraint: risking something important for something unimportant makes no sense. Compounding is slower than a borrowed sprint, but it never passes through LTCM’s summer or Archegos’s March.