Pointing the Finger at Quants

By Inya Ivkovic, MA — The Financial World According to Inya column

Remember the movie “Wall Street” from 1987, starring Charlie Sheen and Michael Douglas? The movie was about a young and hungry-for-success stockbroker who, infatuated by his hero, Gordon Gekko, an obscenely wealthy and even more obscenely unscrupulous corporate raider, starts believing that “greed is [really] good” and fraud is just cost of doing business.
There is one quote I like in particular, spoken by the Gekko character, which, although a bit long, kind of prophetically explains how on earth things could have gone so terribly wrong not so many months ago. Gekko was giving his young protégé a prep talk, when he said:”The richest one percent of this country owns half our country’s wealth, five trillion dollars. One third of that comes from hard work, two thirds come from inheritance, interest on interest accumulating to widows and idiot sons and what I do, stock and real estate
speculation. It’s bulls**t. You got ninety percent of American public out there with little or no net worth. I create nothing. I own. We make the rules, pal. The news, war, peace, famine, upheaval, the price per paper clip. We pick that rabbit out of the hat while everybody sits out there wondering how the hell we did it. Now you’re not naive to think we’re living in a democracy, are you buddy? It’s the free market. And you’re a part of it. You’ve got that killer instinct. Stick around pal, I’ve still got a lot to teach you.”A bit creepy, isn’t it, for Hollywood to get it right over 20 years ago?

These days, we have our own Gordon Gekkos. The only problem is that they are not fictional characters. And they are nothing like Gordy. “Wall Street 2: Money Never Sleeps” is coming out this month and I’d be curious to see who Hollywood picks now for the villains. But, judging from the trailer, I don’t think it would be the eccentric quant physicists or math geniuses who put their knowledge of advanced geometry and computer programming to work exploiting tiny, almost imperceptible by traditional means market inefficiencies, resulting in billions of dollars in profits and creating a bona fide monopoly over global trading in nearly all asset classes; from commodities, to currencies, to mortgages, to complex derivatives.

Granted, not all “quants” are created equal, or equally bad, but the quants that I’m talking about nearly took over the world. Those quants retired traditional risk management, rendering it obsolete. They enchanted big investment banks into giving them free rein to
float complex products that no one but them understood. They mastered the art of attracting pensions and endowments into their schemes. And still no one knew what they did and no one bothered to ask.

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In the meantime, quants spread their “goodies” around, such as the infamous synthetic collateralized debt obligations (CDOs), which spread high and low through global financial systems like a bad rash, elevating the devil’s disciples to new positions of power, from New
York, to London, to Milan, to Athens, to Reykjavik.

And then things got progressively worse. Gekko’s “greed is good” mantra kicked in, soon followed by an overdose of fear. Quants’ love of computer models and their worship of the efficient market theory simply could not deal with the virus called the human condition.
Almost overnight, their computers crashed and nearly took the global economy along with them. Billions of dollars literally evaporated within days. Many financial institutions teetered at the edge of the abyss and some tipped over into oblivion. But, when one of the largest and among the most infested with quants had crashed, Lehman Brothers, quant hell froze over, freezing the global financial and credit systems in the process.

The fingers blaming quants for the inflation of the global asset bubble, its subsequent bursting and the ensuing meltdown are pointing in the right direction. If Wall Street were ever to be honest, quants had a hand in other financial messes, such as the 1987 crash
and the 1998 collapse of the infamous hedge fund called “Long-Term Capital Management.” Yet, regardless of how many fingers point towards quants, oh no, they are not ones to accept any blame.

Rather annoyingly, quants like to portray themselves as victims. Their reasoning is that the mess the global economy found itself in is the fault of governments and reckless risk-takers. It is not their fault that investors hoarded products they didn’t understand. It is not their fault that models cannot compute greed and fear. It is not their fault that they were the ones to figure out how certain parts of the market worked, while others did not.

To an extent, quants are right. There were many players willing to be caught in the whirlwind for as long as profits were churning out, too. However, no matter how much quants may flash plausible deniability, it was quants who provided the fuel and matches to light
the greatest fire in a generation.

All this finger pointing has another message to convey. Quants may have been chastened by humbling realizations that they are prone to the same mistakes that only mere mortals make. However, they are not the kind of guys to be told to withdraw from the playing field.
Although a number of quants have returned to the relative obscurity of academia or the anonymity of retirement, the majority seem to be addicted to the game. As long as access to credit remains more or less frozen, they will lay low. But you’ll see; the minute leverage
comes back, so will the quants. After all, Wall Street and Prisoner’s Games are much more appealing intellectually than building space shuttles or working out math proofs.