On Quant Funds and the Financial Market Meltdown (II)

This is a continuation of my critique of the article "For Wall Street's Math Brains, Miscalculations. Complex Formulas Used by 'Quant' Funds Didn't Add Up in Market Downturn," by Frank Ahrens in the August 21, 2007 Washington Post. I also discuss events that have occurred since then during the financial and credit meltdown of the past year.

Ahrens quotes Nassim Nicholas Taleb, whom he refers to as a "former quant-jock and best selling contrarian author," as saying 'Most ['quant-jocks'] are idiot savants brought to industrial proportion. They are very smart in front of a textbook but not smart enough to understand very elementary things in reality."

Ahrens states: "The sentiment [of people like Taleb] is reminiscent of the demise of Enron, a company said to have been designed by geniuses but run by idiots. The oil-and-gas trader used next-generation financial tools designed by brilliant mathematicians. But they couldn't overcome the inept and criminal actions of the management."

My response: How can one compare quant funds with Enron? For sure, the quant fund field was crowded and things were overleveraged, but there is a big difference between being overly clever and greedy and with outright criminality. Most investors in hedge funds are high rollers who can take the hit, a lot like Ken Lay (the Chairman of Enron, who eventually was indicted, convicted, and shortly thereafter died), and not at all like most of his employees who got the shaft. And I don't think "brilliant mathematicians" had anything to do with the accounting shenanigans at Enron. Ahrens and Taleb try to show how clever they are by setting up a straw "mathematics man" which they then proceed to attack.

The latest exodus of CEO's from firms like Citigroup and Merrill-Lynch shows that even very talented and experienced people can sometimes get things terribly wrong, but let's not blame this on mathematicians or mathematical models

When the subprime mortgage meltdown occurred last year, I for one wondered who was going to be left "holding the bag". I had no way of finding this out, but
people to whom it mattered should have rushed to find out. As it happened, the hedge funds and venture capitalists took the first direct hit, but then the moves they took in response had the secondary effect of magnifying all the resultant chaos and turbulence in the financial and capital markets during the past year. The most recent casualty being Bear Stearns, which nearly went bankrupt before being "rescued" by JPMorgan Chase*.

The situation is somewhat analogous to Hurricane Katrina and its aftermath. Katrina did not score a direct hit on New Orleans, but it caused the massive flooding which was responsible for most of the resulting devastation.

What really rankles me is that our capitalist system is so predatory and that oftentimes many in the financial world believe that, as Oliver Stone's fictional character, Gordon Gekko, famously said, "greed is good". Just as New Orleans has shored up its levees, we should be shoring up our safety nets and protection for consumers. I hope that the low-income people of our country are not, like much of New Orleans, permanently below sea level.

*Now it appears that Bear Stearns' demise may have been "murder", rather than "death by natural causes," according to an article in the August issue of "Vanity Fair."