Acad. Quest. (2010) 23:506–514 DOI 10.1007/s12129-010-9189-4 REVIEW ESSAY The Quants: How a New Milken, Warren Buffett.1 In the Breed of Math Whizzes “quant” revolution on Wall Street Conquered Wall Street and that took place over the past twenty Nearly Destroyed It, by Scott years, in which mathematical and Patterson. New York: Crown scientific experts created new high-tech Publishing, 2010, 352 pp., investment strategies, we put the $27.00 hardbound. two together. Everyone from Barney Frank to Ben Bernanke to Fannie My Life as a Quant: Mae to the heads of the Harvard and Reflections on Physics and Yale endowment funds to the chief Finance, by Emanuel Derman. executives of the world’slargest Hoboken, NJ: John Wiley & banks and investment banking Sons, 2007, 292, pp., $16.95 houses—even average investors in paperback. many cases—fell under the spell of the quants. The Crash of the Quants It turns out that Roger Lowenstein’s very fine When Genius Failed was Wight Martindale, Jr. wildly mistaken2—so-called “genius” Published online: 27 October 2010 did not fail, it returned with a # Springer Science+Business Media, LLC 2010 vengeance to create even greater havoc. These two books, The Quants: Americans have long been mesmerized How a New Breed of Math Whizzes by scientific genius. Think Thomas Conquered Wall Street and Nearly Edison and Albert Einstein. We are Destroyed It, by Scott Patterson, and equally fascinated by financial My Life as a Quant: Reflections on wizards: J. P. Morgan, Michael Physics and Finance, by Emanuel Derman, provide contrasting insights Wight Martindale, Jr., is an adjunct professor in both the business school and the college of arts and sciences at Lehigh University, Bethlehem, PA 18015; 1 ’ [email protected]. He began working as a business Randall E. Stross s The Wizard of Menlo Park: journalist, served as finance editor of Business Week, How Thomas Alva Edison Invented the Modern and spent twenty years on Wall Street, largely as a World (New York: Three Rivers, 2007) is a senior vice president in the bond department at popular biography. Dozens of books, many with Lehman Brothers. He left Wall Street to earn a equally grand titles, have been written about the Ph.D. in English literature at New York University other men mentioned in this paragraph, and more and he has taught core humanities courses at Temple no doubt will be written in the future. and Villanova Universities. He is the author of Inside 2Roger Lowenstein, When Genius Failed: The the Cage: A Season at West 4th Street’s Legendary Rise and Fall of Long-Term Capital Management Tournament (Simon and Schuster, 2005). (New York: Random House, 2000). The Crash of the Quants 507 into the financial crisis of 2007–2008 Smart kids spot this nonsense and give us an opportunity to consider immediately. Run the best, the what part education, or the lack of it, brightest, and the most ambitious played in forming the mindset of its students through this transparently enablers. silly process, and you get unrepentant Patterson’s intriguing book arrogance and the 2007–2008 introduces us to the handful of financial crash, the biggest since the mathematical whiz kids who managed stock market collapse of 1929. to legitimize the 30- and 40-to-1 The financial crisis of the past debt-to-asset investing ratios that were few years was fueled by too much eventually taken on by Fannie Mae, borrowing, and the boldest and the subprime mortgage originators, and most confident borrowers—which some commercial banks and brokers. includes the hedge funds but These men are game-players—but also the off-balance sheet financing game-players with an edge. Their of special purpose investment edge is intellectual; they learned vehicles—could only operate by how to beat the dealer when they invoking the authority of the were quite young—while still in super-quants. It could be argued high school. that they provided the intellectual Their college experience did authority—“peer review approval” nothing to change this. Why? in academic circles—for reckless Because college, too, can be a lending that ensued everywhere. game, not about wisdom or attaining Without the intellectual bravado, wisdom, but a game for grades, for or what might better be called certification, and for social climbing. insensibility to risk, that these Far too often humanities and hedge fund traders flaunted, undergraduate business students are normally financially conservative taught how to play the game by institutions such as Deutsche Bank teachers who manage their own and the Harvard Management careers through bogus peer review Company Endowment would not publishing no one reads, political have been handing over their advocacy masked as “learning how money without understanding the to think independently,” utterly risks they were taking. trivial classroom discussions, and All of the trading wizards in The by coddling their impressionable Quants are also enthusiastic gamblers young students with inflated grades and all of them have impressive and easy assignments. academic pedigrees. For example: 508 Martindale Edward Thorpe (b. 1932), Princeton- father worked the graveyard shift at Newport Partners, author of Beat the San Pedro shipyards while his the Dealer: A Winning Strategy mother worked the swing shift at for the Game of Twenty-One Douglas Aircraft. He was alone for (1962), the godfather of quants; many hours and Patterson writes that BS in physics, Ph.D. in “he had the freedom to let his mathematics, UCLA; imagination roam wild. Blowing things up was one diversion. He Jim Simons (b.1938), founder of tinkered with small homemade Renaissance Technologies; BA in explosive devices in a laboratory in mathematics, MIT, Ph.D. in his garage.” mathematics, University of Cliff Asness grew up in fashionable California, Berkeley; Roslyn Heights on Long Island. Patterson writes of his high school Peter Muller (b. 1963), Morgan days: “In school Asness received good Stanley private hedge fund, pianist grades, but his interest in Wall Street and songwriter; BA in mathematics, didn’t extend beyond the dark towers Princeton; of Gotham in the pages of Batman. Obsessed with little other than girls Cliff Asness (b. 1966), Goldman and comic books, Asness was listless Sachs Global Alpha fund; BS in as a teenager, without direction and economics and electrical engineering, somewhat overweight. At times he University of Pennsylvania, Ph.D. in showed signs of a violent temper that finance, University of Chicago; would erupt years later when he sat at the helm of his own hedge fund.” Ken Griffin (b. 1970), Citadel Ken Griffin spent his youth in Investment Group; BA in economics, Boca Raton, Florida, where he took Harvard; an early interest in computer programming. “His mother would Boaz Weinstein (b. 1974), Deutsche ferry him to the local Computerland, Bank, chess life master at 16; BA in where he would spend hours chatting philosophy, University of Michigan. up the salespeople about new gizmos and software,” Patterson recounts. Most of these men grew up as if Considered a math whiz, Griffin they were intellectual latch-key kids started managing other people’s money with plenty of time on their hands. In while he was an undergraduate at Lomita, California, Ed Thorpe’s Harvard. The Crash of the Quants 509 Peter Muller grew up in Wayne, point of view, Patterson explains, New Jersey. He showed an early Simons realized that “the ability to aptitude for math and loved to play predict what will happen tomorrow, all kinds of games, from Scrabble or the next few hours, is far better to chess to backgammon. As a than the ability to predict what senior in high school he designed will happen a week or two down a computer program that could play the road.” Simons also pushed backgammon. beyond mere algorithms; he hired Boaz Weinstein was raised, as code-cracking cryptographers as well Patterson tells us, “in the privileged as speech recognition experts—this Manhattan neighborhood of the last group because speech recognition Upper East Side. He seemed to have programs try to guess what sound is money all around him.” In addition to coming next in order to keep up with playing chess he won a stock-picking the speaker. contest while a student at New York While all of these super-quants City’s elite Stuyvesant High School. were intensely secretive, the field soon became overpopulated. When Beating the House this happened, returns fell. For example, Ken Griffin’s Citadel Thereissomeparallelbetween Investment Group, which began in the quantitative trading these men late 1990, racked up returns in its perfected and card-counting at the first three years of 43 percent, 41 blackjack table: in both cases the percent, and 24 percent. But in 2002 bets increase when the odds improve. its flagship fund was up only 13 Quantitative trading required super-high percent, slipping below 10 percent speed computers that would not only for the next three years. As detect patterns before competitors performance slipped, managers could see them, but also execute could only boost returns by adding trades instantly. This last technical more leverage, that is, by borrowing achievement is often referred to as more money to finance their trading “high frequency trading,” and it positions. was pioneered by Jim Simons at The speculative crash of 2007– Renaissance Technologies. 2008 might have been anticipated Speed as a factor in getting into because quantitative trading and out of trades was important meltdowns occurred twice recently, because positions often were not and they both occurred for the same held for long. From a statistical reason. The first event was the 510 Martindale October 1987 equity market collapse, mortgages were extended to people when portfolio insurance, the new with very little equity who could not quant device of the time, accelerated really afford them.