Tuesday, May 18, 2010

Brilliant Quants Beside Us and Their Perfect Quarter

In a sense, brilliance is like a fast computer with lots of memory, it can be used to manage a ponzi scheme like Madoff's without detection, or to devise a new drug to cure cancer. Brilliance is like atomic energy, it can either power the city or destroy it.

How it is aimed matters.

Imagine reading the news to discover a close friend was, in fact, a master-thief, serial-killer, or driving intellect behind schemes that would bankrupt whole nations.

This gut wrenching experience has lately manifested in millions of investors and politicians as it did in crime writer, Ann Rule, author of The Stranger Beside Me.

Ms. Rule, at Seattle's Suicide Hot Line, worked with a man she described as brilliant and handsome. His name was Ted Bundy (yes, that one). Despite an early, avid interest in crime-fighting, which led her to undergraduate minors in criminology and psychology, Ms. Rule failed to see the budding serial-killer in her co-worker.

Her positive impression was so strong that, even after multiple arrests (and escapes), she couldn't quite believe the man she knew was a killer. She describes the moment of revelation in an interview:

"To be absolutely sure about his guilt," Rule remembers, "I needed to see direct physical evidence, and there it was [the bite marks and dental comparison], no question. It made me sick to my stomach. I went down to the hall to the ladies' room and threw up. Yet he still maintained this suave, friendly look. It was a bad day for me."

To this day, the experience haunts her and she feels fortunate that there had never been a romantic attachment between her and Bundy. "I felt dumb, I felt fooled, and I thought that my perception, which I'd always counted on, was flawed. Ever since then, I've felt I can't really know anybody." But she wasn't the only one. "We had very rigid screening at the Crisis Clinic where we had worked together, to be sure we were well adjusted and could help people who called in. Bundy fooled everybody."

Bundy fooled everybody. So did Bernie Madoff. So did many other fund managers, financial quants (experts in financial mathematics) and, I'm sure many will soon discover, so did the CEOs of major banks.

But how?

Each of these people was "brilliant" (in their way). They read people like a genius reads books, quickly, yet thoroughly- providing the appropriate responses to create their desired self-image in the minds of those testing them, at schools, jobs, and in social situations. They looked like the image they wanted to create and people judged the book by its cover.

Brilliant, intelligent, smart. These words will keep popping up.

To wit, in a Harvard thesis, Anna Katherine Barnett-Hart asks, How could so many brilliant financial minds have misjudged, or worse, simply ignored, the true risks associated with CDOs?

To wit, Michael Lewis, in The Big Short, leavening his prose with sarcasm observes: There was a sense that these were brilliant men, men of force, not cruel, not harsh, but men who acted rather than waited. There was no time to wait, history did not permit that luxury; if we waited it would all be past us…. Things were going to be done and it was going to be great fun; the challenge awaited and these men did not doubt their capacity to answer that challenge…. We seemed about to enter an Olympian age in this country, brains and intellect harnessed to great force, the better to define a common good.

To wit, in The Quants, Scott Peterson notes: On Wall Street, they [the young math whizzes] were all known as "quants," traders and financial engineers who used brain-twisting math and superpowered computers to pluck billions in fleeting dollars out of the market. Instead of looking at individual companies and their performance, management and competitors, they use math formulas to make bets on which stocks were going up or down. By the early 2000s, such tech-savvy investors had come to dominate Wall Street, helped by theoretical breakthroughs in the application of mathematics to financial markets, advances that had earned their discoverers several shelves of Nobel Prizes.

Perhaps brilliance isn't all its cracked up to be.

In a sense, brilliance is like a fast computer with lots of memory, it can be used to manage a ponzi scheme like Madoff's without detection, or to devise a new drug to cure cancer. Brilliance is like atomic energy, it can either power the city or destroy it.

How it is aimed matters.

And invariably, brilliance aims itself, seeking its own self-interest.

Importantly, brilliance is not synonymous with omniscience or omnipotence. Knowing more than most is not knowing all. Brilliance used for deception inevitably fails. In the end, Bundy hadn't fooled everybody, nor had Madoff, nor will the quants and TBTF elite. Bite marks, missing funds and paper trails always catch up to brilliant deceivers, sadly after much damage has been done.

What are we mere mortals to do?

1) Remember that brilliant people are people. They suffer temptation, to lie, cheat, steal and (in some cases) kill, but unlike the average person, they aren't as constrained by a lack of ability. Temptation rises with ability and just as those with the gift of gab can baffle with words, those with the gift of numbers can baffle with math.

2) Remember that brilliant people live in the same world we all do. Tiger Woods, at his best, beats all other competitors, but he doesn't birdie every hole, and will post a bogie from time to time.

In other words, demystify brilliance, which admittedly is easier written than done. Things which are too good to be true, even when promised by brilliance, usually are. Financial speculation, at best, makes an economy more efficient, but does not create money from nothing.  Checks and balances necessary for mere mortals are even more- not less, as seems to be the American view about financial wizardry- necessary for brilliance.

To wit, the signs of Madoff's deceit were obvious to any who examined his record with a skeptical eye as this excerpt relates:

Michael Ocrant wrote a story in 2001 for MARHedge, which covers the hedge fund industry, about how some traders, money managers and financial consultants questioned Madoff's record of 72 winning months in a row. "When I spoke to them about something not being right … they were adamant — there's no way this could be real," says Ocrant, now at Institutional Investor. "There's no one in history with that kind of results."

72 winning months in a row. "There's no way this could be real. There's no one in history with that kind of results."

Hmmm, if 72 winning months in a row couldn't be real, what should we think when a financial institution (check that, 4 financial institutions) claims to profit from each and every day's trading over a full quarter?

Those guys must be brilliant, eh?