How the USSR gave us Wall Street's quant craze
They are the rocket scientists of finance, highly trained mathematicians, scientists, and engineers who delve deep into quantitative analysis. They create mathematical models that can make the frat boys who push stocks and commodities on the trading floor very, very rich. Quants cook up formulas that coolly demonstrate which financial instruments have the highest probability of generating the highest return at the lowest risk, and Wall Street rolls with them -- though, as we've learned, those formulas sometimes work better on paper than they do in real life.
Wired's latest cover story by Portfolio.com's Felix Salmon, The Secret Formula that Destroyed Wall Street, tells the story of David X. Li, a Chinese-born math whiz who made it possible for bankers to spread the virus of collateralized debt obligations (CDOs), which in turn spread risk and fueled the subprime crisis.
The New York Time's most emailed story of the day, as of this writing, They Tried to Outsmart Wall Street, is another aptly-titled look at quants. The verdict from the article seems to be that banks shouldn't have taken these formulas as seriously as they did. However, if you build it, they will come. And did they ever!
Far from being a source of shame, being a quant jock is still a popular career choice for the best and the brightest coming out of leading universities. The Times article mentions an M.I.T. career workshop, "So You Want to Be a Quant," that was "overflowing" with students. Sheesh, a generation falleth, another riseth. But they'll have their hands full conjuring up ways to make Wall Street profitable again.
What's interesting to me, as a lover of Freakonomics, is that if the Cold War kept on going, then Wall Street would probably never have gotten a wave of quants, eager to apply the fine laws of mathematics to unruly financial markets. The Times explains:
Physicists began to follow the jobs from academia to Wall Street in the late 1970s, when the post-Sputnik boom in science spending had tapered off and the college teaching ranks had been filled with graduates from the 1960s . . . Things got even worse after the cold war ended and Congress canceled the Superconducting Supercollider, which would have been the world's biggest particle accelerator, in 1993.So if scientists got squeezed out of science as the Cold War ended and found jobs on Wall Street instead, where will the quants go now? Geniuses will be geniuses -- good and evil (and how much power they wield) depends on who's paying them. And I suspect that despite the financial crisis, many quants will stay on Wall Street, searching for profits amid the ruins.