Previously I’ve talked about the quant culture of D.E. Shaw as well as the tendencies of people working there. Today I wanted to add a third part about the experience of being “on the inside looking out” during the credit crisis.
I started my quant job in June 2007, which was perfect timing to never actually experience unbridled profit and success; within two months of starting, there was a major disruption in the market which caused enough momentary panic and uncertainty that the Equities group decided to liquidate their holdings. This was a big deal and meant they lost quite a bit of money on transaction costs as well as losing money because other investors were pulling out of similar trades at the same time.
The August 2007 market disruption was referred to internally as “the kerfuffle”. I’ve grown to think that this slightly dismissive term, which connotates more of an awkward misunderstanding than any real underlying problem, was indicative of a larger phenomenon. Namely, there was a sense that nothing really bad was afoot, that the system couldn’t be at risk, and that as long as we kept our trades on balance market neutral, we would be fine, except for possibly bizarre moments of exception. The tone would be something like, if an upper class man went to a restaurant and his credit card was denied- the waiter would return the credit card with almost an apology, assuming that it must have expired or something, that surely it is a mistake more than an exposure of underlying bankruptcy.
This framing of the world around us, as individual exceptional moments, as mysterious, almost amusing singularities in an otherwise smooth manifold, continued throughout the credit crisis (I left in May 2009), with the exception of the days after Lehman collapsed (Lehman was a 20% owner of D.E. Shaw at the time of its collapse, as well as a one of our major brokers).
But Lehman fell kind of late in the game, actually, for those in the industry. In other words there were months and months of disturbing signs, especially in the overnight lending market (where banks lend to each other for just the night or over the weekend) leading up to the Lehman moment. I remember one experience during those times that still baffles me.
It was a company-wide event, an invitation to see Larry Summers, Robert Rubin, and Alan Greenspan chat with each other and with us at the Rainbow Room in Rockefeller Center. It started with a lavish spread, fit for the dignitaries that were visiting, as well as introductory remarks wherein David Shaw described Larry Summer’s appointment as managing director at D.E. Shaw a “promotion” from being President at Harvard (just to be clear, this was a joke – even David Shaw isn’t that arrogant). In incredibly collegial terms, each of the three spoke for some time and reminisced about working together in the Clinton administration. Whatever, that’s not the important part, although it is kind of strange to think about now.
The important part, in retrospect, was later, near the end, when Alan Greenspan started talking about CMO‘s and how worried he was that anybody investing in them was in for a world of hurt. When I had gotten to D.E. Shaw, one of the first presentations I’d ever gone to was by a guy describing how he thought the same thing, and how we had divested ourselves of any such holdings, at least for the high-risk kind. So when Greenspan asserted these warnings, I sensed quite a bit of smugness in the crowd around me. It made me imagine us investors as a bunch of people playing illegal poker in the back of a club, where the smartest ones in the game get told a few minutes before the cops come and they leave out the back (except in this case it wasn’t actually illegal, and it was retired cops- Greenspan left the Fed at the end of 2006).
I wish I could remember when exactly that Rainbow Room event was, because I specifically remember Rubin saying absolutely nothing and looking uncomfortable when Greenspan was going on about CMOs and the danger in their future. Way later, it was revealed that Rubin, who was being paid obscene amounts by Citigroup at the time, claimed not to know about how toxic those mortgage-backed securities were (nor did he claim to know how much Citibank had invested in them- which begs the question of what he actually did for Citigroup) back when he could do something about it. He was booted in January 2009.
I wanted to mention one other specific thing I remember about this attitude of bemused nonchalance in the face of the world crumbling. When Lehman fell, and the overnight lending market froze for some weeks leading to government intervention, there was a term for this at D.E. Shaw, attributed (perhaps wrongly) to Larry Summers. Namely, the term was “magic liquidity dust”, implying that all we needed, to solve the problems around us and the apparent irrational panic of the markets, was for a fairy to come down to us and shake her wand, spreading this liquidity dust generously in our otherwise functional and robust system.
The saddest part of all of this is that, in a very real sense, these guys were essentially right not to worry. There has been no real restructuring of the system that led to this, just its continuation and backing.
In my next installation I’ll talk about why I think people in finance were, and to some extent still are, so insulated from reality.
I wanted to tell you guys about Meetup.com, which is a company that helps people form communities to share knowledge and techniques as well as to have pizza and beer. It’s kind of like taking the best from academics (good talks, interested and nerdy audience) and adding immediacy and relevance; I’ve been using stuff I learned at Meetups in my daily job.
I’m involved in three Meetup groups. The first is called NYC Machine Learning, and they hold talks every month or so which are technical and really excellent and help me learn this new field, and in particular the vocabulary of machine learners. For example at this recent meeting, on the cross-entropy method.
The second Meetup group I go to is called New York Open Statistical Programming Meetup, and there the focus is more on recent developments in open source programming languages. It’s where I first heard of Elastic R for example, and it’s super cool; I’m looking forward to this week’s talk entitled “Statistics and Data Analysis in Python with pandas and statsmode“. So as you can see the talks really combine technical knowledge with open source techniques. Very cool and very useful, and also a great place to meet other nerdy startuppy data scientists and engineers.
The third Meetup group I got to is called Predictive Analytics. Next month they’re having a talk to discuss Bayesians vs. frequentists, and I’m hoping for a smackdown with jello wrestling. Don’t know who I’ll root for, but it will be intense.
So I’ve been reading David Graeber’s book about debt. He really has quite a few interesting and, I would say, wonderful points in his book, among them:
1) Debt came before money, often in the form of gift giving (you can read about this in his interview with Naked Capitalism)
2) In ancient cultures, and even in more recent cultures before the introduction of money, there were typically two separate spheres of accounting: the first was for daily goods like food and goats, which worked on the credit system, and the second for rearranging human relationships. Here there were things like dowries and symbolic exchanges of gold, meant to acknowledge the changing human relationship, but not as a “price” per se – because it was understood that you couldn’t put a price on a human.
3) Money as we know it is intricately tied in with slavery because it was when a person became a thing that could be sold for profit that we had a sense of price and when these two separate spheres were united. In particular the existence of money also implies the existence of a threat of violence. Moreover, it is this “decontextualizing” of people from their homes, their communities, and families who are forced into slavery that allows us to measure them with a dollar value, and in general it is only through pure decontextualizing that we can have a money system. It is this paradigm, where everyone and everything has no context, that economists rely on to describe the standard game theory of economics.
4) There are three social structures that people come into contact with in their daily lives and in which they give each other things: communistic, reciprocal, and hierarchical. For example, among parents and children, it is communistic; among a CEO and his workers it is often hierarchical, and among two strangers at a market it is reciprocal.
Even though I could (and might) write a post on any of the above points, because I find them each rich with stimulating and challenging concepts (and I haven’t even finished the book yet!), I want to first describe something Graeber mentions about the last one. Also, if someone is reading this that thinks I’ve misrepresented Graeber’s points then please comment.
Namely, Graeber mentions that, although we each have experience, and maybe lots of experience, in the three different social structures, when we tell the story of economics and exchange we invariably talk about reciprocal exchange. So, for example, I have three sons and I spend way more time hanging out with my sons, attending to their needs and making sure their infected toes are treated and helping them find their raincoats, then I spend at any market. In other words, if I were tallying up my contributions to things, my kids would be a far greater drain on my resources than groceries. But our “story” of how we give things and take things is inevitably about buying stocks or negotiating for a house price. In other words, we have been trained (by economists?) or we have trained ourselves to define exchange as a reciprocal, Austrian schoolish, “be selfish and take advantage whenever possible” endeavor, even when in the face of it we can’t claim to be like that.
Since I’m unwaveringly interested in how one tells the story of oneself, this fascinates me. It’s a really excellent example of how we are blind to the most obvious things. It also makes me think that economic theory has a loooong way to go before it can really explain meaningful things about “how things work”. After all, when you allow yourself to include “personal feelings” in your definition of giving and receiving, you realize that the reciprocal exchange part of your life is actually pretty insignificant, and in fact if that’s all that economists can even hope to explain (and it’s not clear they can), then there is more left unexplained than explained.
Moreover, the fact that we don’t see this as a failing (or at least a major hole) in the economic theory, because we are blind to it in ourselves, also immediately points to the possibility that we have overemphasized this aspect, the reciprocal exchange sphere, in our current economic system. In other words, if we had a healthy understanding of how the other two systems work (communistic and hierarchical) we may have developed them in parallel with the reciprocal system, and we may well be better off for it. We may even have an economics system that doesn’t reward rich people and punish poor people, who knows.
By the way, ridiculous and ignorant critique of Graeber’s book here (as in he didn’t read the book) with rebuff in comments by Graeber himself. Thanks to a commenter for that link!
First, right on the heels of my complaining about publicly available data being unusable, let me share this link, which is a FREAKING cool website which allows people to download 2010 census data in a convenient and usable form, and also allows you to compare those numbers to the 2000 census. It allows you to download it directly, or by using a url, or via SQL, or via Github. It was created by a group called Investigative Reporters and Editors (IRE) for other journalists to use. That is super awesome and should be a model for other people providing publicly available data (SEC, take notes!).
Next, I want you guys to know about stats.org, which is a fantastic organization which “looks at major issues and news stories from a quantitative and scientific perspective.” I always find something thought-provoking and exciting when I go to their website. See for example their new article on nature vs. nurture for girls in math. Actually I got my hands on the original paper about this and I plan to read it and post my take soon (thanks, Matt!). Also my friend Rebecca Goldin is their Director of Research (and is featured in the above article) and she rocks.
Along the same lines, check out straightstatistics.org which is based in the UK and whose stated goal is this: “we are a campaign established by journalists and statisticians to improve the understanding and use of statistics by government, politicians, companies, advertisers and the mass media. By exposing bad practice and rewarding good, we aim to restore public confidence in statistics. which checks the statistics behind news and politics.” Very cool.
FogOfWar kindly wrote a guest post for me while I was on vacation:
There’s an economic crisis going on around us, and periodically one hears people suggesting that we go back to the gold standard. It’s a pretty complicated issue, and I don’t really have an answer to the “gold standard debate”–just probing questions and a lingering feeling that the chattering class has been dismissive when they should be seriously inquisitive. I think this dismissiveness is driven by the fact that Ron Paul is the leading political proponent of the gold standard and competing currencies, and he’s (1) a traditional conservative libertarian (a bit in the Goldwater vein); and (2) a bit of a wingnut.
Aristotle would be ashamed— the validity of an argument does not depend upon the person making the argument, but upon whether the ideas contained are valid or invalid. Andrew Sullivan recently linked to this article by Barry Eichengreen, claiming that it’s “a lucid explanation of why calls to go back to the gold standard are so misguided.” In fact, it’s a fairly serious examination of the gold standard (ultimately coming down “nay”), which is a welcome relief from the flippant and arrogant dismissiveness one usually sees from economic pundits.
As with many edited articles, I recommend skipping the first page and a half (begin from the paragraph starting “For this libertarian infatuation with the gold standard…”). Here’s how I think the article should have begun:
[T]he period leading up to the 2008 crisis displayed a number of specific characteristics associated with the Austrian theory of the business cycle. The engine of instability, according to members of the Austrian School, is the procyclical behavior of the banking system. In boom times, exuberant bankers aggressively expand their balance sheets, more so when an accommodating central bank, unrestrained by the disciplines of the gold standard, funds their investments at low cost. Their excessive credit creation encourages reckless consumption and investment, fueling inflation and asset-price bubbles. It distorts the makeup of spending toward interest-rate-sensitive items like housing.
But the longer the asset-price inflation in question is allowed to run, the more likely it becomes that the stock of sound investment projects is depleted and that significant amounts of finance come to be allocated in unsound ways. At some point, inevitably, those unsound investments are revealed as such. Euphoria then gives way to panic. Leveraging gives way to deleveraging. The entire financial edifice comes crashing down.
This schema bears more than a passing to the events of the last two decades.
First, I would reword that last sentence as follows: This schema bear a striking resemblance to the events of the last two decades. Moreover, I would add, in light of this data, one might ask not why fringe candidate Ron Paul is calling for examination of a return to the gold standard, but rather why this view is considered to be on the fringe rather than at the center of debate. There are a number of reasons to believe that a return to the gold standard might not have the desired effect, although that certainly begs the question of what can be done to prevent future crisis on the order of 2008.
I’d place myself in the camp of “not convinced that the gold standard is the answer, but think it would be really hard to fuck up the economy as bad as the Fed did over the last 20 years even if you were trying, so maybe it’s an idea that deserves some real thought.”
Here’s another key paragraph:
Society, in its wisdom, has concluded that inflicting intense pain upon innocent bystanders through a long period of high unemployment [by allowing bubbles to work themselves out as Austrians advocate] is not the best way of discouraging irrational exuberance in financial markets. Nor is precipitating a depression the most expeditious way of cleansing bank and corporate balance sheets. Better is to stabilize the level of economic activity and encourage the strong expansion of the economy. This enables banks and firms to grow out from under their bad debts. In this way, the mistaken investments of the past eventually become inconsequential. While there may indeed be a problem of moral hazard, it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial systems.
This gets to the crux of Eichengreen’s argument, but consider the following points:
- The “help” proposed by Keynsians in fact might make things worse in the long term (not out of malice, but the road to hell is paved with good intentions) by dragging out the inevitable consequences of misallocation during the bubble. In essence, this is a ‘rip the band-aid’ off argument. I think I’ve seen some historical analysis that the total damage done from a bank-solvency driven recession is, in fact, worse over time if extended rather than allowing banks to fail and recapitalize (Sweden vs. Japan).
- “… nor is precipitating a depression…” It’s taken as an article of faith that we would have been in a depression if not for the stimulus package, but I’m skeptical. This is and will always be a theoretical “what if” analysis, conducted by economists who have a cognitive bias in favor of a certain answer (and, for those working in government, a President who needs to juke the stats to get reelected).
- “While there may indeed be a problem of moral hazard it is best left for the future, when it can be addressed by imposing more rigorous regulatory restraints on the banking and financial system.” Whaaaaaaaaat? This is where Keynesians lose me. The sentence is so hopelessly naïve that it undermines the entire argument. Take your nose out of your input-driven models for a minute and take a look around and ask yourself how good a track record bank regulators have at imposing “more rigorous regulatory restraints” during boom times; major new regulatory changes only have political will during a crisis (Securities Act of ’33, Exchange Act of ’34, Glass-Steagall in ’34). I’m not going to argue the relative benefits of economic models when the theory is premised on a factual event that’s very likely not going to happen.
Here’s a paragraph I liked:
Bank lending was strongly procyclical in the late nineteenth and early twentieth centuries, gold convertibility or not. There were repeated booms and busts, not infrequently culminating in financial crises. Indeed, such crises were especially prevalent in the United States, which was not only on the gold standard but didn’t yet have a central bank to organize bailouts.
The problem, then as now, was the intrinsic instability of fractional-reserve banking.
This is a really good point; I don’t have an answer and it ties in to a lot of deep questions about the structure of the banking system and “what is money”. I do like that it’s being discussed, and I’d love to hear views (educated and layman alike) on “so if the gold standard won’t work and the Fed fucked things up so bad, what do you suggest?”
Lastly, here’s the end of the piece:
For a solution to this instability, Hayek himself ultimately looked not to the gold standard but to the rise of private monies that might compete with the government’s own. Private issuers, he argued, would have an interest in keeping the purchasing power of their monies stable, for otherwise there would be no market for them. The central bank would then have no option but to do likewise, since private parties now had alternatives guaranteed to hold their value.
Abstract and idealistic, one might say. On the other hand, maybe the Tea Party should look for monetary salvation not to the gold standard but to private monies like Bitcoin.
I don’t have an answer to the many questions raised here, but they’ve been on my mind a lot. Any thoughts?
As many of you know, I am fascinated with the idea of an open source ratings model, set up to compete with the current big three ratings agencies S&P, Moody’s, and Fitch. Please check out my previous posts here and here about this idea.
For that reason, I’ve recently embarked on the following thought experiment: what would it take to start such a thing? As is the case with most things quantitative and real-world, the answer is data. Lots of it.
There’s good news and bad news. The good news is there are perfectly reasonable credit models that use only “publicly available data”, which is to say data that can theoretically gleaned from quarterly filings that companies are required to file. The bad news is, the SEC filings, although available on the web, are completely useless unless you have a team of accounting professionals working with you to understand them.
Indeed what actually happens if you work at a financial firm and want to implement a credit model based on “publicly available information” is the following: you pay a data company like Compustat good money for a clean data feed to work with. They charge a lot for this, and for good reason: the SEC doesn’t require companies to standardize their accounting terms, even within an industry, and even over time (so the same company can change the way it does its accounting from quarter to quarter). Here‘s a link for the white paper (called The Impact of Disparate Data Standardization on Company Analysis) which explains the standardization process that they go through to “clean the data”. It’s clearly a tricky thing requiring true accounting expertise.
To sum up the situation, in order to get “publicly available data” into usable form we need to give a middle-man company like Compustat thousands of dollars a year. Wait, WTF?!!? How is that publicly available?
And who is this benefitting? Obviously it benefits Compustat itself, in that there even is a business to be made from converting publicly available data into usable data. Next, it obviously benefits the companies to not have to conform to standards- easier for them to hide stuff they don’t like (this is discussed in the first section of Compustat’s whitepaper referred to above), and to have options each quarter on how the presentation best suits them. So… um… does it benefit anyone besides them? Certainly not any normal person who wants to understand the creditworthiness of a given company. Who is the SEC working for anyway?
I’ve got an idea. We should demand publicly available data to be usable. Standard format, standard terminology, and if there are unavoidable differences across industries (which I imagine there are, since some companies store goods and others just deal in information for example), then there should be fully open-source translation dictionaries written in some open-source language (python!) that one can use to standardize the overall data. And don’t tell me it can’t be done, since Compustat already does it.
SEC should demand the companies file in a standard way. If there really are more than a couple of standard terms, then demand the company report in each standard way. I’m sure the accountants of the company have this data, it’s just a question of requiring them to report it.
There’s been lots of talk lately about how people are not having sufficient clarity of thought to be really creative any more; the argument is that they’re constantly interrupting themselves by reading tweets or their email, or of course crappy blogs, and never think about the big picture like they used to.
First, doesn’t it seem like every generation thinks that the kids of today are lazy? Doesn’t it just make us old fuddy-duddies to say stuff like this? Just because it’s a cliche doesn’t mean it’s not true.
Instead of complaining about young people, how’s this: a new way of having ideas is emerging, which is less individualistic and is therefore less recognizable to people who like to worship at the feet of “great thinkers.” There are more ad hoc communities being formed to explore ideas (like the Linux movement) and fewer larger-than-life personalities, but innovation and creativity are definitely taking place.
Okay, now that I’ve given those lazy-asses their due, I can complain about the obvious kinds of brain rot going on, mostly versions of lack of discipline and patience. I’m going to focus on a nerdy kind: the capacity for old-school reckoning (note how I’m even inserting fuddy-duddiness into the name).
Here’s the thing. It’s just too easy to google something when you don’t know it off the top of your head. There’s even some amount of feeling virtuous for bothering to scan wikipedia for, say, the population of the world or the prevalence of religions by number of worshipers. However, my claim is that it is better to delay the googling for at least half an hour.
Yes, I’m that guy who closes people’s laptops on their fingers and says, “hey let’s figure it out! Let’s not google it!!” Perhaps this explains why people don’t come to my house very often (please come back, you guys!). So yes, it’s come down to this: I torture my kids.
When my family has dinner, we have a rule that nobody can ‘use electricity,’ which includes watching TV or computers. We are also (obviously) super nerdy so we end up having pretty cool conversations (at least I think so!) in which we reckon.
Our reckoning skills, and our kids’ reckoning skills, have been getting honed this summer with the introduction of the daily ‘bonus question,’ which was our attempt to keep our kids’ brains from completely rotting over the summer while keeping things fun.
At first we would give them puzzles but later on they started asking us questions too. If the questions end up interesting enough (judged essentially by whether we all got genuinely into the discussion) then the kids win the prize of getting to watch TV after dinner until bedtime (don’t tell them but they’d get to watch TV anyway; and yes, they actually watch Netflix).
Turns out it is really fun to reckon with kids. For example one question our nine-year-old asked us is how thick a cylinder would be if it had to reach from the earth to the sun and was the same mass and density as the earth. We ended up googling something for that, I think the distance to the sun, but then again you can’t be crazy rigid!
The whole point is to realize you know more than you think, and you can figure out more than you thought you could based on estimates and a few facts. That, and to see how your biases steer you wrong. For example, when we were trying to figure out the number of people in each religion, we WAY overestimated the number of Jewish people. Then again, we live in New York.
One question I asked them which I thought was pretty cool, because they had such different and interesting answers to it, was how they could build the lightest bridge from our apartment to their school. There was no correct answer and that made it even neater, and it didn’t keep it from being a classic reckoning conversation.
So here’s my challenge: wait half an hour before googling something, and see how much you can figure out about the answer before you find it.
I’m back from vacation, and the sweet smell of blog has been calling to me. Big time. I’m too tired from Long Island Expressway driving to make a real post now, but I have a few things to throw your way tonight:
First, I’m completely loving all of the wonderful comments I continue to receive from you, my wonderful readers. I’m particularly impressed with the accounting explanation on my recent post about the IASP and what “level 3″ assets are. Here is a link to the awesome comments, which has really turned into a conversation between sometimes guest blogger FogOfWar and real-life accountant GMHurley who knows his shit. Very cool and educational.
Second, my friend and R programmer Daniel Krasner has finally buckled and started a blog of his very own, here. It’s a resource for data miners, R or python programmers, people working or wanting to work at start-ups, and thoughtful entrepreneurs. In his most recent post he considers how smart people have crappy ideas and how to focus on developing good ones.
Finally, over vacation I’ve been reading anarchist David Graeber‘s new book about debt, and readers, I think I’m in love. In a purely intellectual and/or spiritual way, of course, but man. That guy can really rile me up. I’ll write more about his book soon.
Every now and then I meet someone who tells me they want to live forever. Whaaa? First of all, even if I were somehow forced to live forever, I simply don’t want to be around other people who have been living way too long. Haven’t they noticed that as people get older they tend to get more rigid and set in their ways? If we had to live with a bunch of 1000 year olds, how would we ever move past the weird issues they have about how women shouldn’t work or gays in the military? It’s a crucial fact that our culture is replenished by youth. Don’t want to lose that!! Eww!
Second of all, and more to the point I want to make, there really are people interested in this idea, and it always seems to me they are typically people that really should be focusing on living more now. What is actually going to be their plan if they suddenly were told, “hey, you’ll live forever starting now”? And if they have some awesome plan, why not just go for it? What is keeping them from making those decisions?
I have always had a great deal of admiration for people who do make those interesting and brave moves in their lives. Just this week an old friend of mine, who is a successful artist, told me she’s going back to school (at Columbia, so good for me!) to become a full time student in Narrative Medicine. If you don’t know what that means, then I don’t blame you, because I didn’t either, but what matters is that she is totally into it and that fucking rocks that she’s doing that.
Another good friend of mine is getting her Ph.D. in the ethics of nursing, after careers in energy and publishing. On the one hand I think she’s addicted to school, but on the other hand, how cool is that? To see so many different parts of the world? And by the way, if you think I’m disregarding things like money and kids, let me say that she is a single mom with two kids, and is still making this work. It’s just that she never decides not to do something because it’s hard – she’s all about intellectual curiosity and trying new things. Love her.
What would you study if you were to go back to school right now? How would you reinvent yourself?
Personally, I’ve always made my big decisions by asking myself, how will I feel on my death bed if I did or didn’t do this? It’s closely related to the other question I dwell on constantly, who am I and what is the story of my life? And it goes along with my advice post, where I pretty much always tell people to go for it or to do what they’d do if they weren’t insecure – good advice for oneself as well. I’ve actually gotten to the point of looking forward to my death bed, so I can swap stories with the people around me about the crazy shit I’ve tried. I know the chances of that working out are about zero, but it’s a nice thing to think about.
Going back to the idea of living forever: if I didn’t have a death bed to look forward to, how could I ever motivate myself to get my ass off the couch and try something new? It’s precisely because we have a finite amount of time to try things that it’s really exciting to be alive.