Home > finance, hedge funds > Working with Larry Summers (part 3)

Working with Larry Summers (part 3)

September 11, 2011

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.

Categories: finance, hedge funds
  1. Darren
    September 11, 2011 at 12:04 pm

    I find these insider-look posts about your experiences in finance to be incredibly informative, but they’ve also raised a few questions that I hope you won’t mind answering.

    The tone article you wrote for the AMS about working in finance was, overall, rather positive. Was that your intent at the time or was that the work of the editing? Later, (in part 2), it seemed like your departure was motivated by your moral compass; is that conflict–morality vs. job responsibility– inevitable when one chooses to work in finance?

    A couple of times you mentioned that you knew nothing about finance when you started. Could you recommend a good book or place to start for someone that’s interested and also knows nothing about finance?

    This question isn’t directly related to your posts, but to finance in general: I’ve heard it said that to work in finance one must live in New York, London, or a couple of select cities in the Far East. Is there any truth to that statement?

    Finally, you’ve focused on three areas of potential employment for a math PhD: academics, finance, and start-ups. Are there other options out there?

    Sorry for bombarding you with questions. I just recently found your blog and worked my way through the archives, accumulating questions as I caught up. Thanks very much.


    • September 11, 2011 at 1:45 pm


      To some extent my Notices article was edited, but not really so much- I guess I was more positive about working there near the beginning, and I wasn’t judgmental about what we did, since I was still learning the craft myself. I ended up leaving partly because of the feeling that it wasn’t moral, but I don’t think people who stayed and/or who still work there are necessarily immoral- although I did end up concluding that a lot of them are at least really unpleasant. In fact it’s the co-existence of my weird feelings of personal responsibility and my genuine affection for some of the people in finance that I am exploring in part by writing this blog. So to answer your question, I really think it depends critically on your personality and, to some extent, your politics whether working in finance is a moral action or not for you.

      In terms of educating yourself about quantitative finance, I’d recommend Neil Chriss’ book “Black Scholes and Beyond”, which I read before applying and which gives you a pretty good sense of the kind of math that’s used (although certainly doesn’t spell out how to develop models). Also read the technical posts here! I’m writing posts which I consider very relevant to the job of a finance quant. Also please see Quantivity for more involved quant finance issues.

      In terms of working in finance, if you’re interested in futures you can work in Chicago too, but yes otherwise it’s pretty much New York, London, or Hong Kong or other places in Asia if you want to be in a center of finance. And I’d add that you do want this, since otherwise the atmosphere, which in most finance firms isn’t great, tends to be even worse, since people are “trapped” in their jobs since there are fewer other places to jump to.

      There are lots of other things! But in terms of who will pay you to do stuff (assuming you have a math Ph.D.) that other people without mad math skills can’t do, you need some amount of sophistication and mathematical models. I guess, besides the three things you mentioned and which I’ve done, you could work in various fields like epidemiology or mathematical biology where mathematical modeling is nascent and promising. If you’re more entrepreneurial and you are willing to set something up for yourself, I think there are some pretty incredible opportunities to do that nowadays for people who are analytical and mathematically broad.

      Thanks for the questions!


  2. September 12, 2011 at 4:24 am

    Cathy I want to thank you for an insider view.

    I keep wanting to recommend that you read some Nassim Taleb except that
    1) I haven’t read his book, The Black Swan, myself, only articles and reviews available on the web
    2) He writes in an annoying allegorical style
    3) His ideas could be seriously corrosive to your ability to function as a quant

    Essentially he argues that if you have a time-varying statistical process, you never get enough data to model the extremes and that it is a mistake to assume that the higher moments are defined, never mind to assign them values.

    My own view is that it isn’t clear how much the underlying processes are changing but unless your data includes all three crashes in the UK stock market associated with railway building in the UK you won’t have enough serious extreme events in your data set to analyse. (Probably you need to go back even further to include the crash generated by the introduction of Tulips from Turkey to Holland).

    A good start is his essay, ‘The Fourth Quadrant’ http://www.edge.org/3rd_culture/taleb08/taleb08_index.html

    I also like David Tweed’s take on Taleb’s ideas posted as a comment in John Baez’s blog, Azimuth, http://johncarlosbaez.wordpress.com/2011/08/19/bayesian-computations-of-expected-utility/#comment-7169

    Finally, note that the Normal is the only stable probability distribution that is not fat-tailed http://en.wikipedia.org/wiki/Stable_distribution which suggests that the assumption of finite variance in the derivation of the central limit theorem is a strong assumption and should not be applied unless there is reason to believe it to be applicable.


  3. human mathematics
    September 16, 2011 at 3:47 am

    You’re saying David Shaw is quite arrogant?


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