Working with Larry Summers (part 3)
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.