The Quants arrived in bookstores today. Now begins the process of getting the word out. Monday, Fresh Air ran an interview with Ed Thorp and me. Ed is one of the main characters in the book, the scientist who invented a mathematical method to count cards in blackjack, which he wrote about in Beat the Dealer. He later went on to found the first quant hedge fund in 1969, which was eventually called Princeton Newport Partners. He also wrote about a new method to price stock warrants in a 1967 book called Beat the Market. I spoke with Ed at length as I wrote the book and his views about the market and quantitative strategies informed the perspective I took a great deal. Ed has grown extremely disappointed with how quants have misused math and models as an excuse, a sleight of hand, to make huge bets.
I also did an interview at TheStreet.com today and another for Bloomberg Radio.
There have been some interesting developments in Washington in recent weeks that are related to issues I address in The Quants. The Obama administration, in consultation with former Federal Reserve Chairman Paul Volcker, is taking aim at proprietary trading, in which traders at Wall Street banks use firm capital to make side bets on the direction of the market. My book profiles two such prop desks, Process Driven Trading at Morgan Stanley, which used a statistical arbitrage strategy (betting on shifting relationships between stocks and other securities), and Saba, a Deutsche Bank prop desk that traded credit instruments such as credit default swaps. Both went through highly volatile periods during the credit crisis.
Many say the Volcker Plan will be ineffective, in part because prop trading only makes up about 5% or so of most firm’s profits (it’s a bit higher at Goldman Sachs). That misses the point. Prop trading was a big part of bank profits before the credit crisis hit, and was in many ways responsible for the huge gains banks were booking before the meltdown. Ironically, one of the key players in turning banks into (as I argue in the book) souped up, highly leveraged hedge funds was former Treasury Secretary – former Goldman Sachs CEO – Henry Paulson, whose book about the crisis came out a day before mine.
Here’s an excerpt from my book on page 200:
“Paulson himself had outlined the new paradigm in the bank’s 2005 annual report. ‘Another key trend is the increasing demand from clients for investment banks to combine capital and advice,’ he wrote. ‘In other words, investment banks are expected to commit more of their own capital when executing transactions…. Investment banks are increasingly using their own balance sheets to extend credit to clients, to assume market risk on their behalf and sometimes co-invest alongside them.'”
The phrase “co-invest alongside them” is an interesting choice of words. Goldman has been taking a great deal of heat for making bets that complex credit instruments tied to mortgages would lose value, to the detriment of clients of the bank who purchased similar instruments that did in fact lose value when the housing market fell apart.