More On Scott Patterson's "The Quants"

I last wrote about Wall Street Journal reporter Scott Patterson's new book, The Quants, here on Monday of this week. At the time, I'd read less than a third of the book.

Yesterday morning I finished it. I'd still recommend it as a very useful read. However, as I made my way through more and more of the book, it began to feel not only like a cross between Tom Wolfe and Michael Lewis, but Ayn Rand began to appear, as well.

By that I mean the following. When I read Atlas Shrugged, it took very little time to realize that Rand was a poor writer when it came to doing much more than espousing her philosophies. Character development and, in particular, romantic scenes in her book were so poorly written that I learned to just optically scan over those passages and return to full reading comprehension when they had ended.

Another major annoyance, and what I would call a glaring defect, is Patterson's apparent need to label certain phenomena with cute names. Perhaps it stems from post-The Right Stuff style requirements. When Tom Wolfe coined that term, it was a relatively new idea. And, anyway, Wolfe made somewhat of a career, as a leading writer of the new school of the late '60s, labeling phenomena.

Patterson calls the interconnected financial markets of the modern era The Money Grid, while the much-sought after inefficiencies in financial markets, when found and implemented to create wealth for the quants, becomes The Truth.

By the book's end, I'd become sickened by the word "truth," he'd employed it in so many predictable, silly passages.

I like Patterson's WSJ columns, and even his book. But he's no Tom Wolfe. Not yet, anyway.

Patterson does, however, a truly wonderful job cataloging the roots of modern quantitative trading in financial markets. That's why the first third of the book is so captivating.

When he turns his focus to the books four main contemporary characters- Peter Muller (Morgan Stanley's PDT) , Boaz Weinstein (Deutsche Bank) , Cliff Asness (AQR) and Ken Griffin (Citadel)- he becomes infatuated with their personal lives, idiosyncrasies and immense wealth.

As a result, the last third of the book can be read quite quickly, because so much of it cites all manner of numbers of total fund assets, losses, equity, and personal fortunes of the protagonists. Plus their various romantic couplings, births of children, latest expensive mansion purchase, etc.

To put Patterson's book in perspective, let me express it thus. He provides deep and numerous empirical confirmations that several things which I have long contended, and expressed in prior posts on various related topics, are, according to Patterson, true of this class of quantitative traders:

1. They all exhibit a shallower comprehension for the human behavioral aspects of financial markets than their mentors.

2. With each succeeding generation of acolytes, the belief that pure mathematical and statistical methods can apply, sans contextual understanding, to financial markets grows stronger, and the awareness of key underlying, limiting assumptions grows weaker.

3. Crucial dimensions of risk management for both the hedge funds, and the instruments they often trade, e.g., leverage, collateral, and ability to meet an instrument's, such as a credit derivative swap's obligations, are profoundly separated from the actual trading activities.

4. As such, both senior managers of the firms engaging in these activities, as well as counterparties, bear significant responsibility for having little understanding of the pragmatic aspects of risks which were undertaken by these quantitative traders.

5. Perhaps most ironically, all of the current generation of quantitative traders believed in exceptions to Eugene Fama's general EMH model, yet, in a fallacy of composition, when, together, they exploit commonly-observed inefficiencies, they become the very agents of EMH, obliterating the profitable inefficiencies they so recently observed and on which they traded.

At the book's end, Patterson brings back several historical figures from the earlier part, including Ed Thorp, Nassim Taleb and Benoit Mandelbrot. He has them voicing knowing sentiments concerning the eventual meltdown of the quants' funds from over-leveraged, commonly-held positions which were all simultaneously undone by the behavior of other investors which had not been modeled by the quants' research.

However, my fourth point is distressingly not explicitly driven home by Patterson. He succeeds marvelously in providing all the supporting evidence. He has the salient characters, including Fama and his ilk, in the book. The stage is magnificently set for Patterson to coyly spring the ultimate irony.

But he never delivers on it.

You have to figure that one out for yourself. Which is a pity.

Because if there is any one, over-arching, ultimate Truth (my bad- I can't resist mocking his label) to the book, it is the totality of the book's contemporary content in proving that, even when quantitative mavens find and exploit market inefficiencies, to the contradiction of the Chicago School's contention, they are, in reality, simply becoming players in that school's EMH world, pushing values back in line and eliminating the profitable inefficiencies.

That so few of these quants expected this is somewhat shocking. That they persisted, and persist, still, in believing they can escape this self-fulfilling prophecy is perhaps more shocking.

After a bit more reflection, I'm going to write a post discussing, from the viewpoint of Patterson's book, the folly of the TARP, government intervention, and implicit saving of the quant funds by the federal government.