They helped banks make money faster than ever before, until they had laid the foundations for a mathematician-led market meltdown. Meet the quants, the “Alchemists of Wall Street” on show at the annual science film festival in Paris.
When French “rogue trader” Jérôme Kerviel, upon hearing his prison sentence at a Paris court last week, protested that he was merely the scapegoat of a perverse financial system, he was referring primarily to the managers who clapped so long as he made millions of euros and then cried foul once he had lost a lot more.
But the former Société Générale trader may also have had in mind the people who provided the tools that made the financial system spin out of control.
Enter the quants, the “financial technologists” who devise mathematical models for the world of finance and are the subject of an intriguing documentary screened at the Pariscience international science film festival, which wrapped up in the French capital on October 12.
'Quants, the Alchemists of Wall Street', by Dutch duo Marije Meerman and Gerko Wessel, explores finance’s growing reliance on mathematicians to come up with models that help banks reduce risks and, more importantly, make more money.
Quants are trained mathematicians drawn to the world of finance by the possibility of an immediate and lucrative application of their scientific research. Their declared purpose is to serve the real economy by finding ways of controlling risks, typically by spreading them out to reduce the chances of defaults on debt.
In ideal market conditions, their models work wonders; which is why bankers eager for a profit turn these models (which they rarely understand) into systematic policies. One such policy, which brought the global financial system down on its knees, was to offer subprime mortgages to virtually every household in the US.
‘Sublime and absurd’
The film is centred around three main characters: Briton Paul Wilmott, a renowned quantitative finance “guru”, South African Emanuel Derman, nick-named the Einstein of Wall Street, and American Mike Osinski, a former Lehman Brothers employee who designed “the formula that made Wall Street crash”.
“The project started off as a film on the financial crisis, but as we moved along we became increasingly fascinated by the characters,” said Gerko Wessel in an interview with FRANCE 24.
The three characters are indeed intriguing. But they are also deeply unsettling. Wilmott says quants’ models are both “sublime and absurd”, while Derman argues that the models did not cause the crisis but is then curiously inept at explaining what did. As for Osinski, he has abandoned the world of finance altogether to start a new life as a repentant oyster farmer.
“We were particularly appealed by the obvious disappointment of quants, who were hoping to find free rein for mathematics in the field of finance, only to realise that the material was not suitable”, said Wessel.
The quants featured in the film are at their most moving when comparing the beauty and perfection of a mathematical formula with the frustrating lack of order in society. The tension between the elegance of mathematics and the chaotic real world is palpable. But their frustration is also alarming. Should they really be dictating the way fallible human beings operate on financial markets?
Wilmott and Derman do not shy away from criticising their profession. The two have written a ‘Modeler’s Hippocratic Oath’ in which they vow they “will not be overly impressed by mathematics” and “will never sacrifice reality for elegance”. Future quants are also warned against basing their models on a mere five years of data, an insignificant time frame relative to economic cycles.
Osinski, the man whose revolutionary software helped turn subprime mortgages into a systemic cataclysm, is more scathing in his criticism. Banking, he says, has lost touch with its original purpose, that of helping people produce and purchase the products they need. So much so, that trading in commodity derivatives has become more important than the actual commodities.
Trading at the speed of light
The festival’s organisers invited a French quant to take questions after the screening, alongside the film’s directors. Predictably, Crédit Agricole’s Christophe Michel spent most of his time fending off the assaults of spectators incensed by the excesses of the banking industry.
“The maths are not about concealing the complexity of finance, but rather throwing new light on it,” he argued. Yet, while stressing the beneficial role of mathematicians in helping banks reduce risks, Michel conceded that “the more one controls risks, the more one is eager to take them”; and whereas quants may be conscious of the limits of their models, those who apply them – remember Kerviel – are all too often unwilling to be constrained.
The recent backlash against the world of finance may have left quants in the dock, but only very briefly. The alchemists of Wall Street were soon back in favour, along with traders’ hefty profits and bonuses.
Today, special academies are training legions of new quants, most of them from Asia. Their rising numbers match the current shift towards high-frequency trading; trading at the speed of light, where the human factor gives way to machines that are programmed to apply the quants’ models.
“The next crisis could happen within seconds,” warns Wilmott at the end of the film. He could not have been more prescient. A few weeks after the shooting, on May 6 of this year, the Dow Jones index of shares dropped by an unprecedented 6% in just twenty minutes – for no apparent reason. High-speed traders and the computer programs they rely on, it seems, were to blame.
Date created : 2010-10-12