Dark Night of the Quants

Last March, seeking a readable take on the prospects of my retirement savings, I picked up Michael "Moneyball" Lewis's character-driven financial crisis tale The Big Short. Soon a word Lewis favors there caught my fancy: quant. A quant is a math whiz who sells his skills to the banking industry. Quants invented, elaborated, and tailored the collateralized debt obligations (CDOs) and credit default swaps (CDSs) that wrecked the world economy, and like everyone in the banking industry, albeit at a higher level of difficulty, they think more in numbers and less in words than I or probably you. The term stayed with me because I was given my college scholarship to become a quant but stubbornly trained instead to become a wordsmith. Soon my math aptitudes atrophied, as did any chance I had to internalize the fast-evolving language that would so profoundly affect my material well-being. In this I'm like most civilians -- it's not an easy language.

So having already decided that The Big Short was too glib to serve as my last word on the defining political issue of our time, I hoped more reading might help me become, if not fluent, at least an informed citizen who knows how to ask directions out of town. Intuitively and associatively, although with an eye to balance, I ended up downing ten books all told, a million-some words' worth, without ever getting to Andrew Ross Sorkin's well-regarded Too Big to Fail or anything by a name left-liberal economist like Joseph Stiglitz. Since there's no way to cover them fully, let me begin with a graded list in the order I finished. Anything under B plus isn't worth your time.


Michael Lewis, The Big Short. Focuses on the value investors who bet against, that revealing parlance, the mortgage securities market. Too entertaining about greed and irrationality for its deep pessimism to be altogether trustworthy. B+

 

 

 

 

 

 

John Lanchester, I.O.U. Having survived a mortgage of his own, British novelist and banker's son finds a journalistic specialty, which he aces. Explains credit default swaps, dismantles risk models, and actually visits one of the ruined neighborhoods whose fates so many bemoan. A

 

 

 

 

Ha-Joon Chang, 23 Things They Don't Tell You About Capitalism. South Korean-born British economist loves Swedish capitalism and hates the free-market kind. Like most liberal economists, not much use on political implementation of his sane proposals. A-

 

 

 

 

Richard Posner, A Failure of Capitalism. With dispassionate clarity, brainy, union-hating conservative jurist insists the recession is a depression, puts "greed" in quotes, and calls for regulation in due time -- because, after all, "no one has a clear sense of the social value of our deregulated financial industry." B+

 

 

 

 

 

Matt Taibbi, Griftopia. Rolling Stone staffer explains abstruse things lucidly, nails the evil Alan Greenspan, and uncovers heartbreaking stuff on commodities speculators ginning up the 2008 gas shortage and investment bankers gulling Greece and Chicago. But he's so mad he can't resist dumb ad hominems like "dumbasses" and thinks his myriad targets are both stupider and more malevolent than they are. A-

 

Robert Scheer, The Great American Stickup. Lefter-than-thou scold proves efficient and clear on the Glass-Steagall and GSE fiascos that paved the way for the subprime disaster, only mounting his pulpit at the very end. B+

 

 

 

 

 

 

Gretchen Morgenson and Joshua Rosner, Reckless Endangerment. In need of a hook, Times reporter and the researcher who noted early that "A Home Without Equity Is Just a Rental with Debt" come down too hard and long on Fannie Mae and Freddie Mac, the profit-mad government-sponsored enterprises (GSEs) the Right fallaciously blames for the whole crisis. The many lobbying details are scary and disgusting. B-

 

 Danny Schechter, The Crime of Our Time. Documentarian lodges poorly written, abysmally edited, sketchily sourced criminal charges against, well, all of Wall Street. But because he knows these can't stick in court and thus puts some thought into other avenues of public action, his name-calling is more tonic than Taibbi's. C+

 

 

 

Bethany McLean and Joe Nocera, All the Devils Are Here. Although the Vanity Fair and New York Times stars are too understanding about the inner lives of cutthroats, their outrage is palpable as they get the story. From the earliest mortgage-backed securities to Dodd-Frank, they drive their narrative by devoting whole chapters to firms and agencies, whose cultures vary just like characters do. A

 

 

 

Henry M. Paulson, Jr., On the Brink. The long-winded Treasury secretary who oversaw the bailouts gets credit for working inhuman hours in 2008, and for emphasizing if not quite elucidating the "repo" market in overnight liquidity loans. Wish he'd mentioned his leverage-escalating efforts as Goldman Sachs CEO. Or the $500 million stock sale that would have been $400 million if he'd ponied up capital gains taxes. Or that Fannie Mae mortgage Schechter says he got his mom. These guys don't pay cash for anything. C

 

  
Let me continue by briefly explaining some of the terms above. What I call the banking industry includes many entities that aren't banks and has been weasel-branded the "financial services industry," a phrase I can't type without scare quotes. Glass-Steagall is the 1933 law that prevented commercial banks, where citizens and small businesses can stockpile and borrow money, from acting like investment banks, which deal speculative, high-stakes instruments and maneuvers affordable only by rich people, large corporations, and such naive collectivities as local governments and pension funds; its Republican-powered 1999 repeal was abetted by gung-ho Democratic Treasury secretaries Robert Rubin and Larry Summers and a complaisant Bill Clinton. A collateralized debt obligation is a bond typically backed by student loans, credit-card debt, and, notoriously, mortgages; even more notoriously, synthetic CDOs are backed by other CDOs, and then additional synthetic CDOs are backed by them, pretty much ad infinitum. A credit default swap is an insurance policy on debt you're owed -- if your creditor defaults, your insurer has to cough up the cash instead. And if you're "subprime," another weasel brand, many would say you can't afford that mortgage some shyster is talking up. Multiply by x million home buyers -- and even more owners transforming their abodes into piggy banks -- and many CDOs will go south.

And there you have the makings of what we hope is merely the worst financial crisis since the Great Depression. If you take the Glass-Steagall rout as a metonym for the breakdown of regulation that began with Reagan, speeded up with Clinton, and took off under Bush, all that's missing is the perfidy of the rating agencies and the ugly specifics of the greed Posner doesn't believe in. We all know the crisis is upon us, certainly including the 1 percent, as we've learned to label them. The difference is that few of the 1 percent are morally gifted enough to internalize it, while even the frugal or lucky or relatively well-off among the rest of us feel the contraction: the jobs sped up or pared down or done in, the savings eroded, the investments gone sour, the kids stuck at home, the public services starved, the stores shuttered, the anxiety and fear and ambient rage.

In fact, many understand how it happened well enough to be depressed if not overwhelmed by their own powerlessness. That's one reason most people I talk to have yet to pick up a single book on the crisis. But this seems wrongheaded to me. I won't claim that my reading has allayed my own sense of powerlessness -- certainly not as much as the Occupy agitators have. But at least it's familiarized me with the terms of my exploitation. "We are the 99 percent" is a great slogan. I've chanted it myself. But if we're to imagine what we want from the 1 percent, we need a better grasp on how they're screwing us.

 

 

For us word people, one level of this understanding comes easy: seeing through jargon, obfuscation, and weasel words, like calling an insurance policy a "swap" or saying short sellers are (I love this one) "expressing their views." Weasel words traditionally come in the form of the fine print where Moody's declines to verify the information its ratings are based on, or a buried hedge like "the pool may contain underwriting exceptions and these exceptions, at times, may be material." But "collateralized debt obligation" is itself just a weaselly way of saying "consumer debt bond." As Lewis observes, "bond market terminology was designed less to convey meaning than to bewilder outsiders": overpriced bonds weren't "expensive," they were "rich," divided into risk levels dubbed "tranches" rather than "floors," with the high-risk triple-B tranche designated the "mezzanine," "like a highly prized seat in a domed stadium."

Having likened the 1973 invention of the Black-Scholes formula for calculating derivative risk as finance's modernist moment, Lanchester, the most artful writer-qua-writer here, sees the 2008 derivatives crisis as its postmodernist moment, in which value recedes from our comprehension like meaning in Derrida, with the crash its Derridean "aporia." In this he was anticipated by the genius who was wrong about everything, the Ayn Rand-schooled, postobjectivist Fed czar Alan Greenspan. As Taibbi reminds us, that supreme oracle once crowed about the "ever increasing conceptualization of our Gross Domestic Product -- the substitution, in effect, of ideas for physical value."

Speaking in 1998, what Greenspan meant by "ideas" was the business plans of Internet start-ups that would soon go bust as the mathematicians who designed them failed to achieve monetization. But his pronunciamento applies as well to the triumph of math in the banking industry. The most telling fact I ran across in my million-plus words appears only in Lanchester. In 1986, the financial sector earned 19 percent of U.S. profits; by the '00s, that percentage had doubled to 41 percent. In other words, two-fifths of what Americans made money on wasn't material goods or human services, but money itself, as average pay in banking, which ran parallel to the rest of private industry till 1982, rose to 181 percent of par by 2007. No wonder that for Lanchester "there is sometimes a moment talking to [bankers] when you hit a kind of wall" -- a wall "based on the primacy of money and the unreality of other schemes of value."

Granted, I just did some weaseling myself, by pretending that math and money are the same thing. My excuse is that, ultimately, the instruments the quants devised were what separated Lanchester from his City pals, because all serve what McLean and Nocera call "the delinking of borrower and lender." Only rapacious mortgage sellers coked up on Red Bull had any concrete knowledge of the default-prone subprime suckers on whom the "real estate boom" was built. For everyone else they were abstractions, and not just as victims -- as risks. With overworked grunts at the ratings firms cowed into adjusting the numbers till every CDO got the triple-A rating few whole corporations were awarded, traders who outearned the analysts by factors of 10 and 100 could convince themselves that even if the boom ended, someone else would be holding, in Taibbi's metaphor, the hot potato.

This is partly because they were as rapacious as the mortgage hawkers -- just smarter and better educated. And it's partly because they weren't quants themselves. Because if we're talking competing languages, here's a really scary part: as physicist-turned-risk manager John Breit told McLean and Nocera, most traders were "quantitatively illiterate. Executives learned terms like 'standard deviation' and 'normal distribution,' but they didn't really understand the math, so they got lulled into thinking it was magic." This is especially unfortunate because, as Lanchester explains, the quants themselves are terrible at predicting very unlikely events. According to their risk models, the 1998 failure of the Long-Term Capital Management hedge fund -- an early warning sign quickly forgotten -- was a "seven-sigma event" that, statistically, could only happen once every three billion years. That is, it was impossible. Nearly-as-impossible five- and six-sigma events arose "numerous times." Yet the risk models remained in place. One hopes they seem less magical now; maybe they're even more realistic. But who knows whether the worst financial crisis since the Great Depression is destined to set off disastrous aftershocks even so? Taibbi, Lewis, Scheer, and Morgenson/Rosner are the gloomiest, but no one's sunny about it. Read up on the euro and you won't be either.



As a better-informed citizen, my biggest takeaway from my million-plus words is that, as Posner especially maintains, the Paulson bailouts addressed not illiquidity, in which cash is temporarily unavailable, but insolvency, in which banks have leveraged themselves so irresponsibly that it isn't there at all. As Lanchester says, "nobody knows which banks are solvent." I'm also persuaded that the doubling of consumer debt between 2000 and 2007 was deeply unhealthy even if I see raw survival as well as rank self-indulgence in it. I'm convinced along with economist Chang that the economics profession is bad for most economies. And I also think Chang is right to argue that markets need to become less rather than more "efficient," thus allowing for the development of long-term "patient capital" as well as impeding the rapid-fire computerized trading that turns Wall Street into a rich guys' casino like nothing else. And with no more idea than Chang how to implement this sane idea, I'll resist sharing any more of my inexpert economic insights. Instead I'll conclude with a few thoughts on language, where I can claim some professional authority.

First, I feel enriched if not empowered to have gained minimal fluency in Quantish and Traderese, including a rudimentary grasp of their mathematical underpinnings. Having glanced regularly at the business pages since the crash of 1987, I find that my ease of comprehension has taken a major leap, and recommend an informal course of study to every politically concerned person. One advantage of my fluency is that it buttresses my right to voice my disdain for those who turn human beings into abstractions by making abstractions the substance of their private subcultural argot -- who think primarily in numbers. But it also buttresses my admiration for an economist like Chang, who takes care to deploy numbers humanistically.

Second, these books set me thinking about rhetoric. Partial to Lewis and Taibbi on old New Journalistic principle,  here I find their approaches inappropriate. Lewis's characters -- the most appalling a walk-on junk-CDO dealer who in one year went from bagging $140,000 in life insurance to $26 million in the banking industry -- are fascinating. By taking on the social-historical task of portraying subcultures, however, McLean and Nocera tell a more gripping story more suitable to the crisis's shape and scope. Similarly, as a lifelong partisan of impolite discourse I share Taibbi's anger that "in our media you're just not allowed to kick the rich in the balls and use class-warfare language." But flinging schoolyardese like "dumbasses" or, famously, calling Goldman Sachs a vampire squid leaves the testicles at issue unscathed. Goldman Sachs is too savvy, complex, and powerful to beat in a bar fight. Still, I was heartened to read that a few Occupy agitators took a papier-mâché squid to the streets while I was writing this. And in an October blog post called "Hit Bankers Where It Hurts," Taibbi provided one of the more focused and practical of those lists of demands with which thoughtful progressives have showered Occupy Wall Street.

My own linguistic contribution to that struggle is briefer. It's a slogan: "Tax and prosecute / We want their loot." Chant it loud. You may be screwed, but you're still proud.

 

About the Columnist
Robert Christgau is a critic at All Things Considered, writes for the National Arts Journalism Program's ARTicles blog, teaches in NYU's Clive Davis Department of Recorded Music, and has published five books. His highly searchable website is robertchristgau.com.

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