In "The Quants," Wall Street Journal reporter Scott Patterson paints a vivid and highly readable portrait of a little-known and less-understood coterie of key players in the Wall Street meltdown. Like Icarus, they soared high for a time on exhilaration, pride, and wings of their own making. Too high, as it turned out. Unlike Icarus, they dragged with them the savings and wealth of millions when they plummeted to earth.
Quants is short for quantitative investors, who used "brain-twisting math and super-powered computers to pluck billions in fleeting dollars out of the market." Patterson tells us the quants "couldn't care less about a company's 'fundamentals,' . . . . That was for dinosaurs of Wall Street, the Warren Buffetts and Peter Lynches of the world." Their goal was to discover The Truth, "a universal secret about the way the market worked that could only be discovered through mathematics."
In 2006, Business Week magazine described "the quintessential quant." From Ph.D.s with "nosebleed" grades in applied mathematics, computer science, or physics from M.I.T., Cal Tech, or the Indian Institutes of Technology, quantitative investment firms would select one candidate in 1,000. For several years, their computerized wizardry, capacity for 20-hour work days, take-no-prisoners competitive drive, and personal greed earned millions for their clients and themselves, and sometimes billions for the hedge-fund owners and banks.
Some of the luminaries were as eccentric as they were brilliant. Peter Muller, manager of a Morgan Stanley hedge fund, would ride the New York subway, singing Bob Dylan songs and accompanying himself on a keyboard, "his keyboard case sprinkled with coins from charitable commuters with no idea the seeming down-on-his-luck songster was worth hundreds of millions and flew around in a private jet."
So what went wrong? Partly, it was the bursting housing bubble, which shrank over-leveraged portfolios of hedge funds and banks, forcing them to raise capital by selling their most liquid holdings. These selling frenzies drove down the prices of many corporate stocks that the quants' formulas had predicted would increase in value.
The underlying flaw, according to one of the quants' critics, was that the emotions, decisions, and events that control markets can be so volatile, extreme, and unpredictable that no mathematical model can capture them.
The math geniuses should have heeded the warning of the greatest mathematician of all, Isaac Newton: "I can calculate the motion of heavenly bodies, but not the madness of people," he wrote.
Have the quants been discredited and banned from Wall Street? Far from it. Some believe that "would be tantamount to banishing civil engineers from the bridge-making profession after a bridge collapse." No, the quants are back with faster computers, more dazzling formulas, more opaque markets, and apparently no loss in self-confidence. Patterson's closing chapters are ominous.
If you are so disgusted with Wall Street that you don't want to read or think about it -- and such a reaction may be common -- then this book is not for you. But if you want to know what happened to your 401(k) plan savings and why, Patterson provides a large and easily digestible slice of the answer.
Hugh Ryan of Barrington co-authored a book with two investment managers: "WealthBuilding," on retirement savings. He can be reached at firstname.lastname@example.org.