Book review: The Quants, by Scott Patterson

The quants all but wrecked Wall Street when their formulas went wrong, but they weren't colourful enough villains to become the stuff of legend, says John McLaren.

by John McLaren
Last Updated: 27 May 2011

I once read that there have been more books written about World War II than all other wars combined, and it looks as if, among volumes on bubbles and crashes, we're in for something similar with the credit crunch. The similarities are striking. Like WW2, the CC was global, threatened life as we know it, had many moments of high drama, offered a clear-cut moral line between baddies (hedgies and bankers) and goodies (almost everyone else), and featured larger than life personalities. Bizarrely, there are even some lookalikes - if Dick Fuld, the scary-skull former boss of Lehman, went anorexic, he would be the spit of Goebbels. Give Hank Paulson a tin hat, and you've got a dead ringer for Patton.

Scott Patterson is a well-regarded Wall Street journalist, and offers a pacy, thoroughly readable history of the mega-funds that relied on hugely complex mathematical models which theoretically could generate profits whatever the economic weather. As Patterson recounts, the origin of all this was a method for beating the roulette tables in Las Vegas invented by Ed Thorp, who went on to be the founding father of the 'quants'. 'Beware geeks bearing formulas,' warned Warren Buffett, but American investors and banks (soon followed by many of their European counterparts) ignored this and funds under hedge management - many using quant-style techniques - grew from around $40bn in 1990 to $2trn by 2007. The quant funds were arguably the greatest moneymaking machines ever invented. You could charge fat annual fees and skim off around 20% of any gains - as you chewed a cigar with your feet up on your desk, while your supercomputer did the real work.

Unfortunately, there turned out to be a couple of glitches. First, the models worked admirably in normal times, but went haywire in 2008 when the dirt hit the fan. Second, all the funds liked to play their strategic cards close to their chest - much like poker which, according to Patterson, was the quants' game of choice. However, this meant there was no transparency in their dealings, so when things began to unravel, no one knew what was going on, or trusted anyone else, which led to panic deleveraging, ever-spreading contagion, and ultimately to giving Wall Street and the rest of the world the hangover from hell.

Patterson provides a good blow-by-blow account of what happened in the biggest quant firms, many of which were proud to advertise their techniques through their names, like PDT (process driven trading) and AQR (applied quantitative research). If he doesn't quite match the astonishing fly-on-the-wall feel of Sorkin's Too Big to Fail, he nevertheless conjures up a convincing sense of the numb in comprehension and denial inside those firms as their precious models fell apart.

His only problem is that most of the key individuals aren't famous or interesting enough to be truly compelling villains.

Maybe geeks are just too hard to love or loathe.

The top quants made obscene sums of money, lost quite a bit, and have mainly returned to extremely well-heeled obscurity. Even their largest funds hadn't been around long enough to build up any real corporate lore.

When AIG and Lehman fell, when Morgan Stanley and Goldman Sachs tottered, it felt like giant sequoia trees were crashing down onto the forest floor. But Citadel or Saba? It's as if Brutus didn't assassinate Julius Caesar but Alius Campo, a dangerously influential spin doctor - hardly the stuff of legend. Or, to return to WW2, this book might be compared to one of those fascinating, but rather specialised histories of leading weapons manufacturers, without which there would have been no bullets or bombs, but whose stories lack the roles which Steve McQueen or Tom Hanks would have killed for.

Most books on the crash, naturally enough, aim to point out the dangers of a repetition. If Jamie Dimon, the CEO of JP Morgan Chase, is right in predicting that financial crises will occur every five to seven years, then we had better leap hungrily on any such pointers.

Patterson ends by alerting us to how the quants have moved on from derivatives to shares, in the form of 'dark pools' which instantly match buyers and sellers in vast computerised block trades, far away from the prying eyes of stock exchanges and regulators. It's a reminder that the financial world inexorably grows more sophisticated and complicated, so regulators' ability to understand and govern it can only continue to weaken. Add to this the eternal aspiration of mankind to get rich quick and there should be plenty of opportunities for future generations of geeks to wreak more damage.

The Quants: The maths geniuses who brought down Wall Street

Scott Patterson

Random House Business Books £12.99

- John McLaren is chairman of the Barchester Group

Find this article useful?

Get more great articles like this in your inbox every lunchtime

Martin Sorrell: “There’s something about the unfairness of it that drives me”

EXCLUSIVE: The agency juggernaut on bouncing back, what he would do with WPP and why...

The 10 values that will matter most after COVID-19

According to a survey of Management Today readers.

Why efficiency is holding you back

There is a trade-off between performance and reliability, but it doesn’t have to be zero-sum....

A simple way of achieving work-life balance

A new study has looked into the impact of setting boundaries - and how organisational...

35 Women Under 35 2020: Britain's brightest young business leaders

As the UK heads towards the worst recession for decades, these talented young businesswomen will...

Gratitude as a management tool

A simple thank you can go a long way.