Tuesday, November 11, 2008

The Myth of Wall Street's Genius

Michael Lewis has a long piece in Portfolio called "The End of Wall Street's Boom" that I highly recommend. A recurring theme in the piece is that Wall Street financiers just aren't as smart as everyone thinks they are. I couldn't agree more. Virtually no press account of the financial crisis is complete without paying homage to how smart the financiers who got us into this mess are. (Usually the homage is paid by referring to the "financial wizards on Wall Street," or asking how "some of the smartest people in the world" ended up being so terribly wrong?") Wall Street's perceived genius has reached almost mythic proportions, especially among clueless pundits like David Brooks and Sebastian Mallaby. I was never terribly impressed with the overall level of intelligence on Wall Street when I worked there in the '90s. But since returning to Wall Street (or more accurately, Greenwich/Wall Street) a couple months ago, I've been shocked by how many utter morons there are now in financial houses and hedge funds. I've encountered more than a few traders who, when pressed, reveal a very meager understanding of their own product. The one area that seemed to attract genuinely brilliant people back in the late '90s and early '00s was risk management. But no more. Risk management departments are now disproportionately populated by spoiled Harvard legacies with no apparent intellect. All the genuinely smart people I knew on Wall Street back in the day seem to have moved on to hedge funds or retired. I'm not saying there aren't any brilliant people in the big financial houses (there are), I'm just saying that they're the exception rather than the rule. More generally, though, I think the current financial crisis pretty well demonstrates that Wall Street financiers aren't, in fact, "some of the smartest people in the world." I wish the media would put that ridiculous myth to bed.


View From the Top said...

Your view is a privileged and naïve one. When you’re a news anchor with zero finance experience and poor logical reasoning skills "wall street wizards", “economic wizards” are the smartest people in the world. Therefore, while Wall Street financiers aren’t the smartest--- they are really smart, news anchors most certainly are the dumbest. This is based on academic major and general qualifications needed to get an anchor position. Detailed fact based journalist in the Edward Murrow tradition may fare better in understanding context, but structured finance products are so black box you really need a quant Ph.D to understand it all.

With all that said even the smartest people have a problem overcoming greed.

Good night, and good luck.

John B said...

Indeed, while your average arb trader mightn't be the sharpest tool in the box, the quant modellers are the best maths and physics PhDs from the best universities. You need to redefine 'smart' fairly radically before they don't qualify.

Economics of Contempt said...

John B & View from the Top -- I guess I wasn't clear enough, but my point was that while you do need to be very smart to fully understand structured finance products, most people on Wall Street don't actually understand a lot of the structured finance products.

And John B, I agree that most quant modellers are genuinely brilliant, but they have very little influence (and get even less respect, bizarrely). Traders are the ones who put the products the quants design into the marketplace, and a lot of those kids are true blockheads.

(Speaking of arb traders, I wonder how John Meriwether, Haghani et al. are doing in their new fund. My guess is badly.)

View From the Top said...

I think this is another case where technology is beating the human. So for traders sophisticated algorithms are used to execute transactions in program trading schemes which only require one to input a bunch of numbers, and presto something comes out the other end. The complexities of the algorithms are not always intuitive or make understanding why they latched onto certain data or relationships clear. As far as why quant modelers not getting fully respected by the trading community, I get the sense they are viewed as part of the “problem” contributing to job loss. Jobs once done by human traders are being switched to computers. Add to the fact really good traders are front line and stationed at a prop desk. Therefore really good traders take all the money off the table. As we all know, on Wall Street compensation equals respect. This respect influences hiring and promotion decisions to follow a certain type of past “successful” previous profiles i.e Harvard, Yale legacies. Also Wall Street’s memory is very short when it comes to crisis and losses, so pedigreed but not always qualified candidates get first dibs. Therefore block head begets blockhead ad infinitum. While you’re typical investment banker is simply ignorant and greedy and simply does not know enough and care to.

Meriwether, Haghani et al. (JWM Partners, LLC) are hurting bad.

Anonymous said...

" I guess I wasn't clear enough, but my point was that while you do need to be very smart to fully understand structured finance products, most people on Wall Street don't actually understand a lot of the structured finance products.

The bankers do not understand the structured products. For that you need to call some fifth year associate at one of the large law firms that actually wrote all the paper and had to THINK about what the heck it means. But the bankers? I think not.


A bull market makes a stock market genious.

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