Financiers Still Aren't Rocket Scientists

Over at Slate, John Dickerson has a piece expressing amazement that "numbers guy" Mitt Romney was so badly misinformed about the election. While I'll admit to a certain amount of schadenfreude about the general bafflement of the Romney campaign and the Republicans generally, this particular slant (which Dickerson isn't the only one to take, just the latest in a series) is more annoying than entertaining.

You would think that the 2008 economic meltdown, in which the financial industry broke the entire world when they were blindsided by the fact that housing prices can go down as well as up, might have cut into the idea of Wall Street bankers as geniuses, but evidently not. The weird idea that the titans of investment banking are the smartest people on the planet continues to persist, even among people who ought to know better-- another thing that bugged me about Chris Hayes's Twilight of the Elites was the way he uncritically accepted the line that Wall Street was the very peak of the meritocracy. It's not hard to see where it originates-- Wall Street types can't go twenty minutes without telling everybody how smart they are-- but it's hard to see why so many people accept such blatant propaganda without question.

Look, Romney was an investment banker and corporate raider at Bain Capital. This is admittedly vastly more quantitative work than, say, being a journalist, but it doesn't make him a "numbers guy." The work that they do relies almost as much on luck and personal connections as it does on math-- they're closer to being professional gamblers than mathematical scientists. This is especially true of Bain and Romney, as was documented earlier this year-- Bain made some bad bets before Romney got there, and was deep in the hole, and he got them out in large part by exploiting government connections and a sort of hostage-taking brinksmanship, creating a situation in which their well-deserved bankruptcy would've created a nightmare for the people they owed money, which bought them enough time for some other bets to pay off.

Romney has no shortage of nerve, and while he creeps me out, he has the sort of faux charm that works well in the finance community. But he's not a "numbers guy" in any sense that looks meaningful from over here in the land of science. He can do the math needed to add up his personal fortune, but the game that he made his money playing isn't a rigorously mathematical one-- people get rich in finance as much by playing hunches and cutting sharp deals as by crunching numbers. There are people who make their way in that business by taking a rigorously data-driven approach to investing-- one of the many things I need to write up for the blog at some point is a review of a forthcoming book called The Physics of Wall Street-- but they're nowhere near a majority of the industry, and Romney's not one of them.

Nobody should actually be surprised that Romney's campaign cooked the books as badly as they did, because that's what his class of Wall Street sharks do-- they take quantitative data as a starting point, but they make their money betting against the simplest numbers. They make "gut" decisions all the time, and slant their projections in a way that justifies what they want to do. When one of their bets come through, they rake in huge amounts of money, when it doesn't, they chop up the company and sell the pieces to cut their losses. And when a disaster that thousands of other people see coming a mile off blows up in their faces (the housing crash, or last Tuesday's election), they're left utterly flabbergasted.

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I've just launched a personal campaign to expunge the term "data-driven" from popular discourse: there is a meaningful alternative, "data-informed", which lacks the faux objectivity and scientism of the notion that the conclusions we reach from data are always or mostly clear and obvious. Information cannot be given the authority to make decisions about the destinations we should look towards or the interpretations we put on it--human interpeters of data do that, and are merely attempting to obfuscate their choices by ascribing an impossible level of agency to the information they are arguing supports their perspective.

By Fred Mindlin (not verified) on 12 Nov 2012 #permalink

Take the UK

Official government debt - 1.1 trillion GBP.

Er? That's the borrowing, that's not the debt.

You can have lots of debt that isn't the amount you've borrowed. They are cooking the books on a scale that is unimaginable.

For example, we can find out an estimate of what has been hidden of the books for one of the state run pension schemes. It's 4.7 trillion.

Add up all the other debts and it comes to around 7 trillion.

What's government tax revenues? 0.57 trillion.

The UK government is 13 times geared.

None of these debts are anything to do with the City or wall Street. It's the other way round. It's a fraud run by politicians.

To put the losses from the banking mess in context, the losses in the UK are zero. The government has just booked a 35 billion profit from lending at penal rates to the banks.

Swap Wall streat in your comments for the word Jew, and ask, would that be an acceptable statement to make? I suspect not.

The real crisis is government Ponzis, by a huge amount.

"they’re closer to being professional gamblers than mathematical scientists."

Aren't the best professional gamblers good numbers guys? Like the MIT blackjack players of lore and the like?

The Wall Streeters are more like professional Calvinball players - they change the rules (or make them up) as they go along.

Professional gamblers need to know the odds of their games very well, but they also, particularly in poker, have to go against those odds sometimes. Otherwise, it would be impossible to do as a profession at the highest levels-- if you had a bunch of robots running identical algorithms play poker against each other, over the long run, you'd expect them all to end up with identical records. There's some element of bluffing and guessing, and trying to model the behavior of other players, and those factors play a big role in business as well, probably at least as big as sheer number crunching.

I think there is a similarity between quants working in the securities bubble and wonks working in the Romney campaign that isn't being acknowledged: for most of them there was no upside in talking about expecting a big crash. In the bubble it wasn't enough to think that things were inevitably going to go pear-shaped: unless you knew roughly *when* the bubble was going to pop you couldn't take advantage of your knowledge. If you talked about your lack of confidence in the market to your boss or, god forbid, your clients, it was time to kiss that six or seven figure income goodbye. Your job was to exploit overconfidence, not predict its demise. The incentives were all set up to ignore the risk.

The situation was similar for the Romney campaign and pundits on the right. Their job was not to be the oddsmakers who correctly called the game; they were there as players and cheerleaders, respectively.

Nate Silver did his job: oddsmaker.

Fox News did its job: cheerleader. Part of being a cheerleader in this game is gainsaying the oddsmakers when they say your team will lose.

I doubt very many people at the top levels of Romney's campaign or the true quants of the bubble were honestly flabbergasted when things finally fell apart. They just had to play the part for the cameras/clients.

@Mike: Completely agree, I've always seen quants as making a sort of Faustian bargain. In return for obscene salaries they merely need to create as complex and opaque a screen of mathematics as possible between their bosses' whims and their customers understanding of risk; oh, and leave their consciences behind.

It would be lovely to envisage a Nate Silver for the world of finance... But I can't see any way for that to happen the way the system currently works.

By Jim Millen (not verified) on 12 Nov 2012 #permalink

Chad, the reason people think rich people are smart is that they're rich. Most people aren't even capable of distinguishing the two. Even some of the ones who are will cynically tell you that rich smart is the only kind of smart that matters.

The readers of this blog are able to understand the distinction between people who are good at money numbers and people who are good at science numbers, and the different kinds of intelligence the fields require, but most people aren't.

In my opinion, the true job of quants is to conceal bankruptcy fraud.

If you make $10,000 on 99.99% of days and lose $10,000,000 on 0.01%, it looks like a fair bet, but of course you plan on declaring bankruptcy when the loss comes. Quants hide the fact this is the game they are playing from the counterparties and frequently from themselves as well. They manage to do so because the counterparties are all themselves engaged in less outrageous looking bets and winning and losing (essentially from and to the other counterparties, hedged against each other) all the time.

By Alexander Woo (not verified) on 12 Nov 2012 #permalink

Mitt Romney's refusal to release tax returns prior to the past two years also suggests the likelihood that a good part of his financial success has come from arbing/gaming the tax code (in ways that may be perfectly legal but which have no true economic value, generating profits from technical paperwork sleight of hand that increases after-tax profits without improving the underlying fundamentals of the business.)

By Mary OKeeffe (not verified) on 12 Nov 2012 #permalink

Sociopaths, like logs of fatty shit, always rise to the top.

On Wall Street they call themselves "Masters of the Universe."

By Egmont Ouerveture (not verified) on 12 Nov 2012 #permalink

Masters of the Universe, whatever field they are in (financial, political, military, etc.), have a pronounced tendency toward hubris. Mitt Romney is no exception to that rule. Often they fall because they get high on their own supply, just as the Romney campaign did, and only come down when reality hits them in the face.

Financiers don't always come down, because (as pointed out above) their actual game is Calvinball. It's easier to win when you make up the rules as you go along.

By Eric Lund (not verified) on 13 Nov 2012 #permalink

Chad: re: poker, the best professional poker players go against the odds *really* rarely. As a poker player, you figure a range of hands that your opponent could be on (including bluffs), the weighted odds that you'll win against those hands, and the expected payoff in the different scenarios.

The best poker players can run these numbers quickly, or just have a much more intuitive feel. They also read their opponents better, so they have less uncertainty about their chances to win.

By Windchasers (not verified) on 13 Nov 2012 #permalink

I almost hesitate to comment reading how truly informed most of the people are who post here: I are just a simple liberal arts grad. But I did read this book called Black Swan that makes me think there is way too much hubris out there (and perhaps here as well).

After all, aren't most of the quants (which I kind of see as different than the Romney types who simply have a lot of money and mug someone) out of some of the best business schools with highly specialzed mathematical degrees?

And many of them have created brilliant mathematical models showing the inevitability of their actions making money (at least for them).

But I'm also reminded of this concept called "Tragedy of the Commons" whereby everyone does immenently rational and self interested things that taken all together and put into one system crashes the system.

It really seems that this ability to take into account a larger whole, with many more variables, is why Obama was successful and Romney was not in this last election.

By DuaneBidoux (not verified) on 13 Nov 2012 #permalink

@Duane: Romney and the quants are indeed different, but not in the way you imagine. Romney has an MBA from Harvard. He is the second MBA holder to win a major party nomination for President. The first was George W. Bush, who also got his MBA at Harvard.

The quants were typically people with Ph.D. degrees in physics or mathematics who turned their modeling skills to financial instruments. They seem to have gotten some assumptions wrong, notably the distribution of outcomes, but those assumptions seemed reasonable given what was known at the time. Their bosses (who typically did have business degrees from top universities) felt no need to understand the limitations of the quants' models as long as their companies were raking in the dough. Alas, there is a key difference between academic science and the financial world: when academic scientists make plausible but wrong assumptions (a common occurrence, and an important part of how science advances), they generally don't endanger the world economy. Also, academic scientists' colleagues are more likely to understand the limitations of the models and therefore not compound the problems when the models go spectacularly wrong.

By Eric Lund (not verified) on 13 Nov 2012 #permalink

Closer to professional gamblers - I think they're even closer to junkies. Way too many Wall Street people make their decisions because this is how they get their thrills. They get a rush from contemplating how much money they're screwing with. And a lot of them are drug users. Even the one's that aren't have their egos tied up in this. Their personalities get wrapped around dollar signs, because they're sociopathic and money is how the keep score. To them it's a contest to see who can move the most money. So every time a deal gets made on Wall Street or by Wall Streeters, in some part it's going to be done the way it is because some guy who's using cocaine wants to be able to brag in the club about how badly he hosed someone in that deal. Wall Street business is legalized psychopathy.

Alternate explanation.

Romney's lying. And he's basically doubling down on the lie.

I have no difficulty believing that the Romney camp kept assuring the major donors (and others) that they were virtually certain of winning. Nor do I have any difficulty believing that Romney and his inner circle managed to talk themselves into believing they had a solid (and maybe better than even) chance of winning.

I'm extremely dubious of the idea that Romney and his inner circle genuinely thought victory was anywhere near certain. I find it much easier to believe that they simply don't want to admit that they were lying about this all along.

By Michael I (not verified) on 13 Nov 2012 #permalink

another thing that bugged me about Chris Hayes’s Twilight of the Elites was the way he uncritically accepted the line that Wall Street was the very peak of the meritocracy

Because Chris Hayes was almost certainly using the word meritocracy in the sense Michael Young coined it back in the 50s. The important thing about the system Young called meritocracy is that the people in it believe that merit justifies their status.

It did, the first time out, they passed the exams, they built their careers. Next time out, they change the rules to ensure that it's their kids and their kind of people who are selected. Importantly, they don't feel any need to change this, any guilt, any noblesse oblige, because they believe they're there on merit.

It's not how the elite is formed; it's how it's justified.

Mike makes a good point that Nate Silver more fully explores in his book. It's not that no one sees signs of a bubble - there were articles warning of the dot-com bubble and of the housing bubble - it's that the timing is basically unpredictable.

Four scenarios:
1) You buy and the market keeps going up. Good times, you get a bonus just for following the pack.
2) You buy and the market crashes. Not good, but everyone's in the same boat so you keep your job.
3) You sell and the market keeps going up. You look bad. You probably won't be inclined to sell again next month. If this scenario repeats for a few months, you're likely to get fired.
4) You sell and the market crashes. You look smart, you make some money, maybe even get some celebrity as the person who beat the market.

The problem is, even when there are signs that the end is coming, it may be years off. You'll have years worth of option 3 and lose your job long before the prediction comes true.

Mike being the other Mike on 11/12, not me on 11/14

I don't like Romney, but this is a flawed entry. It is like reading some paleo-Republican opine on science. Romney was never an investment banker. Nor was he a corporate raider (a term which no one really uses since the 80s). He was a partner in a PE fund, and by all accounts was outstanding. This is an industry full of guys who got 800 on their math SATs. Admittedly, nothing they do even requires calculus. But, outside of some parts of academia, engineering and medicine, you will not find a sharper cohort.

By Rob Aiello (not verified) on 16 Nov 2012 #permalink