The Quants: Discussion kick-off

Okay, I guess it's officially time for me to repent of my idleness.  (If I may provide my excuse, I've spent my free time the last few months installing sod, sprinkler, drip irrigation, a garden, and most importantly, building a sandbox).

A few disclaimers: First, I listened to the abridged while navigating California traffic to and from work, so I now feel like I know just enough about the world of quantitative economics to make a fool of myself.  Second, I will be referring to the main characters in this book as "quants" for convenience, even though I recognize that there are those who would consider some or all of the main characters not to be true quants.

Here my discussion questions:

1) Is Wall Street moral?

I wish Patterson ventured more into the morality/ethics of the quants.  I thought he gave some suggestion of how he thinks I should feel about the quants in his description of their decadence, and in his constant gambling analogies.  I think he tried to portray the crash as judgment from on high (i.e. from the god of this 'the truth' he keeps talking about).  But honestly, without a more thorough analysis of the costs and consequences of the various trading strategies the quants employed, I'm not exactly sure how to feel.  For example, were the quants really making money out of thin air (or rather adding value to the overall economy), or is there some group of people that ultimately lost as a result of the money the quants were able to make?

I guess this discussion hints at the question that bugged me most throughout the book.  Where do you draw the line between investing--which I think has a fairly obvious social and economic benefit--and exploitation or gambling?  Is finding a way to beat the market essentially the same as finding a way to beat the dealer, or is there an underlying economic benefit that is realized in, e.g., day trading or arbitrage?  One benefit that was hinted at was that of correcting prices when uninformed traders shift them out of balance.  But does this benefit justify the payout that the "quants" were able to make?  And is it fair to so harshly penalize unwise traders for daring to trade without spending years and millions of dollars in computer systems to gather the same information that the "quants" were able to harvest?

I'm not saying that I think all investment fund managers are evil--I, for one, value some of the services that they theoretically provide--i.e. educating themselves about the best investment opportunities and investing my money based on the information they learn.  But I'm skeptical about the underlying morality of many of the strategies the quants employed.

I guess I see the market as a system (albeit an imperfect system) for allocating capital to the most productive causes, and most other uses of the market seem like exploitations of flaws in the system.  But then again, what do you do to fix things?  You can't, for example, ban short sales simply because (as I suspect) they usually have no benefit to the overall economy, because then what do you do about those times when they do have a benefit?

2) Does the solution have something to do with leverage?

Here's my ignorance shining through, but were the hedge funds at all regulated in their use of leverage?  At any rate, I can see the benefit in having some flexibility to borrow money, but the leverage ratios Patterson mentioned seem very dangerous.  Theoretically, of course, it shouldn't matter.  I firmly believe that, in theory, people should be allowed to be dumb and face the consequences of being dumb.  But when a hedge fund collapses, it's not just the hedge fund (or their investors, or their creditors) that are harmed.  It leaves a hole in the economy.  And when you have enough people acting stupidly enough, with enough leverage involved, it leaves a very big hole in the economy that hurts many who didn't necessarily have it coming to them.

3) Did the quants really play as big of a role in the crash as Patterson makes out?

I really don't know.  I think it's possible.  When you have enough computers trading fast enough for long enough on (inevitably) flawed models with enough leverage, I think systemic consequences are possible.  But I really would like to hear more from Jesse here, because I just don't know enough about the big picture.

4) Should the quants have seen it coming?

I wish the author had also spent time exploring the big picture impact of the various strategies employed by the quants on the rest of the market.  Surely the quants were bright enough to realize that their strategies would have a butterfly effect on the rest of the market, and the effect would become larger the more the strategies were exploited.  That being the case, should someone have, or did someone, recognize that they could have been creating a bubble.

5) Adaptive Market Hypothesis.  Not a question.  But if economic theories were women, and if I weren't already married, I'd be trying to get AMH's number right now.  Not sure where things would go with her though.

6) I made a note to myself to write about the last line(s) of the book.  I erased my audible copy (no, I don't plan on listening to it again), and I can't find the text, so I can't remember why.  I think it may have been related to my favorite Alan Greenspan quote of all time, but I'm not sure.  Anyway, nevermind.

7) What is the moral to Patterson's narrative?

I see Patterson's narrative as his attempt to tell a tragedy--essentially a cross of Icarus and the Tower of Babel.  The problem is, I'm not so sure the real-life characters would have seen things that way.

Well, that's all I have time for.  And I won't be too surprised if no one else picked the book up.  But feel free to comment anyway.