January 11, 2010
As Americans worry about our nation’s competitive edge, observers note that there’s a crisis in recruitment for the fundamental and applied sciences that are the foundation of a country’s technical prowess. Science graduates are demanding that potential employers “show me the money.” Lawrence Krauss observes in New Scientist,
…young people interested in a productive career [have had] two choices: take a technically demanding route and become an engineer or scientist, guaranteed to earn a respectable middle-class income, or go into the financial world, where the long hours are taxing but the intellectual demands much lighter, and the potential pay-off far greater. In the market-driven First World, is it any wonder that hard-working students are choosing the latter route?
This position contrasts with that of bright, young people in the Third World, where it is clear that the path to prosperity is a scientific or technical education. I recently lectured at the Indian Institute of Technology in Kharagpur, where only one out of every 121 applicants is admitted – a smaller percentage than at Harvard. Enrollment virtually guarantees a job as an engineer at a multinational corporation, with the possibility of starting up your own company a little further down the road.
And there’s the rub. Investment bankers and venture capitalists manage and help create wealth by building on ideas, but ultimately it is to developments in science and engineering that about half the growth in US GDP per capita over the last half-century can be attributed, according to the National Academy of Sciences’ report Rising Above the Gathering Storm, published last year.
Where then will we find ourselves a generation from now? In a world that is increasingly technological and increasingly “flat” – free of barriers to trade or capital flows – how long can a country thrive on managing wealth rather than creating it?
(See also this recent study.)
And then there are those who argue that the problem isn’t what these budding young scientists aren’t doing, it’s what they are– those who blame these Wall Street “rocket scientists” for the financial crisis through which still we struggle. For example, Sebastian Smith in PhysOrg suggests that
…there’s a reason Wall Street resembles a rocket experiment gone wrong: rocket scientists helped make it happen. Known as quants, these are the mathematicians and physicists who devised the financial instruments and computer programs fueling stock markets’ spectacular rise and collapse.
And while in good times they became financial rock stars, quants — short for quantitative analysts — are now being cast as villains of an industry that abandoned its values.
“They thought they could make it easier to make money, one New York investment manager, speaking on condition of anonymity, told AFP. “They thought you don’t need to do your homework anymore.”
Calvin Trillin put it more directly (and more humorously) in The New York Times, quoting “a man sitting three or four stools away from me in a sparsely populated Midtown bar”:
“The financial system nearly collapsed,” he said, “because smart guys had started working on Wall Street”…
“Two things happened. One is that the amount of money that could be made on Wall Street with hedge fund and private equity operations became just mind-blowing. At the same time, college was getting so expensive that people from reasonably prosperous families were graduating with huge debts. So even the smart guys went to Wall Street, maybe telling themselves that in a few years they’d have so much money they could then become professors or legal-services lawyers or whatever they’d wanted to be in the first place. That’s when you started reading stories about the percentage of the graduating class of Harvard College who planned to go into the financial industry or go to business school so they could then go into the financial industry. That’s when you started reading about these geniuses from M.I.T. and Caltech who instead of going to graduate school in physics went to Wall Street to calculate arbitrage odds.”
“But you still haven’t told me how that brought on the financial crisis.”
“Did you ever hear the word ‘derivatives’?” he said. “Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn’t have done the math.”
“Why do I get the feeling that there’s one more step in this scenario?” I said.
“Because there is,” he said. “When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”
But in fact, Trillin’s drinking buddy notwithstanding, the tradition of brilliant mathematicians and physicists “going over” to Mammon is centuries old. Indeed, arguably the greatest scientific mind of all time, Isaac Newton, capped his extraordinary career with stints as Warden, then Master of the Mint.
It was a job that Newton took deadly seriously. At the time of his first appointment in 1696, the British currency had been so seriously debased by clipping and counterfeiting during the Nine Years’ War that all English silver coinage was recalled. Newton’s extraordinary knowledge of chemistry and math saw him– and the English Mint– through the crisis. Building on that success, Newton oversaw the recoinage in Scotland, which resulted in single currency for the UK; then spent the rest of his life– he kept the Master’s post until his death in 1727– protecting the coin of the realm from the bogus and the bent. (For a taste of his zeal, see Thomas Levenson’s terrific Newton and the Counterfeiter: The Unknown Detective Career of the World’s Greatest Scientist.)
So mathematicians and scientists have worked with– and for– money since the Enlightenment. But one huge difference does jump out: The rocket scientists of today are (to quote Trillin) ” securitizing things that didn’t even exist in the first place”– pushing the limits of money and value. From the specious (CDOs) to the nefarious (front-running), the best minds of our time have devoted themselves to finding ways to conjure return out of (what turns out all too often to be) thin air… and as we all know, if it seems too good to be true, it is.
Conversely, Newton devoted himself to protecting the economy by policing the currency that fueled it; he devoted himself to assuring that the system was stable, trustworthy.
So while our society could surely do with a renaissance of interest in actually practicing science and technology, the fact that many whiz kids want to enter finance isn’t in itself a problem. The problem, as Newton’s example reminds us, is how those prodigies want to use their gifts.
Filed in Competition and Industry Structure, Economic, Entrepreneuring, Information Industry, Scenario Planning, Social, Technological
Tags: Calvin Trillin, CDO, competitiveness, engineering, Financial Crisis, financial engineering, front-running, Isaac Newton, Master of the Mint, mathematics, Rocket scientists, science, Sebastian Smith, technology, Thomas Levenson, Wall Street, Warden of the Mint
August 10, 2009
source: The New Yorker
“As we grow older and more experienced, we overrate the accuracy of our judgments.” -Malcolm Gladwell
A friend, Mick Costigan, recently sent along a pair of articles suggesting that there’s good reason to be circumspect about the long-term prospects for the securities rally that’s lightened the hearts of investors this summer.
John Authers in Saturday’s FT and Mish Shedlock quoting David Rosenberg serve up historically-informed reasons for careful skepticism about the recent rally and where we can go from here. Just to be clear on analytical frames, Authers has a very differentiated technical analyst viewpoint and uses this to makes some very scary points about parallels with the bear market rallies of the 1930s, while Mish Shedlock, who is personally more of the Austrian school of “we need a cleansing recession, abolish the Fed etc., Keynesian stimulus doesn’t work” view, is quoting Rosenberg who is more mainstream skeptical.
Both are fascinating reads (though best avoided immediately before children’s birthday parties, weddings, or other occasions on which radiant optimism and good spirits are in order).
I raise them here, as I found them evocative of yet another argument. In “Cocksure,” Malcolm Gladwell offers an explanation of the train wreck on Wall Street:
Since the beginning of the financial crisis, there have been two principal explanations for why so many banks made such disastrous decisions. The first is structural. Regulators did not regulate. Institutions failed to function as they should. Rules and guidelines were either inadequate or ignored. The second explanation is that Wall Street was incompetent, that the traders and investors didn’t know enough, that they made extravagant bets without understanding the consequences. But the first wave of postmortems on the crash suggests a third possibility: that the roots of Wall Street’s crisis were not structural or cognitive so much as they were psychological.
Wall Street and it’s captains were both overconfident, Gladwell suggests, and not confident enough. On the one hand Jimmy Cayne (the Bear Sterns ex-CEO who is the object lesson in Gladwell’s essay) and his ilk were breathtakingly hubristic. On the other, in a business that depends absolutely on the faith and trusting cooperation of counterparties to the deals one wants to do, he and Bear Stearns were ultimately undone the evaporation of that investor confidence.
Bear Stearns did not collapse, after all, simply because it had made bad bets. Until very close to the end, the firm had a capital cushion of more than seventeen billion dollars. The problem was that when, in early 2008, Cayne and his colleagues stood up and said that Bear was a great place to be, the rest of Wall Street no longer believed them. Clients withdrew their money, and lenders withheld funding. As the run on Bear Stearns worsened, J. P. Morgan and the Fed threw the bank a lifeline—a multibillion-dollar line of credit. But confidence matters so much on Wall Street that the lifeline had the opposite of its intended effect.
All of this is of course history. But it seems to me apposite to the arguments Mick cites. It’s hard for me to escape the sense that the market– and more broadly, that we in the developed world– are on the horns of the same “overconfident – not confident enough” dilemma.
Gladwell reports that our tendency to overconfidence in our own judgement grows as we mature and succeed, and that our tendency to apply that overconfidence rises with the stakes; citing a episode recounted in Military Misfortunes (an old GBN Book Club pick that I highly recommend), he notes:
As novices, we don’t trust our judgment. Then we have some success, and begin to feel a little surer of ourselves. Finally, we get to the top of our game and succumb to the trap of thinking that there’s nothing we can’t master. As we get older and more experienced, we overestimate the accuracy of our judgments, especially when the task before us is difficult and when we’re involved with something of great personal importance. The British were overconfident at Gallipoli not because Gallipoli didn’t matter but, paradoxically, because it did; it was a high-stakes contest, of daunting complexity, and it is often in those circumstances that overconfidence takes root.
Which is all to suggest, in the context of the articles that Mick sent, that we might on the one hand understand the updraft in the stock market as a kind of social overconfidence, a mass projection of the belief that “we can lick this just as we have before”… even if this isn’t a situation just like one’s we’ve seen before.
On the other hand, we might worry that we have the resolve– rooted in true and deep confidence– to make it stick. As we encounter the bumps that will inevitably accrue as deleveraging continues, will we have the conviction to continue to invest long?
For my part, I do worry. While I find the optimism that’s driving this rally heart-warming, I just can’t find the justification in the facts of the market. Perhaps that’s just because I’m not looking in the right places. But in any case, I worry that the short-attention-span culture (and infrastructure) that’s grown up in the financial sphere (as in so many others) effectively undermines any real chance that this optimism can survive the as-yet-unknown-but-inevitatble shocks it will encounter. It’s very, very hard to sustain broadly-engaged commitment for the long run in a “what can you do for me instant?” investment community; it’s harder still, when players’ confidence has been as badly shaken as over the last couple of years it has been.
More generally, this is one of my main concerns for the Obama Administration’s economic recovery plans: to the extent that those programs depend on our collusion– the active cooperation/participation of citizens-at-large– over time, they require us to be patient [in some cases, forbearing], understanding, and at least a little self-sacrificing– characterisitics that seem to have waned with U.S. ascendency over the last few decades…
It’s all got an uncomfortably fin de siecle-like feel… which should perhaps be no surprise, given Gladwell’s argument: we’re a mature society/economy, victims both of the too-often preterconscious cocksureness that comes of having grown up in success, and at the same time, of the nagging doubt that resides in knowing, somewhere deep inside, that nothing lasts forever.
And so, to the two reasons for wariness that Mick sent along, we might add another: the real danger that we will fail to find the effective balance between too much and too little confidence.