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Rise of the Machines: How "Quant" Trading Triggered the Credit Crisis

Posted Feb 11, 2010 04:19pm EST by Aaron Task

Greedy CEOs, bad regulators, short sellers, debt-happy Americans, and politicians of all stripes have been blamed for the great credit crisis of 2008. Add another name to the blame list, says Scott Patterson, staff reporter at The Wall Street Journal: Quants, which is shorthand for the elite mathematicians and computer experts who've come to dominate trading in recent decades. As chronicled in Patterson's new book "The Quants", the runaway success of computer-driven trading in the 1980s, '90s and early '00s led to complacency and hubris, ending in near total disaster for Western-style capitalism. "Mathematical constructs" such as CDOs, derivatives and mortgage-backed securities "caused banks essentially to implode," Patterson says, placing blame for the credit crisis squarely on the quants. Recalling the 1987 crash and the 1998 Long Term Capital Management saga, Patterson notes the 2007-09 credit crisis wasn't the first time quant creations nearly blew up the financial system. Nevertheless, the CEOs of big Wall Street firms had little or no idea what their own proprietary (or "prop") trading desks were doing, just that they were generating huge profits - until suddenly it all went wrong. Even more frightening, Patterson says very little has changed in the aftermath of the market's latest near-death experience. "All of Wall Street [trading] is really quantitative - there's very little that's not," he says. "When you peel the onion you're going to find a math guy sitting in the midst." So what chance do "Mom and Pop" investors have against a room full of PhDs totally focused to finding market opportunities? Not much, Patterson says, holding out little hope than any of the proposed regulatory changes will really change the game, or the odds.


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Comment by Tejamoy Ghosh on February 23, 2010 at 10:38pm
Predictive analytics, tactical asset management and optimization would surely help extract the best out of resources. Now having said that, predictive analytics would probably need to expand its scope to be able to raise a flag for black swans - I'm optimistic, in fact, confident, about our collective intelligence to get us there.
Comment by Larry on February 16, 2010 at 7:06am
There certainly is enough blame being thrown around. Its really interesting to listen to all of these complaints about who caused the credit crisis. When its being written in history I have a feeling that the consensus is going to be that there was not one thing but many things that caused the crisis.

If you really want to put a label on the cause it simply just comes down to greed.

On an optimistic note I believe the "Quants" can help save the credit crisis in the future. Predictive analytics, tactical asset management, and optimization can help fund managers and investors make the most of their resources. Its a matter of learning from past mistakes and applying new objectives.

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