Of Quants and Kings

There is a lot of speculation that nerds contributed to the global financial meltdown with all their fancy pants statistical models that didn’t work. Neeeeeeerrrrrds!

The story goes something like this: The nerds emigrated from physics and mathematics to wall street for better paying jobs and fancy cars. The banks needed them to do their modeling wizardry with derivatives, so that the banks would know what and when to buy and sell, to make money and all that. This is called risk management, and the nerds were renamed quants. Meanwhile, the SEC was wooed by these new computer models, they seemed so sciencey after all, and began turning a blind eye to the whole process. Without proper regulation, they let them play with their derivatives, over-leveraging themselves in the the process with risky debt. Life was good for a while the money was flowing, as high-risk mortgage bundles were sold halfway across the world rated as triple A securities. The bad alchemy was working. Then came a little bump in the road. The housing bubble burst. The bubble that wasn’t supposed to burst. The computer models didn’t take this into account. Who’s fault was it? The quants? After all, their models were wrong. Only the quants and risk management officers will be the first ones to tell you that risk management is hardly a science. And they had already warned the Kings of Corporate America, who turned a blind eye with the government, and kept over-leveraging themselves.

What have we learned? What we already know. Risk science is hardly a science, and risk scientists will the first ones to admit it. Don’t blame a quant when there is a king in the room. The banks knew the risky mess they were getting themselves into all along.