Nerds on Wall Street: Math, Machines, and Wired Markets

Chapter 12. Shooting the Moon

Stupid Financial Technology Tricks

Like many others from the stock side of greater Wall Street, I felt blindsided by the events of 2008. "Blindsided" is actually a gross understatement; I felt like the guy who comes home and finds the neighbors were running a meth lab that has exploded and flattened the block. I have tried to moderate this "mad as hell" attitude in writing this, and recognize that many participants did in fact realize that something was very wrong. One commented, "Bit by bit, we iterated toward more dangerous things, and each step seemed okay."

It is an understatement to say the steps were okay. This was not a natural event, like Hurricane Katrina, or an external attack, like 9/11. This was a case of "Honey, I think I broke the world financial system."

To repeat the disclaimer of professional expertise on this subject: Of the billions in institutional assets I managed in the 1990s, exactly zero were invested in collateralized debt obligations (CDOs), credit default swaps (CDSs), and mortgage-backed securities (MBSs). I knew what they were, and particularly enjoyed the stories in Michael Lewis's book Liar's Poker of how the inventors of mortgage-backed securities at Salomon Brothers would shut down the market occasionally for food orgies of Roman proportions.

Our market neutral portfolios would often be equitized, putting back the market return with a simple futures position. Sometimes clients would want so-called portable alpha using ...