14 November 2008

BSDs vs quants

Brad Hicks on the institutional / social / psychological dynamics in financial institutions that led to the mortgage crisis ... and other past breakdowns.
When Michael Lewis was first hired, right out of college, as a salesman at Solomon Brothers, his instinctive belief that things have an actual value was something that got relentlessly mocked by his coworkers. In his early days on Wall Street, they explained to him that there is a pecking order in the financial services industry. For a variety of cultural and regulatory reasons, investment firms are required to have people working for them who are experts at calculating the actual value of an investment based on current mathematical models and best available data. Their department is called “Quantitative Analysis,” and the people who work there are derisively called “quants.” Quants have the lowest prestige jobs in the entire industry, draw remarkably low salaries considering the level of education you have to have to get those jobs and the long hours and the awful working conditions, and Lewis says that they are routinely and cruelly and ruthlessly snubbed by the other half of the business. Those are the people whose specialty is sales. And at the absolute top of the pecking order, Lewis taught us, are the people who were called the Big Swinging Dicks, people who demonstrated the superiority of their manhood by being able to sell anything, however worthless the quants said it was, for however much the company needed it to sell for.

How does a BSD make his money? First, he starts by asking, “what do I have available to me to sell?” How much of it is there? Now divide that into his assigned sales goal. Add in the cost to sell it. That tells him what the thing he has to sell has to be worth; for it not to be worth that is flatly unacceptable. Which leads to the next, and last, and hardest part: what lies does he have to tell to himself to convince himself that it really is worth what he needs to sell it for, and how does he fool himself into believing his own lies? That's the only use that any BSD has for a quant: once in a very, very rare while a quant says something to him that, if he ignores the caveats and footnotes and fine details, he can twist into a justification. The quant doesn't have to have been right. Even if the quant was right, the salesman doesn't even have to accurately remember, let alone accurately pass on to others, what the quant said. He just needs to be able to believe that he is honestly representing what the quant told him when he quotes some bit of (what is to him) quant bullcrap about what the investment is “really worth” when he's on the phone to the client. And he really, really has to believe it, himself, even if he used to know that he was lying, even if he used to know that he was making this stuff up out of whole cloth. Humans kid themselves that they're good at detecting it when people tell them things that aren't true. They aren't. But to the limited extent that they are, they're really only good at detecting one thing: whether or not the other person believes what they're saying. So the ultimate BSD is the guy with the greatest talent for figuring out what he needs to believe in order to get you to give him money, and then making himself believe that, and believe it really hard.
I guarantee you that in every firm involved in this market, somewhere in some windowless cubicle in the basement, there was at least one quantitative analyst screaming his head off in emails about this, about how the mathematical modeling that underlaid the calculations that determined pricing on collateralized debt obligations was based on statistical analysis of customers who were buying their primary home, not as an investment vehicle but to live in, and pricing those homes based on reasonable expectations of what someone in their social class could afford to live in and paying no more for them than three times their income. And no BSD in the entire industry wanted to hear that caveat. He didn't dare. He almost certainly paid people to intercept those emails and keep them from him. Because if he let himself get drawn into what must have seemed to him like an arcane and wrong-headed argument about what something is “actually worth,” when there really is no such thing, when everybody knows that the only accurate way to value something is to put it in the hands of a talented salesman and see what he can sell it for? He wouldn't have made his numbers.

Lots of examples of the principle, in tales well told, if you click through.

I leave the parallel to another conflict between people who have been successful by virtue of believing their own BS and the “reality-based community” as an exercise for the reader.

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