Sunday, April 10, 2011

their new scheme

If you feel like taking the intellectual equivalent of a knee to the crotch, I highly recommend this piece from the Atlantic. If you want to know why exactly our economy is inevitably going to go hurtling off another cliff, you could do worse.

You can learn more from the tone of this article, actually, than you can from anything within its content. Because while the writer takes some stabs at being skeptical, the general attitude towards these hedge fund types is still one of deference and respect, rather than treating them as they deserve to be treated, like your drunk uncle at a craps table at the Bellagio. There's a lot of reasons why we seem simply incapable of reforming our financial institutions ("they've got the money" being numero uno), but the media's seemingly inexhaustible appetite for treating these people like geniuses, in spite of all evidence to the contrary, goes a long way.

The charming subject of this story is the brave new world of "quant" investing, where computers determine whether large swaths of stocks are undervalued or overvalued and buy and sell accordingly. I know what you're thinking: what could possibly go wrong? I agree, and I can certainly think of no recent history that might make me worried about this brilliant scheme! The subject of the personal profile in this piece is a Galtian overlord named Cliff Asness. (Remember that all magazine journalism about complex phenomena now has to be written like a celebrity puff profile; understanding stuff is just too hard unless you tell it like a fun little story about a real person you can get to know! Thanks, Michael Lewis.) Asness is right out of central casting: rich, entitled, and contemptuous of government and bailouts even though he was, er, bailed out:
Asness abhors the idea of increased quant regulation. With some reluctance--given the vitriol with which he typically condemns Washington on his blog--Asness conceded that the government bailouts in September and October 2008 saved AQR by rescuing the firms with which AQR trades, an outcome at odds with his Chicago-school economic training, which champions Milton Friedman, free markets, and the survival of the fittest. The bailouts "saved any levered fund's bacon," he said. (Of the $33 billion that AQR currently manages, $13 billion is in levered funds, which use borrowed money to increase returns on the equity invested.) Nevertheless, he remains unapologetically critical of the bailouts. He thinks the government should have let the banks fail and the chips fall where they would.
What a brave, brave stance. Now, you'll find that the article talks about Asness with a story the media loves to tell. He is described as the classic underachieving but brilliant kid who never wanted to do the hard work but got by on his big brain and gumption and sassiness and whatever. And he saw something that nobody else saw, and he decided to stick it to the man at the big firm and go rogue and make his own fortune, and blah blah blah blah.... How many times have we heard this story before?

But I know what you're thinking; this guy's rich! He must have some long history of success to be eligible for such hagiography from the august Atlantic. Here you go.
As it happened, AQR had started just months before Long-Term Capital blew up (and needed to be rescued), and in the midst of the Internet bubble, when anything related to the Web seemed to double or triple in price overnight. It was a world of irrational momentum, an environment that could not have been worse for Asness's investing style. In 1999, AQR owned a bunch of seemingly undervalued stocks, in businesses like banking and manufacturing, while holding short positions on seemingly overpriced tech stocks. The firm was getting killed, bringing to mind Keynes's famous observation that the market "can stay irrational longer than you can stay solvent."

Within AQR's first 20 months, its $1 billion fund was reduced to $400 million. The firm was near complete collapse, but Asness fought hard to keep it alive. He added to his value investments as the bubble inflated and kept his short positions in place, with the hope that he could capitalize when it popped. He met repeatedly with investors, and argued that he would be proved correct once the hysteria subsided. And indeed, things soon turned around. From 2000 to 2002, in a bear market, AQR "made a ton of money," Asness said, and then for the next few years "made decent money" in a generally bull market. The firm nearly lost it all again in the August 2007 fiasco, and suffered along with everyone else during the financial crisis the following year. But because AQR was now more diversified--with products ranging from mutual funds for small investors to a variety of funds available only to sophisticated institutional investors--the threat to its existence was not nearly what it had been in 1999.
If your great accomplishment over eight years is "reducing the threat to your firm's very existence," you sure sound like the kind of Wall Street wizard we all want determining the future of our economy, am I right? What a record of proven results! You'll also note a really important part of how we the media talks about the markets: still, despite it all, irrationality in the markets is seen as some unusual and temporary phenomenon. There's no consideration here that the Internet bubble could be the expression of the market's fundamental tendency to an ever-more-violent bubble and bust cycle.

Here's the part where I get really mad, though.
Such losses can be fatal for fund managers like AQR, since sophisticated investors pay them big fees for exceptional performance and, understandably, have little patience for anything less. As AQR's founders felt the tremors from Wall Street rippling through their offices, Asness said, "we worried about the stability of the financial sector, the stability of the economy, and the stability of society." To Bloomberg Markets magazine, last fall, he was even more explicit: "I heard the Valkyries circling. I saw the Grim Reaper at my door."

Yet they survived.
 It's demonstrably untrue that these big time financial types live on the razor's edge of risk. That's a totally discredited notion, but one that persists. There are seemingly no consequences for people working in Wall Street. No matter how much damage they do, or how complicit they are in actions that wreak havoc on our economy and cause massive human suffering, they always fall upward. The word that really bothers me here is "survived." Now, I've never been the editor at a fancy magazine, but I'd like to think that one thing any editors can agree on is that words have meaning. And in this context, where so many Americans have been in situations where they might worry about Valkyries and the Grim Reaper, this is pretty inexcusable. Asness is described in the piece as having a personal fortune of $500 million. That's not surviving.

So this is the hot new investing mechanism, and it's where billions of dollars are going, and it's insufficiently regulated, and the people pushing it all have a stake in the game, and nobody is 100% sure if it will really work in the long run, and the interested parties have too much money for our political process to be able to rein it all in. It's just business as usual. You don't have to be Trotsky to look at our society and see that our relationship with the financial class is terribly and permanently broken. We are incapable of disciplining these people. There's apparently no series of events that can compel change in this arena. And so the boat we're all on together hurtles down the river.

12 comments:

Petey said...

"You can learn more from the tone of this article, actually, than you can from anything within its content. Because while the writer takes some stabs at being skeptical, the general attitude towards these hedge fund types is still one of deference and respect, rather than treating them as they deserve to be treated, like your drunk uncle at a craps table at the Bellagio. There's a lot of reasons why we seem simply incapable of reforming our financial institutions ("they've got the money" being numero uno), but the media's seemingly inexhaustible appetite for treating these people like geniuses, in spite of all evidence to the contrary, goes a long way."

I'm a bit confused as to your reaction to the journalism here. The story seemed a pretty boring and pedestrian, but an utterly inoffensive business piece to me.

Business writing about people who run money is a specific genre. And it's a genre with a audience, since there are people who think about running their own money, and advertisers like those people.

Think of it like writing sports news, or like writing trade news for an industry that people are interested in. You get lots of stories in the NYTimes Arts section about Hollywood producers for the latter reason, for example.

Cohan is just writing a reasonably coherent tale of people who run money. (And FWIW, while Cohan is using similar narrative techniques to Michael Lewis, some of the stuff that Lewis writes is actually interesting.)

"The word that really bothers me here is "survived." Now, I've never been the editor at a fancy magazine, but I'd like to think that one think any editors can agree on is that words have meaning. And in this context, where so many Americans have been in situations where they might worry about Valkyries and the Grim Reaper, this is pretty inexcusable. Asness is described in the piece as having a personal fortune of $500 million. That's not surviving."

See, now here's an example. Cohan isn't talking about whether Asness survived in living in terms of comfort, or whether Asness survived in terms of being obscenely rich, or even whether Asness survived in terms of being employable in high finance.

Instead, he's talking about something specific to the genre. He's talking about whether Asness' fund, the one whose strategies he's been writing about, survived the Great Bank Panic.

"So this is the hot new investing mechanism, and it's where billions of dollars are going, and it's insufficiently regulated, and the people pushing it all have a stake in the game, and nobody is 100% sure if it will really work in the long run, and the interested parties have too much money for our political process to be able to rein it all in."

Perhaps my earlier confusion about your reaction is cleared up here. You wanted a different story. You wanted a story about economics and/or politics. (Or, as the kids a couple of centuries ago would've said, you wanted a story about political economy.)

Fine. But don't go looking in the Atlantic Business section for that particular story. They don't write that.

The NYTimes Business section does cover that beat a bit, but even most of their stories are just Andrew Ross Sorkin-style pieces, which are of the specific genre as Cohan's.

For pieces on political economy, go read the Politics section, or the US section, or the World section, or best yet, turn to econobloggers like Yves Smith or Paul Krugman or Brad DeLong.

Freddie said...

You're repackaging my point as disagreement. That this is standard operating procedure is exactly the problem. The conventions of the genre aren't an excuse for the problems in the piece, they are the problem. Reform requires criticism.

Petey said...

"You're repackaging my point as disagreement."

But I think we do disagree.

"That this is standard operating procedure is exactly the problem. The conventions of the genre aren't an excuse for the problems in the piece, they are the problem."

I just don't see any problems in the piece, other than that it is somewhat boring and pedestrian.

And I don't the conventions of the genre as being part of any problem.

Even if we lived in a better world, if that world had markets, there would still be a thriving niche for genre stories about people who play the markets for a living.

It's like complaining about a story about a football team because the story doesn't talk about the long-term damage football regularly inflicts on its labor...

Petey said...

I guess what I'm trying to say is that if you are mad at Asness, or Bob Rubin, or George Bush, or Barack Obama, fine.

I just don't get why you're mad at Cohan.

Phil K. said...

It's telling that you frame this as an attack on form rather than on content, because you seem not to understand the basic facts of the financial crisis all that well. Banks—not mutual funds—caused the financial crisis by investing in bonds—not stocks—and those investments failed because the people making them did not try very hard to understand the risks. The basic premises of your analysis are wrong, but it's okay because the villains still live in Greenwich.

burntbeans said...

"Now, I've never been the editor at a fancy magazine, but I'd like to think that one think any editors can agree on is that words have meaning. And in this context, where so many Americans have been in situations where they might worry about Valkyries and the Grim Reaper, this is pretty inexcusable."

make sure you change that second think to thing. excellent post; i heartily concur.

Freddie said...

Thanks for your Very Serious correction, Peter K. You can always be counted on for your banal establishmentarianism.

By the way, if you really think that hedge funds weren't complicit in the subprime mortgage fiasco, I'm not sure what to tell you.

Petey said...

More broadly, the Atlantic is total and utter crap. I was once offered a no-strings-attached free print subscription, and I turned it down.

These are folks whose "stars" are Andrew Sullivan, Megan Mcardle, And Jeffrey Goldberg fergawdsakes. That should tell you something about where they're coming from. (I'm surprised Mickey Kaus didn't hook up with them.)

I'll go there to read Jim Fallows sometimes, but even he's tainted by being part of the abominable Carter crew.

But stay far away from their articles. If you want to know what the idiots are writing, read something like the National Review or WSJ instead...

Phil K. said...

I guess that's as good a response as any when you've been caught out: attack the fools in old-style hats and coats.

The facts may indeed be banal—certainly they afford neither the excitement of the class-war narrative nor the thrill of the self-styled voice-in-the-wilderness martyrdom that you flog so unrelentingly. But I invite you to consider why it's such a lonely wilderness that find you find yourself in; it isn't only because you've got the facts wrong. (After all, what's more banal than that?)

sheenyglass said...

Whenever I read about quants and their automated trading strategies I keep thinking about their brilliantly innovative investment strategies were not only foreseen, but satirized by vonnegut in Hocus Pocus (published 1990, four years before the founding of LTCM) with the "MicroSecond Arbitrage" corporation.

Anonymous said...

And, it's a major problem when the quants believe the world is limited by their own blinders. It becomes axiomatically true...

Recipe for Disaster: The Formula That Killed Wall Street

So reassuring that these folks still garner such overweening support./s

~bystander (a Greenwald-ite taking refuge from Balloon Juice, although I thank John Cole for the pointer)

Anonymous said...

Kind of hilarious the ships passing each other in the night with the post and the comments. Freddie makes a pretty basic point, which is that the beat reporter covering this story might have used the facts to draw some more general points or offer some criticisms. The critique of that is that The Way Things Are in Media Coverage means that Freddie is naive, or stupid, or wrong, to expect such a fanciful thing. But maybe The Way Things Are could be different and should be criticized, maybe we shouldn't go with the unstated assumption that mediac overing business are going to pump out unreflective pieces that shrink from criticizing the people they cover. Maybe we should ask for more than that.