Wednesday, September 20, 2006

The citadel of finance

Bloomberg is reporting that Citadel, another mega fund started by former physics major (Harvard) Ken Griffin, is negotiating to take over Amaranth's energy positions. In the case of Long Term Capital, the Fed convened an emergency rescue by a consortium of major banks. The banks bought Long Term's portfolio for pennies on the dollar, and eventually made a profit when spreads returned to historical values. Perhaps the only people hurt by this debacle will be Amaranth's investors. Brian Hunter, the trader responsible for the losses, took home a bonus reported to be $100M last year, so I suspect he will recover just fine.

Few appreciate modern finance, in all its complexity and volatility. Even among practioners, there is a wide range of opinions concerning the value of their profession.

Position 1: This stuff is bullsh*t. But it provides the best risk-adjusted economic return for my high powered brain.

Position 2: If we can improve the efficiency of capital markets and resource allocation by even a fraction of a percent, the benefit to society over time is enormous, albeit invisible to the casual observer.

Charlie Munger, Warren Buffet's long time investment partner, on the brain drain into finance:

I regard the amount of brainpower going into money management as a national scandal.

We have armies of people with advanced degrees in physics and math in various hedge funds and private-equity funds trying to outsmart the market. A lot of you older people in the room can remember when none of these people existed. There used to be very few people in the business, [and they were] who were not very intelligent. This was a great help to me.

Now we have armies of very talented people working with great diligence to be the best they can be. I think this is good for the people in it because if you know enough about money management to be good at it, you will know a lot about life. That part is good.

But it's been carried to an extreme. I see prospectuses for businesses with 40-50 people with PhDs, and they have back tested systems and formulas and they want to raise $100 billion. [Reference to Jim Simons of Renaissance Technologies.] And they will take a very substantial override for providing this wonderful system. The guy who runs it has a wonderful investment record and his system is a lot of high mathematics and algorithms with data from the past." [...]

"At Samsung, their engineers meet at 11pm. Our meetings of engineers (meaning our smartest citizens) are also at 11pm, but they're working on pricing derivatives. I think it's crazy to have incentives that drive your most intelligent people into a very sophisticated gaming system."


Anonymous said...

if all this brain power is misallocated, wouldnt the
hyper efficient market correct itself, alternately,
everyone is competeing to work in this market because of the same reason people rob banks, because thats where the money is
if it didnt work, and money was not being made, wouldnt it collapse on its own weight?
so market must be very inefficient? or else there would be no demand for brainpower

Anonymous said...

Please tell us where that Charlie Munger quote is from?

Thank you

Steve Hsu said...

The Munger quote is from his comments at a Wesco annual meeting.

Via Google:

Anonymous said...

what a bunch of self-serving crap. munger's rant basically boils down to "what a shame that all this talent is being wasted in finance...i mean besides me...yeah, it's ok ffor ME to make a bunch of dough but youse other guys stay away". what a pussy

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