Following is a guest post by Bob Fischer, a Wall Street quantitative analyst (“quant”) turned climate scientist. He is now working as a post-doc at NASA. An earlier version of this essay (somewhat different) appeared on the Planet 3.0 blog.
It should surprise no one that the WSJ has posted yet another climate change denial op-ed. What is surprising is that anyone might actually believe them. Why? Of course science is not their thing. But more importantly, the WSJ, along with most of Wall Street, has done a poor job of accurately predicting ECONOMIC calamity in the past — something that SHOULD BE their thing.
Let’s review some recent history. Before becoming a climate scientist, I was a Wall Street Quant for a decade. In that time, I worked for a hedge fund, a proprietary trading desk and an options trading firm. From the fascinating vantage point of the neve center of our economy, I was privileged to experiece first-hand so many of the recent market shocks: the Dot-Com Bubble, the Dot-Com Bust of 2000, the Mutual Fund Scandal of 2003, the Housing Bubble, the Sub-Prime Decline of 2007, the total market meltdown of 2008, the Flash Crash of 2010, and others. Many of these events affected me professionally, financially and personally — one even cost me my job. I also witnessed various responses to the events: by other Wall Street professionals, by Federal regulators, by the financial media, and by the nation at large. The year 2008 was particularly fascinating: I watched highly respected corporations fall apart and vanish in an instant, and the rest write off hundreds of billions of dollars in bad assets. I even got to watch as my co-workers ended up with mountains of illiquid toxic assets on their books.
Unfortunately, the financial press has been remarkably poor at predicting market shocks, or even of warning the average reader of growing market dangers. Where was the WSJ to warn us of the dot-com crash in March 2000, when the average stock was selling for a P/E ratio of 47.2? Where was the WSJ to warn us of a long-term glut of housing in 2007, a year in which home construction vastly outpaced any rational increased demand for housing? Where was the WSJ to do some investigative journalism on widespread mortgage fraud or inflated securities ratings, before it became painfully apparent to everyone in 2008 and beyond? Where was the WSJ to warn us of the folly of buying opaque mortgage-backed securities, with no information of who was going to pay them or what the risk of default might be? Where was the WSJ to suggest that personal debt has gotten out of line?
America today is mad at Wall Street, and rightfully so. The actions of “the Street” as a whole have left our nation today with high unemployment, deflated retirement savings and housing that we don’t need. People who are supposed to be our financial experts and leaders have failed us. The fact that many on Wall St. continued to collect princely sums for their services in 2008, 2009, 2010 and 2011 only adds insult to injury for the average American.
In the face of such massive failures in foresight, money managers typically excuse themselves. “We couldn’t see the bubble,” “everyone else was doing it,” or “hindsight is 20/20.” And then they move on to the “next big thing,” telling themselves <a href=”http://www.amazon.com/This-Time-Different-Centuries-Financial/dp/0691142165“>This Time is Different</a>. And the cycle repeats.
Why is Wall St. so bad at predicting upcoming calamity? It’s not like NOBODY was aware of the dangers. For example, <a href=http://www.econ.yale.edu/~shiller>Robert Shiller</a> accurately predicted the recent housing bubble long before it burst — but he was regularly dismissed in the press. Vanguard Funds <a href=”http://www.bargaineering.com/articles/how-vanguard-avoided-the-subprime-mess.html“>avoided buying toxic assets</a> because they investigated themselves, rather than relying on rating agencies — but few of their corporate peers followed suit. These rational voices did not have to use rocket science to come to their conclusions. Rather, they based their warnings of fundamental economic principles that anyone can understand: namely supply and demand, and reversion to the mean.
But there’s an old saying that Wall St. is ruled by greed and fear. And in 2007, Greed was King. People had a hard time thinking rationally about the long term when they believed they could flip their asset for 50% profit in a few months’ time. Meanwhile, a majority of Wall Street professionals were happy to oblige because they make money on every trade, regardless of whether or not it’s profitable: brokers, investment bankers, real estate agents, mortgage companies, etc. As long as these professionals weren’t left holding the hot potato, they could profit today off of someone else’s future loss. Opaque mortgage-backed securities provided a perfect vehicle for passing off the hot potato.
In my time on Wall Street, worked on the “buy side” (hedge funds), meaning I only got paid if we made money for our clients. But there was still great pressure to chase short-term profit in exchange for future losses. Why? Because we got paid a yearly bonus based on that year’s profit. If the hedge fund blows up next year, we would be out of a job. But we would still get to keep last year’s bonus.
Losing your job is rarely much of a problem on Wall Street, especially for an experienced Quant. We learned to save up during the good times for the next big shock (and pink slip): many Quants go a year or more “on the beach” between jobs. And some of the people who have lost the largest sums of money for their clients still manage to attract mountains of capital for their next attempt. Maybe it didn’t work out last time, but the sure-fire road to riches is just around the corner! Magical thinking never goes out of style.
So the boom-and-bust cycle of the financial markets continues, and will continue, as long as there are markets to go bust. We knew that nothing we did was sustainable — no investment strategy, arbitrage scheme or market making system. Over time, ever-increasing competition and market efficiency always whittle away any edge we had. And we also know that nothing (eg the economy) can grow exponentially forever.
Thus, we lived on a mining mentality: get all you can get today, so you have the resources to mine the next pot of gold tomorrow — a pot that will probably require increased sophistication and infrastructure for smaller returns. We never worried too much about predicting market crashes, just how to survive them (and maybe even make a profit). When things went bust, we would sow our seeds and hope that next year would be better, like an ancient tribal society doing the rain dance. We lived for the moment, with a sincere belief in human ingenuity. This is Darwinian Optimism: the belief that the best and brightest will always somehow find a way to adapt.
So what about climate change? Climate science is warning us of dire consequences that could threaten the habitability of our planet over the next 100+ years. The science suggests that the changes might overwhelm our ability to adapt. But Wall Street, with its millisecond view of the market, quarterly earning statements and belief in infinite human adaptability, has no concept or ability to think 100 years into the future. Heck, we rarely even though 1 year into the future. And the Street certainly cannot imagine a future in which people (the best and brightest) don’t, somehow, come out on top.
All the Street sees is the fact that there are billions to be made TODAY through continued exploitation of fossil fuels. So what if our grandchildren get flooded out? For Wall St, a climate crash would be not so different from a regularly scheduled market crash. “We didn’t see it coming.” “We thought this time is different.” “We were just doing what we thought was right at the time.” And in the end, SOMEONE will make a buck. Speculators will buy up future beachfront property even as today’s beachfront is washing out to sea.
America and world beware. This is the industry that, in pursuit of short-term profit, has again and again failed to predict calamity. Instead of showing financial leadership for the health of the nation, it has brought us toxic assets, acres of unnecessary houses, a foreclosure crisis and high unemployment. Just to name a few. America is rightly angry at this industry. Its track record on disasters is so bad, it has absolutely no authority to speak about potential upcoming climate disasters. Things will always look rosy to those few working up in the Gold Tower of Wall Street. But that view does not extend to the rest of the world. If we listen to these voices in the climate change policy debate, we should not be surprised at the likely outcome: short-term profits in exchange for long-term loss, while the rich get richer. Let’s hope our grandchildren view us charitably.
Copyright (c) 2012 by Robert Fischer. All rights reserved.
*** Bob Fischer was a Wall Street Quant for ten years, a time during which he worked with a number of interesting, smart people. He is now a climate scientist.