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With fall of investment banks, will math majors still be able to find lucrative jobs on wall street? How will this affect quant and trading positions?

The major trading firms that most of the news calls "quantitative hedge funds" are still aggressively hiring.

I'd be much more worried if I were an MBA who thought that I-banking was the road to luxury.

As long as there's trading, there will be demand for people with strong programming and quantitative skills.  And unless technology suddenly disappears, you can pretty much always bet on keen brains to be the most employable asset, even as other skills become economically useless.

So-called "exotic" derivatives developed by quants seem to have played an important role in the present financial crisis.  While many firms traded these instruments and/or bought them as hedges or insurance, it's clear that few, if any, understood their associated risks and the assumptions behind their sometimes complex valuation models.  As a result, most firms that held large leveraged positions in credit default swaps and collateralized  mortgage obligations and the like, did not properly communicate the risks to stakeholders.  Now the trust between buyer and seller that must exist for investing to take place is gone.  We can't look at the financial statements of firms that are heavily exposed to these types of securities (or their bond ratings) and have any assurance of their claims paying ability - even in the short term.

Regaining the lost trust will not be an easy task - it will be years, perhaps decades, before people as willing to invest in complex financial services products as they've been in the past few years.

Honesty and transparency in stakeholder communications will be essential elements in regaining this trust.  Accounting and reporting standards/ethics must change so that risks are more clearly communicated.

Until trust is restored, it's unlikely that we'll see nearly as much demand for complex derivative securities in the future as we've seen in the past decade or so.  It's hard to imagine that will bode well for future private sector quant jobs.  However, with the increasing (if not complete) nationalization/internationalization of the financial services industry, there will probably be a large increase in demand for quants in regulatory positions within government ministries and perhaps within ratings agencies - in whatever future form they might exist.

These are good points -- there will be fewer quant jobs in sell-side derivatives for a little while, and more quant jobs in government.  From what I've seen, this looks like "a transfer from one set of not-terribly-desirable jobs to another," but you're right that it's probably not a nonzero impact on quants.

I guess what really remains to be seen is how this impacts hedge funds, which is where more and more the best quants have been going for the last decade.

I'm not as confident as you are that it will take years for people to invest in complex securities again -- unless the government regulates them heavily, I would expect more and more complicated securities to continue popping up, particularly if the government only regulates them moderately (some of these instruments pop up in response to regulations, as ways to get around them).

I will note that the day that there aren't many good quant jobs in trading will mark a day when the economy is *very* bleak.  I'm not saying that such a day will never come, but as long as there are active markets, there will be good quant jobs available to analyze and attempt to profit from them.  So, I think we'll only have "no or few quant jobs" when we have "no active markets", which would likely be pretty grim.

Looks to me like there will be a severe shakeup among hedge funds - at least half and probably more will be gone within a year or so.  Redemptions are already skyrocketing.  Most of their business models just don't work in an environment of massive deleveraging, random government handouts, complete loss of faith/trust, and evaporating counterparties.

Within a couple of years, we'll see the day when there aren't nearly as many good (high paying?) quant jobs in trading as there were a year ago.  For the jobs that remain, compensation levels will fall dramatically.

Frankly, I hope that bright people find something more meaningful to do with their lives than work for hedge funds or most of what passes for financial services.  Globally, we have waaaay to many smart (but not smart enough) folks and far too many resources tied up in this area of the economy.  Relative to GDP, the FS sector needs to return to levels of a generation ago - that is, reduced by about 3/4 of it's present rapidly declining size.

I just don't see the value that the newer financing activities are adding to society.  As always, we still need good people to assess risks associated with financing various business ventures, property mortgages, and the like.  We also need efficient and effective mechanisms to provide needed resources to viable projects.  However, the ballooning size of the FS industry relative to GDP seems to indicate that we aren't even close to finding such mechanisms - and we're getting further away as time passes.  We'll probably need to start from scratch - and we'll have the opportunity in the next few years (you have the opportunity right now if you live in Iceland.)

It would be nice to have some bright young minds to help design and build a new financial sector.  It's clear we can't rely on publicly traded firms until their governance problems are resolved.  Offloading risks and losses to shareholders and governments while banksters and tradesters loot imaginary profits from Enronesque entities must cease.

I think a lot of this depends on what the government does in the next 6-24 months.  I also think it's not just the people at the big banks that are to blame for this mess.  There's plenty of blame to go around, from the lenders to the regulators to the borrowers.  This isn't just solely a story of "rich person greed".  (I'll also note that hedge funds are largely victims in the current crisis, not perpetrators.  The banks, the borrowers, and the government have far more culpability for this mess.  And I fear the last of those three may make things much worse before things get better.)

Sure, there will be a shakeup among the hedge funds, and hiring will slow, but it won't be the end of trading, and salaries in this industry will still be much higher than virtually anywhere else.  It's the nature of the business -- you're providing services to very wealthy people, and you don't need many people to manage large amounts of money.  The result: very high salaries for those who get the jobs.  The only reason there will be fewer jobs is that it's easier and easier for smaller and smaller groups of people to manage larger and larger amounts of money.   (I'm assuming the government interventions don't decimate everything -- right now there are a fair number of people standing on the sidelines waiting for the government to stop changing the rules.  For example, witness the moronic limitation on short selling that devastated the convertible bond market, thus removing a very crucial funding source for many companies in all areas of the economy, not to mention devastating a lot of hedge funds whose operations up to that point were working to *reduce* the borrowing costs of those companies.  When governments make sudden, drastic changes to markets, there can be very bad consequences.)

I'll also note that the banking crisis isn't the only one to worry about.  The automotive industry failing has little to do with this crisis, and a lot more to do with decades of questionable management and union-induced legacy costs that are impossible to carry.  They mainly have their hands out now because the spigots are open.  And we haven't even started to talk about cities and states, whose collective financial troubles will at least be on the same order of magnitude of the banks, and we can't blame greedy bankers for these problems, either.

As for what value to society of the financial system, I'll simply note that capitalism has brought a great deal of wealth and growth in the last couple centuries.  It's hiccups cause a little misery here and there, but it's nothing compared to the misery that's been caused when other systems struggle.  (Moreover, most successful companies of the last 10 years, like Google, owe their success in no small part to ready access to capital produced by the financial system.)

That said, I agree that it would be nice to get some of these minds into other areas, but I'm probably not as convinced as you are that they would add a great deal.  I think passion for what you're doing is very important to success -- if people have a passion for something, not even easy money elsewhere will deter them from pursuing it.  (And in today's age, partly due to the great successes of the financial world in the last 20-30 years, it's easier than ever for someone with a passion to find the funding to pursue it.  Sure, there's a downtick now, and this will stay lower than, say, 2003 or 1998 levels for a while.  But I think we're more or less permanently beyond 1980 in this regard, mainly due to advances in technology, and the liberation and multiplication of capital.)  Of course, now that some of those people are forcibly removed from the Money River, they may discover (or as I did, rediscover) old passions that lead them to other pursuits.

But also keep in mind, there are more than a few people who believe they are doing a great good by making markets more efficient and more liquid.  And they might even be right, if only they were allowed to get back to doing it ;)

It occurred to me this morning that there's another industry that there are too many very smart people doing nothing in: academia.  And I think the problem there is related to the reason why there are too many in finance.  Just as some stay in trading for financial comfort while not being as "productive" as you might like, others stay in academia for cultural comfort without being very "productive".  Of course, there's also an element of financial comfort for the academic (tenure) and cultural comfort for the traders (masters of the universe).

I'm also not saying academics as a class are not productive, but I'd say they're a lot like the financial sector -- some are critical, but many are not, and would be doing the world a greater service elsewhere.  But I don't think people should make their life choices based on what's good for the world...

[quote="Osud"]Just curious-- how do you define "productive"?[/quote]

Very good point, which is why I put it in quotes.  I guess I'd ask the same thing about "meaningful".  I think the definitions of these things are very much in the eyes of the beholder.  This is one of many reasons I don't think they're things that society should try to define and enforce, such as in a government system that would determine these things from on high.

I think in the end, most people define their productivity and the meaningfulness of their work at a very base level in terms of what satisfies their person desires or needs.  The net result of that, I think, is very good, which is why I don't like to see government trying to meddle in these areas too directly and decide what is "productive" and what is "meaningful".  I guess I have more faith in people deciding what's right for them than I have in government to determine it.  It's not an iron rule, to be sure, but it's the way I'd lean in most cases, if not nearly all.

[quote="rrusczyk"]It occurred to me this morning that there's another industry that there are too many very smart people doing nothing in: academia.  [/quote]
Hmm... What do you mean, rrusczyk? I agree that there are many people in academia who are "doing nothing" (though hardly any more than anywhere else) and I also agree that we've got quite a few "very smart" ones there but, to the best of my knowledge, these two sets are disjoint :?.

By the way, if you want to be any good in pure research, you have to work 14-16 hours a day on average. Of course, it doesn't mean that you have to sit in your office all that time but it means that you have to make your brain run basically non-stop. If one thinks that solving a medium difficulty mathematical problem requires less effort than loading bricks on a a truck, I suggest him to try both jobs for a day (in both cases the job must be done in full: the truck must be loaded to its capacity (3 tons, say) and the problem must be solved). I surmise that anybody who does not have severe physical health problems will be able to load the truck but the percentage of those who will be able to find the solution will be pathetic. True, you do not get physical exhaustion from problem solving but you do not get the mental one from truck loading either. Most people who claim that people in academia do nothing are not capable of even 2 hours of decent mental work.

I'm far from claiming that truck loading is an easy job but I am far from it exactly because I have loaded a few trucks in my life. Those who want to claim something about the work in academia should try it first (and just dwelling inside the university walls for a while doesn't count as trying; just as with truck loading, you should get the respect of your coworkers for what you've done before telling whether the work was easy or not). My impression is that pure research in mathematics is a :censored: difficult thing if you want to obtain anything of value. Monkeying around is rather easy, indeed, but so is honking the horn on the truck that somebody else is loading.

In short, if people think that the life in academia is such an easy thing, why don't they go there? As far as I know, the door is open and anybody can try. Why do they prefer to move heavy bags in warehouses or mess with other "much harder" jobs? I am talking not of those who like what they are doing and stick to it for that reason but of those who hate their occupation and envy the "easiness of life" for the academia people. Rrusczyk is certainly not one of them and is definitely capable of appreciating mental work, so I'm a bit surprised to hear something like that from him.

As to "some are critical but many are not", I admit that most people can be [i]replaced[/i] but assuming that they can be entirely [i]removed[/i] shows a severe lack of understanding of how the academia (or anything else) works. I can easily name about 15 living people in my field so that every recent article in harmonic analysis worth reading can be traced back to their ideas but it doesn't mean that nobody but those 15 people is needed. True, you cannot build a skyscraper without the chief architect but it doesn't mean that the boys who mix the mortar for the brickwork can be disposed of either. It is usually rather hard to find a replacement for "chief architects" and not so hard for "mixing boys", but it doesn't mean that the latter are not crucial for the construction project.

I think you've read more into my comment than I've said.  I have great respect for researchers -- they have a patience, and perhaps an intense curiosity, that I lack.  I'm not at all arguing that successful researchers have an easy career.

But I am arguing that once tenure is achieved, academics can indeed choose to have a very easy life, indeed.   And, yes, there are a great, great many people lining up for that life.  There is an [i]enormous number[/i] of people who try to get into academia.  Simply enormous.  The success rate in applying for professorships may be smaller than in nearly any other profession.  We're producing many, many more people with PhD's who hope to find an academic position than there are academic positions.  It's a much finer filter than the financial world.  The barriers to entry are simply very, very high.  But the rewards are great, which is why people are willing to give up so much of their life and their earning prospects to attain them.  It's a very attractive lifestyle -- you don't see people changing truck tires for near minimum wage for 6-8 years just to get a 15% chance at being able to drive the truck.  You do see people doing something fairly close to this in grad school (particularly outside the sciences -- PhD's in a great many non-scientific pursuits have little value outside academia, though pursuing them may yet be a matter of maximizing utility for some, to be sure).

Please note, I'm not arguing that no researchers are doing anything.  I'm arguing that there are a great many people who are very comfortable in academia, are not great researchers, are not great teachers, and might contribute more to society by most people's measures if they were elsewhere.  (I think this is essentially the same situation in trading, and any societally desirable profession -- a lot of people who are not stars, but are too comfortable to find something else.)  These people stay in academia because just as the barriers to entry are high, so are the barriers to exit -- not many people will walk away from guaranteed comfortable employment with a couple months off each year after they have sacrificed so much to get that position.  The fallback position in case of failure in academia is very nice.  Not as nice as failing at being a CEO of a bank, but it's still much more comfortable to be an unsuccessful tenured professor than it is to have failure result in unemployment or an impoverished old age.  A tenured professor has little worry of these fates, and just as you complain that people who say academics don't do anything are ignorant of the demands of the profession, I think people in tenured professions underrate the real fear of the failure for those of us who have to worry about what next year will bring.

As for smart and doing nothing being disjoint, perhaps I was being too glib, and should have said "doing little" in the sense that gt59 might argue that traders are doing little.  You'll have to go a long way to convincing me that all, or even most, academics are operating at a higher "productivity" in their roles as academics than they would outside academia.  Any profession that requires a very high activation energy to leave will have people trapped in a local minimum.

Again, let me be clear, I don't mean to denigrate the academic profession.  I mean to state that by its very design, it is very easy for someone to be somewhat stuck once the gold ring of tenure is achieved.  To be sure, not all professors respond to this feeling by coasting, and maybe not even many of them do.  But surely there are some, and maybe even plenty.  I think the situation is much like that in finance -- once people have a great deal of cash, a filtering takes place.  Some will look for the next pile to make.  Others will rest, and not be as hungry when they take on their next pursuit.

As for "some can be removed", I stand by my comment -- you'll have a tough time convincing me that the world would be a much worse place if we culled the least "productive" 75% academic researchers.  The reason we need them all is that we don't know which ones are among these 75%.  Again, this is a lot like the "creative destruction" of capitalism -- you need a lot of failures because you can't choose the successes with a high degree of confidence before their careers.  By no means am I advocating reducing the research workforce by 75%.  I'm merely stating that a huge number of them will contribute little, just as a huge number of businesses contribute little and fail.

Of course successful researchers work exceedingly hard.  Successful <fill in the blank> work very hard.  Brilliance only makes a small contribution to success in anything.  Look at the titans of just about any pursuit and you'll find the hardest working people in that field, whether it be academics, trading, politics, basketball, etc.  The mental focus, patience, and perseverance required for success in research must be staggering, and I'm in awe of people who can concentrate at that level past their early 20s or so.

[quote="fedja"][quote="rrusczyk"]It occurred to me this morning that there's another industry that there are too many very smart people doing nothing in: academia.  [/quote]
Hmm... What do you mean, rrusczyk? I agree that there are many people in academia who are "doing nothing" (though hardly any more than anywhere else) and I also agree that we've got quite a few "very smart" ones there but, to the best of my knowledge, these two sets are disjoint :?.
[/quote]

To this, I'd ask, how do you know?  I'm guessing you're defining "very smart" as something very close to "successful in academia".  I'm simply saying that there could well be many "very smart" people who don't have the combination of skills required to be successful in academia, but are good enough to get a position.  They don't get tagged as "very smart" by you because they don't achieve the level of academic success that would cause you to notice them.  However, these same people might be very successful elsewhere, and their lack of success in academia does not at all mean that they are not very smart.  More than raw smarts is required for success in research.  Patience, intense curiosity, and a good taste in selecting research problems seem very important in research, but may not be as important in other fields for which being "very smart" might be necessary.   I'll reiterate that the reason I think you have a high incidence of these people in academia is the same reason you have a high incidence of them in trading -- the barriers to exit are high.  It's very difficult to leave a comfortable career, particularly one you've worked very hard to achieve.

The main points you seem to make is:

1) People tend to dramatically reduce their efforts once achieving a "safe spot" (tenure)

2) A huge portion of academia workforce do not particularly excel in anything.

I tend to rely on my local observations (I know 3 math. departments really well and visited about 25 where I had an opportunity to talk to people and get some idea of what they were doing). I'll also talk only about those in analysis (it is not so easy to get a clear idea of where the people in the field other than my own really stand).

a) Out of all those analysts I met (100+; all levels from postdocs to full professors) I would consider only 7 or so as "removable". True, most people do not work in the "all out" mode and do not particularly "excel" in either research or teaching but they are still "in place" doing a decent and useful work. I can imagine some of them doing something else but to say that they will be more useful there will be an exaggeration.

b) The fear of losing the job is not uncommon in academia either. If you come to the US after your 40th birthday as a professor and try to get a position, unless you are a "superstar", the best you can hope for is a renewable contract. A friend of mine have been changing his place almost every semester for the last 4 years and his salary has been about 50,000 USD a year. He was an equivalent of a full professor in Moscow, Russia and is not bad at all as far as his research is concerned and really excellent with his teaching. Another friend of mine, also quite a fine mathematician, is currently jobless in Canada. So, I can understand the "fear of failure" you are talking about despite I do not currently feel it myself at the level of "what if I lose my job tomorrow?" Living under that fear has added absolutely nothing to my friends' productivity as far as I can tell.

c) Very few people are fanatics of their work. You certainly are (if you were not, there would be no AoPS, at least not as we know it today). Some amount of relaxation and concentration on other priorities in life after getting tenure is to be expected. After all, academia is not a labor camp :). But I will repeat: I do not personally know a single analyst who relaxed to his or her absolute minimum and is just coasting and enjoying good life. Even those nearing the retirement are still doing something useful though it may no longer be the research (as an example, one such person became a department $ \text{\LaTeX}$ expert and also actively collaborates with some onlne calculus textbook developers). Somehow, most of the people who got through the barriers are those who like mathematics and will do either it or something closely related to it no matter what. I agree that once you reach the tenure, you have an option for a very easy life; I just disagree with the statement that many of the people who get there are interested in that option (though I admit that I've [i]heard[/i] of a few who tried to use it). Most of those who line up for academia jobs with the single goal to get an easy ride in the end just do not make it through their first serious undergraduate course. :P

d) As to very smart people who "do not have enough skills to succeed in academia but good enough to get a position", most of them end up working as "mortar mixing boys" and do a great job at that level. You seem to understand the success in academia only as getting a worldwide recognition for the research achievements or as having written an advanced textbook everybody uses. There are many of "smaller" ways to be "successful". I consider a person successful if what he is doing is worth doing in the particular framework he is a part of, if he does that thing reasonably well, and if he likes what he is doing. What exactly that thing is is of little importance. I know many smart people in academia who have never been (and, most likely, will never be) great researchers but whose current work makes perfect sense and also requires quite a lot of effort. Those who really do nothing I would consider valuable tend not to be smart in anything except, maybe, political games.

e) In general, I consider the combination of heavy filtering and the option to do nothing in the end in academia not unlike that of high risk and tough conditions and the same option in the end if you get rich enough for individual entrepreneurs in the outside world. In both cases the trap is that 90% of the people who are capable to get to the level where the option can be used will turn it down as "ridiculously boring" by the moment they get to it, if not earlier. Somehow this trap works fairly well in the outside world. We hope that it can work in academia too. It is quite hard to get people interested in intellectual endeavours in the beginning, especially in mathematics, so some big fat carrot is needed to make them try and the general public should see that carrot clearly. The other part of the story (that the selection process is set up in the way that only those who are allergic to such carrots will be able to get them in the end) is well hidden and seldomly advertised. I admit that the academia selection process may be not tuned finely enough in this way, but the percentage of fat carrot lovers who get their carrots is still rather low, nowhere near 75% you are talking about (at least, within the analysis groups in all the places I've been to). Not everybody is a fanatic of doing mathematics, of course, but everybody seems to have it as a high priority in his life and derives a lot of pleasure from doing it.

f) As to the possibility to be highly successful elsewhere and high exit costs, we have sabbaticals once in a while, you know, and to get a leave of absence for a year is usually not a problem either, not to mention free summers, so if one does not feel happy doing what he is doing, he can go ahead and try that "elsewhere" position where he "can be more successful" for up to a year at essentially no cost or obligation. This is as comfortable exit opportunity as it can possibly be (I don't know if there is anything close to this in finance, I guess not). Some people try something fancy now and then (one very high rank mathematician I know of spends his summers working as a carpenter, say) but most just change one university campus for another. By the way, if you know some interesting place to try for a few weeks in the summer where they might be interested in people like me, let me know. Not that I'm unhappy where I am, but it will be fun to try something unusual when I have free time and it is certainly a better way to spend the vacation than going to some stupid resort :).

I don't think we really disagree all that much (except on the nature of fear of failure as a motivational force, but that's a discussion for another day).

I think mainly our disagreement comes down to my claiming that the mortar mixers might well be expected to produce more elsewhere, just as gt59 argues that the rank and file quants on Wall Street might well be expected to produce more elsewhere.  I suspect the reason we differ on this point is some combination of (1) you value the mortar mixing more highly than I do and (2) I value what they could do outside academia more than you do.  And that might explain why you do what you do and I do what I do :)

As for something interesting for a few weeks, that's a conversation we should probably take offline if you're serious...  Shoot me an email if so.

I would appreciate if you could continue your arguments here. It is very exciting to see both views discussed here. I was talking to a friend and his opinion goes along those lines:

He says the university system does not work perfectly. People are expected to publish each year, if not even quarterly. But most shall be lucky to publish one good paper in a lifetime, and within physics he thinks only Einstein published three good papers in a single year (2005).

This requirement of frequent publications leads to the consequence of journals filled with trivia and waffle. When he was a Cambridge student he says most academics were hired straight from their own undergraduates. If thought good enough they could do their PhD there and got life time tenured after about three years. Some may got lazy and did nothing. But most did not. They had the opportunity to invest like 5 to 10 years attacking a worthwile problem, and some took a Nobel Prize home. But the next generation saw a system change, and researchers got incentive to attack less risky problems, more of toy problems, and publish more rubbish, until they could achieve tenure.

He says looking at journals and textbooks you see most math has been discovered by a small number of people. In his view the difference between the best and mediocre professional mathematician is rather big, and he does not expect the mediocre guy to contribute much, i.e. closer resembling Richard's view. But of course a certain guy can focus on so much only so somebody needs to fill in all the other steps.

But this depends on one's goals. Many university math jobs are held by people not that good by the highest standards, so it perfectly possible spend one's life working in the math department. But will they enjoy it, and looking back at one's life at old age will you be scared by the insight that you lived a research life without inventing much? But then they might appreciate the academic lifestyle as Richard suggests.

But with the foundation of new universities and many more people seeking higher education you may have different goals than producing cutting edge researchers but more applied people who are capable of doing a reasonable job in industry.

The publication requirement is, indeed, ridiculous and leads to publishing a lot of junk. Another idiotic obscession in the USA is that about NSF grants. But after getting tenure, you do not really feel either of those two pressures and, if you are capable of "bringing the Nobel prize home", can go ahead and do it. I've heard that physics is much worse than mathematics in this respect though.

As I said, I can give you a list of 15 names of people in analysis to whom all the modern ideas can be traced. The "mediocre" guys do not contribute much individually but this group, taken as a whole, outputs more than the "top" ones (hence the analogy with "mortar mixing": the chief architects provide the blueprints and make the crucial decisions but they do not really put most of the stones together; most of the time they already think of the next building when the current one is still being constructed). Of course, the percentage of rubbish in that output is rather high but this percentage will not change with changing the quantity of "mediocre" guys. Neither will it go down if we put more pressure on them.

As to living a research life without inventing much, you can do an analogue of that everywhere. It basically amounts to living the life of a professional who introduced nothing drastically new into his craft. Believe it or not, most craftsmen in every conceivable craft are like that and there is nothing fundamentally wrong with it.

The main goal of mathematics departments is keeping the craft of mathematics (or, if you prefer, mathematical thinking) alive. Developing new ideas is just a small part of that. In my humble opinion, rrusczyk has already contributed not less to the craft than almost any top math. researcher by founding AoPS but he is also one of the "chief architects". What we desperately lack now is "mortar mixing boys" who would promote decent math. education locally all over the USA doing not as much each and doing it, perhaps, not so well, but still doing it everywhere every day until we do not hear "Mathematics? It was my least favorite subject and I have never been any good at it" from almost every person we meet on the street. Without those mortar mixers the things like AoPS will not be really effective and will remain just small splashes in a huge still body of water (quite impressive and beautiful splashes sometimes, but still splashes, not stable waves one would like to see).

If we agree on this as far as math. education is concerned, what makes you think that mathematical research is any different in that respect? We could have the industrial revolution during the time of Philomenes, Archimedes, Hero of Alexandria, and Leonardo da Vinci  (yeap, those guys had a general idea of how to put a steam engine together: [url=http://www.tmth.edu.gr/en/aet/5/55.html]see here[/url], and ,given enough incentive and support, would certainly be able to create something that works) if a few top guys were all that mattered. But it didn't happen until much later when great inventions (which were still just splashes) were able to generate big waves due to the presence of the same "mortar mixers" :).

Now that's a defense of mortar mixers I can appreciate ;)

That said, it's not clear to me that mortar mixers have the same, or even nearly the same, importance everywhere.  Take the NBA.  The mortar mixers are irrelevant.  It lives and dies by its stars.  In education, the mortar mixers are essential, because one person can only have a very limited effect on what's happening in classrooms.  That's where the mortar mixers are, and that's where most of the work is done.  In the NBA, most of the money-gathering work is done by the few stars who put the fans in the seats (or the eyeballs on the screen).  The mortar mixers just get in the way of this, which is why they get called for fouls, but Michael Jordan almost never even came close to fouling out.

Where research is on this spectrum, I don't know, but I'd guess it's somewhere in the middle, and you're in a much better position to evaluate it than I am.  Your "aggregate of mortar mixers > one star" argues that research is clearly not the NBA.  But it's not education, either.  I certainly can't name 15 people who shape education the way giants have had an impact on your field.  But maybe I just don't know the education field well enough, and maybe the difference is that your field is much more focused and definable than education.  Come to think of it, if we narrowed the discussion to "math gifted education", then your work and mine look a lot more similar in this regard.  Then we might make a list of 15, and the aggregate sum of the mortar mixers would easily exceed any one...

As for where to get the mortar mixers for math education, I think we need something like a Sputnik event to mobilize them.  I don't think anything else will work in today's environment (or at least, nothing will work until it's too late -- namely, when our economy has been thoroughly passed by countries that do invest in their top students much more than we do).

As an academic, I'd say that rrusyck's comments on academia are pretty much on spot.  Some have said that tenure is like having a rent-controlled apartment in a bad neighborhood - hard to get and even harder to leave.  However, one's ability to obtain academic employment after obtaining the PhD is highly dependent on the field that you choose.  Some fields, like Accounting, have had many more openings than applicants for many years.  Other fields, like Econ and Math, have (far) more applicants than positions.

Why is it that students at the top of the academic heap seem to be attracted to relatively "safe" socialized professions such as finance and academia? Why are they relatively unwilling to take entrepreneurial risks?  The reason probably lies in the fact that many at the top haven't really experienced failure in an intellectual pursuit and fear failure much more than their colleagues in the middle of the academic heap who've failed and recovered many times.  Hopefully, those who participate seriously in math competitions get used to failure and will be better prepared to take risks needed to succeed in most aspects of life.

For most of us, the "feel good" aspect of an academic position relates to the impact that we might have on students rather than research accomplishments.  The typical mediocre prof is part of a system geared towards motivating and guiding college students into a world where their developing talents and passions might be put to good use.  The system is surely inefficient and probably relies too heavily on PhD's.  However, as rrusyck points out for capitalism, there aren't alternatives to academia that have proven themselves more effective on a macro-level.  That doesn't mean we shouldn't try to find such alternatives or push academia into becoming more efficient.

My gripes about the financial system are mainly with the engineered products developed over that last 20 years or so - not capitalism itself.  Today, credit default swaps, collateralized debt obligations, and other forms of securitizations seem like little more than thinly disguised Ponzi schemes.  Markets for such "junk" remain frozen despite government torches and liberal doses of WD40.  I suppose that many people in this part of the industry did (do?) feel good about providing "liquidity"  or "efficiency" with these instruments and newer trading schemes.  Unfortunately, this does not mean that, in aggregate, the benefits of these activities to society have outweighed their heretofore disguised costs.  I'm arguing that the substantially increased size of financial services relative to GDP from 1985-2007 is a clear indication that the costs these activities, even before bailouts, exceed their benefits.  For a more through critique of the industry and the goverment's response to the crisis, see Yves Smith's blog [url=http://www.nakedcapitalism.com/2008/11/finance-has-lost-sight-of-its-role.html]Naked Capitalism[/url].

As mentioned in the above reference, most traders and investment bankers work very very hard and for very long hours in work environments that have little tolerance for errors.  They are paid gargantuan sums, at least by academic standards, in a financial industry that has always been more socialized than academia - at least when losses need to be absorbed and failure occurs (profits, of course, have mostly been privatized.)  Why should traders, bankers, and fund managers throughout the industry receive 6-10 digit annual dollar compensation without long-term results?  Where are the maluses or clawbacks for losing long-term bets or taking excessive risks with other people's money that one might expect in a capitalist industry?  I don't buy rrusyck's argument that the high compensation will always be there just because of the amount of money that is being managed/traded.  Wealthy people don't pay more for housekeeping than others - why should they pay more for investment services?  I'm not sure that barriers to entry are really high enough to support obscene compensation levels we've seen in the past.  If they are, the Obama government will surely place caps on comp.  In the past, there's been a lot more luck than skill involved in short term trading/banking results.  I suspect that compensation for FS professionals will eventually fall in line with that of other socialized sectors (academia, gvt,...) even if the industry somehow escapes effective nationalization.

To gain some perspective on the extent of the problem in financial services relative to academia, remember that all of the roughly 10 million US college students could pay an average of 30,000 dollars in tuition and fees for higher education at a total cost of 300,000,000,000 dollars - less than TARP monies injected into the largest banks in the last few weeks and dwarfed by the 8 trillion or so in guarantees on toxic assets that are now greatly benefitting some larger insolvent financial services companies favored by our government at the expense of their smaller, solvent, competitors.  The FS problem is still far from solved, virtually every industry is being negatively impacted by the crisis, and the US government's response has placed us on a path that appears to be leading to economic hardships for quite some time.

Hopefully, some of the students on this site will study these problems and develop future systems that address the difficulties we're now having.  Opportunities abound.

[quote="gt59"] As mentioned in the above reference, most traders and investment bankers work very very hard and for very long hours in work environments that have little tolerance for errors.  They are paid gargantuan sums, at least by academic standards, in a financial industry that has always been more socialized than academia - at least when losses need to be absorbed and failure occurs (profits, of course, have mostly been privatized.)  Why should traders, bankers, and fund managers throughout the industry receive 6-10 digit annual dollar compensation without long-term results?  Where are the maluses or clawbacks for losing long-term bets or taking excessive risks with other people's money that one might expect in a capitalist industry?  I don't buy rrusyck's argument that the high compensation will always be there just because of the amount of money that is being managed/traded.  Wealthy people don't pay more for housekeeping than others - why should they pay more for investment services?  I'm not sure that barriers to entry are really high enough to support obscene compensation levels we've seen in the past.  If they are, the Obama government will surely place caps on comp.  In the past, there's been a lot more luck than skill involved in short term trading/banking results.  I suspect that compensation for FS professionals will eventually fall in line with that of other socialized sectors (academia, gvt,...) even if the industry somehow escapes effective nationalization. [/quote]

An argument made in one of the books by Nassim Nicholas Taleb  goes along the following lines: In industries that have a high component of luck in the final performance as consulting or investing you need to make more efforts to motivate people work harder because they know that their struggle with the work may have little impact on the final result. Thus the pay gap between success and failure needs to be sufficiently huge to still provide for an incentive to work hard. An interesting article related to investment is [url=http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm]Blowing Up from the "New Yorker".[/url] The article was written in April 2002 but I still think it is ironic how they discuss General Motors which is likely to go bust if they do not get bailed out by the government anytime soon.

[hide="Article"]"How Nassim Taleb turned the inevitability of disaster into an investment strategy

1.

One day in 1996, a Wall Street trader named Nassim Nicholas Taleb went to see Victor Niederhoffer. Victor Niederhoffer was one of the most successful money managers in the country. He lived and worked out of a thirteen-acre compound in Fairfield County, Connecticut, and when Taleb drove up that day from his home in Larchmont he had to give his name at the gate, and then make his way down a long, curving driveway. Niederhoffer had a squash court and a tennis court and a swimming pool and a colossal, faux-alpine mansion in which virtually every square inch of space was covered with eighteenth- and nineteenth-century American folk art. In those days, he played tennis regularly with the billionaire financier George Soros. He had just written a best-selling book, "The Education of a Speculator," dedicated to his father, Artie Niederhoffer, a police officer from Coney Island. He had a huge and eclectic library and a seemingly insatiable desire for knowledge. When Niederhoffer went to Harvard as an undergraduate, he showed up for the very first squash practice and announced that he would someday be the best in that sport; and, sure enough, he soon beat the legendary Shariff Khan to win the U.S. Open squash championship. That was the kind of man Niederhoffer was. He had heard of Taleb's growing reputation in the esoteric field of options trading, and summoned him to Connecticut. Taleb was in awe.

"He didn't talk much, so I observed him," Taleb recalls. "I spent seven hours watching him trade. Everyone else in his office was in his twenties, and he was in his fifties, and he had the most energy of them all. Then, after the markets closed, he went out to hit a thousand backhands on the tennis court." Taleb is Greek-Orthodox Lebanese and his first language was French, and in his pronunciation the name Niederhoffer comes out as the slightly more exotic Nieder hoffer. "Here was a guy living in a mansion with thousands of books, and that was my dream as a child," Taleb went on. "He was part chevalier, part scholar. My respect for him was intense." There was just one problem, however, and it is the key to understanding the strange path that Nassim Taleb has chosen, and the position he now holds as Wall Street's principal dissident. Despite his envy and admiration, he did not want to be Victor Niederhoffer -- not then, not now, and not even for a moment in between. For when he looked around him, at the books and the tennis court and the folk art on the walls -- when he contemplated the countless millions that Niederhoffer had made over the years -- he could not escape the thought that it might all have been the result of sheer, dumb luck.

Taleb knew how heretical that thought was. Wall Street was dedicated to the principle that when it came to playing the markets there was such a thing as expertise, that skill and insight mattered in investing just as skill and insight mattered in surgery and golf and flying fighter jets. Those who had the foresight to grasp the role that software would play in the modern world bought Microsoft in 1985, and made a fortune. Those who understood the psychology of investment bubbles sold their tech stocks at the end of 1999 and escaped the Nasdaq crash. Warren Buffett was known as the "sage of Omaha" because it seemed incontrovertible that if you started with nothing and ended up with billions then you had to be smarter than everyone else: Buffett was successful for a reason. Yet how could you know, Taleb wondered, whether that reason was responsible for someone's success, or simply a rationalization invented after the fact? George Soros seemed to be successful for a reason, too. He used to say that he followed something called "the theory of reflexivity." But then, later, Soros wrote that in most situations his theory "is so feeble that it can be safely ignored." An old trading partner of Taleb's, a man named Jean-Manuel Rozan, once spent an entire afternoon arguing about the stock market with Soros. Soros was vehemently bearish, and he had an elaborate theory to explain why, which turned out to be entirely wrong. The stock market boomed. Two years later, Rozan ran into Soros at a tennis tournament. "Do you remember our conversation?" Rozan asked. "I recall it very well," Soros replied. "I changed my mind, and made an absolute fortune." He changed his mind! The truest thing about Soros seemed to be what his son Robert had once said:

My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking, Jesus Christ, at least half of this is bullshit. I mean, you know the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm, and it?s this early warning sign.

For Taleb, then, the question why someone was a success in the financial marketplace was vexing. Taleb could do the arithmetic in his head. Suppose that there were ten thousand investment managers out there, which is not an outlandish number, and that every year half of them, entirely by chance, made money and half of them, entirely by chance, lost money. And suppose that every year the losers were tossed out, and the game replayed with those who remained. At the end of five years, there would be three hundred and thirteen people who had made money in every one of those years, and after ten years there would be nine people who had made money every single year in a row, all out of pure luck. Niederhoffer, like Buffett and Soros, was a brilliant man. He had a Ph.D. in economics from the University of Chicago. He had pioneered the idea that through close mathematical analysis of patterns in the market an investor could identify profitable anomalies. But who was to say that he wasn't one of those lucky nine? And who was to say that in the eleventh year Niederhoffer would be one of the unlucky ones, who suddenly lost it all, who suddenly, as they say on Wall Street, "blew up"?

Taleb remembered his childhood in Lebanon and watching his country turn, as he puts it, from "paradise to hell" in six months. His family once owned vast tracts of land in northern Lebanon. All of that was gone. He remembered his grandfather, the former Deputy Prime Minister of Lebanon and the son of a Deputy Prime Minister of Lebanon and a man of great personal dignity, living out his days in a dowdy apartment in Athens. That was the problem with a world in which there was so much uncertainty about why things ended up the way they did: you never knew whether one day your luck would turn and it would all be washed away.

So here is what Taleb took from Niederhoffer. He saw that Niederhoffer was a serious athlete, and he decided that he would be, too. He would bicycle to work and exercise in the gym. Niederhoffer was a staunch empiricist, who turned to Taleb that day in Connecticut and said to him sternly, "Everything that can be tested must be tested," and so when Taleb started his own hedge fund, a few years later, he called it Empirica. But that is where it stopped. Nassim Taleb decided that he could not pursue an investment strategy that had any chance of blowing up.

2.

Nassim Taleb is a tall, muscular man in his early forties, with a salt-and-pepper beard and a balding head. His eyebrows are heavy and his nose is long. His skin has the olive hue of the Levant. He is a man of moods, and when his world turns dark the eyebrows come together and the eyes narrow and it is as if he were giving off an electrical charge. It is said, by some of his friends, that he looks like Salman Rushdie, although at his office his staff have pinned to the bulletin board a photograph of a mullah they swear is Taleb's long-lost twin, while Taleb himself maintains, wholly implausibly, that he resembles Sean Connery. He lives in a four-bedroom Tudor with twenty-six Russian Orthodox icons, nineteen Roman heads, and four thousand books, and he rises at dawn to spend an hour writing. He is the author of two books, the first a technical and highly regarded work on derivatives, and the second a treatise entitled "Fooled by Randomness," which was published last year and is to conventional Wall Street wisdom approximately what Martin Luther's ninety-five theses were to the Catholic Church. Some afternoons, he drives into the city and attends a philosophy lecture at City University. During the school year, in the evenings, he teaches a graduate course in finance at New York University, after which he can often be found at the bar at Odeon Café in Tribeca, holding forth, say, on the finer points of stochastic volatility or his veneration of the Greek poet C. P. Cavafy.

Taleb runs Empirica Capital out of an anonymous, concrete office park somewhere in the woods outside Greenwich, Connecticut. His offices consist, principally, of a trading floor about the size of a Manhattan studio apartment. Taleb sits in one corner, in front of a laptop, surrounded by the rest of his team -- Mark Spitznagel, the chief trader, another trader named Danny Tosto, a programmer named Winn Martin, and a graduate student named Pallop Angsupun. Mark Spitznagel is perhaps thirty. Win, Danny, and Pallop look as if they belonged in high school. The room has an overstuffed bookshelf in one corner, and a television muted and tuned to CNBC. There are two ancient Greek heads, one next to Taleb's computer and the other, somewhat bafflingly, on the floor, next to the door, as if it were being set out for the trash. There is almost nothing on the walls, except for a slightly battered poster for an exhibition of Greek artifacts, the snapshot of the mullah, and a small pen-and-ink drawing of the patron saint of Empirica Capital, the philosopher Karl Popper.

On a recent spring morning, the staff of Empirica were concerned with solving a thorny problem, having to do with the square root of n, where n is a given number of random set of observations, and what relation n might have to a speculator's confidence in his estimations. Taleb was up at a whiteboard by the door, his marker squeaking furiously as he scribbled possible solutions. Spitznagel and Pallop looked on intently. Spitznagel is blond and from the Midwest and does yoga: in contrast to Taleb, he exudes a certain laconic levelheadedness. In a bar, Taleb would pick a fight. Spitznagel would break it up. Pallop is of Thai extraction and is doing a Ph.D. in financial mathematics at Princeton. He has longish black hair, and a slightly quizzical air. "Pallop is very lazy," Taleb will remark, to no one in particular, several times over the course of the day, although this is said with such affection that it suggests that "laziness," in the Talebian nomenclature, is a synonym for genius. Pallop's computer was untouched and he often turned his chair around, so that he faced completely away from his desk. He was reading a book by the cognitive psychologists Amos Tversky and Daniel Kahneman, whose arguments, he said a bit disappointedly, were "not really quantifiable." The three argued back and forth about the solution. It appeared that Taleb might be wrong, but before the matter could be resolved the markets opened. Taleb returned to his desk and began to bicker with Spitznagel about what exactly would be put on the company boom box. Spitznagel plays the piano and the French horn and has appointed himself the Empirica d.j. He wanted to play Mahler, and Taleb does not like Mahler. "Mahler is not good for volatility," Taleb complained. "Bach is good. St. Matthew's Passion!" Taleb gestured toward Spitznagel, who was wearing a gray woollen turtleneck. "Look at him. He wants to be like von Karajan, like someone who wants to live in a castle. Technically superior to the rest of us. No chitchatting. Top skier. That's Mark!" As Spitznagel rolled his eyes, a man whom Taleb refers to, somewhat mysteriously, as Dr. Wu wandered in. Dr. Wu works for another hedge fund, down the hall, and is said to be brilliant. He is thin and squints through black-rimmed glasses. He was asked his opinion on the square root of n but declined to answer. "Dr. Wu comes here for intellectual kicks and to borrow books and to talk music with Mark," Taleb explained after their visitor had drifted away. He added darkly, "Dr. Wu is a Mahlerian."

Empirica follows a very particular investment strategy. It trades options, which is to say that it deals not in stocks and bonds but with bets on stocks and bonds. Imagine, for example, that General Motors stock is trading at fifty dollars, and imagine that you are a major investor on Wall Street. An options trader comes up to you with a proposition. What if, within the next three months, he decides to sell you a share of G.M. at forty-five dollars? How much would you charge for agreeing to buy it at that price? You would look at the history of G.M. and see that in a three-month period it has rarely dropped ten per cent, and obviously the trader is only going to make you buy his G.M. at forty-five dollars if the stock drops below that point. So you say you'll make that promise, or sell that option, for a relatively small fee, say, a dime. You are betting on the high probability that G.M. stock will stay relatively calm over the next three months, and if you are right you'll pocket the dime as pure profit. The trader, on the other hand, is betting on the unlikely event that G.M. stock will drop a lot, and if that happens his profits are potentially huge. If the trader bought a million options from you at a dime each and G.M. drops to thirty-five dollars, he'll buy a million shares at thirty-five dollars and turn around and force you to buy them at forty-five dollars, making himself suddenly very rich and you substantially poorer.

That particular transaction is called, in the argot of Wall Street, an "out-of-the-money option." But an option can be configured in a vast number of ways. You could sell the trader a G.M. option at thirty dollars, or, if you wanted to bet against G.M. stock going up, you could sell a G.M. option at sixty dollars. You could sell or buy options on bonds, on the S. & P. index, on foreign currencies or on mortgages, or on the relationship among any number of financial instruments of your choice; you can bet on the market booming, or the market crashing, or the market staying the same. Options allow investors to gamble heavily and turn one dollar into ten. They also allow investors to hedge their risk. The reason your pension fund may not be wiped out in the next crash is that it has protected itself by buying options. What drives the options game is the notion that the risks represented by all of these bets can be quantified; that by looking at the past behavior of G.M. you can figure out the exact chance of G.M. hitting forty-five dollars in the next three months, and whether at a dollar that option is a good or a bad investment. The process is a lot like the way insurance companies analyze actuarial statistics in order to figure out how much to charge for a life-insurance premium, and to make those calculations every investment bank has, on staff, a team of Ph.D.s, physicists from Russia, applied mathematicians from China, computer scientists from India. On Wall Street, those Ph.D.s are called "quants."

Nassim Taleb and his team at Empirica are quants. But they reject the quant orthodoxy, because they don't believe that things like the stock market behave in the way that physical phenomena like mortality statistics do. Physical events, whether death rates or poker games, are the predictable function of a limited and stable set of factors, and tend to follow what statisticians call a "normal distribution," a bell curve. But do the ups and downs of the market follow a bell curve? The economist Eugene Fama once studied stock prices and pointed out that if they followed a normal distribution you'd expect a really big jump, what he specified as a movement five standard deviations from the mean, once every seven thousand years. In fact, jumps of that magnitude happen in the stock market every three or four years, because investors don't behave with any kind of statistical orderliness. They change their mind. They do stupid things. They copy each other. They panic. Fama concluded that if you charted the ups and downs of the stock market the graph would have a "fat tail,"meaning that at the upper and lower ends of the distribution there would be many more outlying events than statisticians used to modelling the physical world would have imagined.

In the summer of 1997, Taleb predicted that hedge funds like Long Term Capital Management were headed for trouble, because they did not understand this notion of fat tails. Just a year later, L.T.C.M. sold an extraordinary number of options, because its computer models told it that the markets ought to be calming down. And what happened? The Russian government defaulted on its bonds; the markets went crazy; and in a matter of weeks L.T.C.M. was finished. Spitznagel, Taleb's head trader, says that he recently heard one of the former top executives of L.T.C.M. give a lecture in which he defended the gamble that the fund had made. "What he said was, Look, when I drive home every night in the fall I see all these leaves scattered around the base of the trees,?" Spitznagel recounts. "There is a statistical distribution that governs the way they fall, and I can be pretty accurate in figuring out what that distribution is going to be. But one day I came home and the leaves were in little piles. Does that falsify my theory that there are statistical rules governing how leaves fall? No. It was a man-made event." In other words, the Russians, by defaulting on their bonds, did something that they were not supposed to do, a once-in-a-lifetime, rule-breaking event. But this, to Taleb, is just the point: in the markets, unlike in the physical universe, the rules of the game can be changed. Central banks can decide to default on government-backed securities.

One of Taleb's earliest Wall Street mentors was a short-tempered Frenchman named Jean-Patrice, who dressed like a peacock and had an almost neurotic obsession with risk. Jean-Patrice would call Taleb from Regine's at three in the morning, or take a meeting in a Paris nightclub, sipping champagne and surrounded by scantily clad women, and once Jean-Patrice asked Taleb what would happen to his positions if a plane crashed into his building. Taleb was young then and brushed him aside. It seemed absurd. But nothing, Taleb soon realized, is absurd. Taleb likes to quote David Hume: "No amount of observations of white swans can allow the inference that all swans are white, but the observation of a single black swan is sufficient to refute that conclusion." Because L.T.C.M. had never seen a black swan in Russia, it thought no Russian black swans existed. Taleb, by contrast, has constructed a trading philosophy predicated entirely on the existence of black swans. on the possibility of some random, unexpected event sweeping the markets. He never sells options, then. He only buys them. He's never the one who can lose a great deal of money if G.M. stock suddenly plunges. Nor does he ever bet on the market moving in one direction or another. That would require Taleb to assume that he understands the market, and he doesn't. He hasn't Warren Buffett's confidence. So he buys options on both sides, on the possibility of the market moving both up and down. And he doesn't bet on minor fluctuations in the market. Why bother? If everyone else is vastly underestimating the possibility of rare events, then an option on G.M. at, say, forty dollars is going to be undervalued. So Taleb buys out-of-the-money options by the truckload. He buys them for hundreds of different stocks, and if they expire before he gets to use them he simply buys more. Taleb doesn't even invest in stocks, not for Empirica and not for his own personal account. Buying a stock, unlike buying an option, is a gamble that the future will represent an improved version of the past. And who knows whether that will be true? So all of Taleb's personal wealth, and the hundreds of millions that Empirica has in reserve, is in Treasury bills. Few on Wall Street have taken the practice of buying options to such extremes. But if anything completely out of the ordinary happens to the stock market, if some random event sends a jolt through all of Wall Street and pushes G.M. to, say, twenty dollars, Nassim Taleb will not end up in a dowdy apartment in Athens. He will be rich.

Not long ago, Taleb went to a dinner in a French restaurant just north of Wall Street. The people at the dinner were all quants: men with bulging pockets and open-collared shirts and the serene and slightly detached air of those who daydream in numbers. Taleb sat at the end of the table, drinking pastis and discussing French literature. There was a chess grand master at the table, with a shock of white hair, who had once been one of Anatoly Karpov's teachers, and another man who over the course of his career had worked, in order, at Stanford University, Exxon, Los Alamos National Laboratory, Morgan Stanley, and a boutique French investment bank. They talked about mathematics and chess and fretted about one of their party who had not yet arrived and who had the reputation, as one of the quants worriedly said, of "not being able to find the bathroom." When the check came, it was given to a man who worked in risk management at a big Wall Street bank, and he stared at it for a long time, with a slight mixture of perplexity and amusement, as if he could not remember what it was like to deal with a mathematical problem of such banality. The men at the table were in a business that was formally about mathematics but was really about epistemology, because to sell or to buy an option requires each party to confront the question of what it is he truly knows. Taleb buys options because he is certain that, at root, he knows nothing, or, more precisely, that other people believe they know more than they do. But there were plenty of people around that table who sold options, who thought that if you were smart enough to set the price of the option properly you could win so many of those one-dollar bets on General Motors that, even if the stock ever did dip below forty-five dollars, you'd still come out far ahead. They believe that the world is a place where, at the end of the day, leaves fall more or less in a predictable pattern.

The distinction between these two sides is the divide that emerged between Taleb and Niederhoffer all those years ago in Connecticut. Niederhoffer's hero is the nineteenth-century scientist Francis Galton. Niederhoffer called his eldest daughter Galt, and there is a full-length portrait of Galton in his library. Galton was a statistician and a social scientist (and a geneticist and a meteorologist), and if he was your hero you believed that by marshalling empirical evidence, by aggregating data points, you could learn whatever it was you needed to know. Taleb's hero, on the other hand, is Karl Popper, who said that you could not know with any certainty that a proposition was true; you could only know that it was not true. Taleb makes much of what he learned from Niederhoffer, but Niederhoffer insists that his example was wasted on Taleb. "In one of his cases, Rumpole of the Bailey talked about being tried by the bishop who doesn't believe in God," Niederhoffer says. "Nassim is the empiricist who doesn't believe in empiricism." What is it that you claim to learn from experience, if you believe that experience cannot be trusted? Today, Niederhoffer makes a lot of his money selling options, and more often than not the person who he sells those options to is Nassim Taleb. If one of them is up a dollar one day, in other words, that dollar is likely to have come from the other. The teacher and pupil have become predator and prey.

3.

Years ago, Nassim Taleb worked at the investment bank First Boston, and one of the things that puzzled him was what he saw as the mindless industry of the trading floor. A trader was supposed to come in every morning and buy and sell things, and on the basis of how much money he made buying and selling he was given a bonus. If he went too many weeks without showing a profit, his peers would start to look at him funny, and if he went too many months without showing a profit he would be gone. The traders were often well educated, and wore Savile Row suits and Ferragamo ties. They dove into the markets with a frantic urgency. They read the Wall Street Journal closely and gathered around the television to catch breaking news. "The Fed did this, the Prime Minister of Spain did that," Taleb recalls. "The Italian Finance Minister says there will be no competitive devaluation, this number is higher than expected, Abby Cohen just said this." It was a scene that Taleb did not understand.

"He was always so conceptual about what he was doing," says Howard Savery, who was Taleb?s assistant at the French bank Indosuez in the nineteen-eighties. "He used to drive our floor trader (his name was Tim) crazy. Floor traders are used to precision: "Sell a hundred futures at eighty-seven." Nassim would pick up the phone and say, "Tim, sell some." And Tim would say, "How many?" And he would say, "Oh, a social amount." It was like saying, "I don't have a number in mind, I just know I want to sell." There would be these heated arguments in French, screaming arguments. Then everyone would go out to dinner and have fun. Nassim and his group had this attitude that we're not interested in knowing what the new trade number is. When everyone else was leaning over their desks, listening closely to the latest figures, Nassim would make a big scene of walking out of the room."

At Empirica, then, there are no Wall Street Journals to be found. There is very little active trading, because the options that the fund owns are selected by computer. Most of those options will be useful only if the market does something dramatic, and, of course, on most days the market doesn't. So the job of Taleb and his team is to wait and to think. They analyze the company's trading policies, back-test various strategies, and construct ever-more sophisticated computer models of options pricing. Danny, in the corner, occasionally types things into the computer. Pallop looks dreamily off into the distance. Spitznagel takes calls from traders, and toggles back and forth between screens on his computer. Taleb answers e-mails and calls one of the firm's brokers in Chicago, affecting, as he does, the kind of Brooklyn accent that people from Brooklyn would have if they were actually from northern Lebanon: "Howyoudoin?" It is closer to a classroom than to a trading floor.

"Pallop, did you introspect?" Taleb calls out as he wanders back in from lunch. Pallop is asked what his Ph.D. is about. "Pretty much this," he says, waving a languid hand around the room.

"It looks like we will have to write it for him," Taleb chimes in, "because Pollop is very lazy."

What Empirica has done is to invert the traditional psychology of investing. You and I, if we invest conventionally in the market, have a fairly large chance of making a small amount of money in a given day from dividends or interest or the general upward trend of the market. We have almost no chance of making a large amount of money in one day, and there is a very small, but real, possibility that if the market collapses we could blow up. We accept that distribution of risks because, for fundamental reasons, it feels right. In the book that Pallop was reading by Kahneman and Tversky, for example, there is a description of a simple experiment, where a group of people were told to imagine that they had three hundred dollars. They were then given a choice between (a) receiving another hundred dollars or (b) tossing a coin, where if they won they got two hundred dollars and if they lost they got nothing. Most of us, it turns out, prefer (a) to (b). But then Kahneman and Tversky did a second experiment. They told people to imagine that they had five hundred dollars, and then asked them if they would rather (c) give up a hundred dollars or (d) toss a coin and pay two hundred dollars if they lost and nothing at all if they won. Most of us now prefer (d) to (c). What is interesting about those four choices is that, from a probabilistic standpoint, they are identical. They all yield an expected outcome of four hundred dollars. Nonetheless, we have strong preferences among them. Why? Because we're more willing to gamble when it comes to losses, but are risk averse when it comes to our gains. That's why we like small daily winnings in the stock market, even if that requires that we risk losing everything in a crash.

At Empirica, by contrast, every day brings a small but real possibility that they'll make a huge amount of money in a day; no chance that they'll blow up; and a very large possibility that they'll lose a small amount of money. All those dollar, and fifty-cent, and nickel options that Empirica has accumulated, few of which will ever be used, soon begin to add up. By looking at a particular column on the computer screens showing Empirica's positions, anyone at the firm can tell you precisely how much money Empirica has lost or made so far that day. At 11:30 A.M., for instance, they had recovered just twenty-eight percent of the money they had spent that day on options. By 12:30, they had recovered forty per cent, meaning that the day was not yet half over and Empirica was already in the red to the tune of several hundred thousand dollars. The day before that, it had made back eighty-five per cent of its money; the day before that, forty-eight per cent; the day before that, sixty-five per cent; and the day before that also sixty-five per cent; and, in fact-with a few notable exceptions, like the few days when the market reopened after September 11th -- Empirica has done nothing but lose money since last April. "We cannot blow up, we can only bleed to death," Taleb says, and bleeding to death, absorbing the pain of steady losses, is precisely what human beings are hardwired to avoid. "Say you've got a guy who is long on Russian bonds," Savery says. "He's making money every day. One day, lightning strikes and he loses five times what he made. Still, on three hundred and sixty-four out of three hundred and sixty-five days he was very happily making money. It's much harder to be the other guy, the guy losing money three hundred and sixty-four days out of three hundred and sixty-five, because you start questioning yourself. Am I ever going to make it back? Am I really right? What if it takes ten years? Will I even be sane ten years from now?" What the normal trader gets from his daily winnings is feedback, the pleasing illusion of progress. At Empirica, there is no feedback. "It's like you're playing the piano for ten years and you still can't play chopsticks," Spitznagel say, "and the only thing you have to keep you going is the belief that one day you'll wake up and play like Rachmaninoff." Was it easy knowing that Niederhoffer -- who represented everything they thought was wrong -- was out there getting rich while they were bleeding away? Of course it wasn't . If you watched Taleb closely that day, you could see the little ways in which the steady drip of losses takes a toll. He glanced a bit too much at the Bloomberg. He leaned forward a bit too often to see the daily loss count. He succumbs to an array of superstitious tics. If the going is good, he parks in the same space every day; he turned against Mahler because he associates Mahler with the last year's long dry spell. "Nassim says all the time that he needs me there, and I believe him," Spitznagel says. He is there to remind Taleb that there is a point to waiting, to help Taleb resist the very human impulse to abandon everything and stanch the pain of losing. "Mark is my cop," Taleb says. So is Pallop: he is there to remind Taleb that Empirica has the intellectual edge.

"The key is not having the ideas but having the recipe to deal with your ideas," Taleb says. "We don't need moralizing. We need a set of tricks." His trick is a protocol that stipulates precisely what has to be done in every situation. "We built the protocol, and the reason we did was to tell the guys, Don't listen to me, listen to the protocol. Now, I have the right to change the protocol, but there is a protocol to changing the protocol. We have to be hard on ourselves to do what we do. The bias we see in Niederhoffer we see in ourselves." At the quant dinner, Taleb devoured his roll, and as the busboy came around with more rolls Taleb shouted out "No, no!" and blocked his plate. It was a never-ending struggle, this battle between head and heart. When the waiter came around with wine, he hastily covered the glass with his hand. When the time came to order, he asked for steak frites -- without the frites, please! -- and then immediately tried to hedge his choice by negotiating with the person next to him for a fraction of his frites.

The psychologist Walter Mischel has done a series of experiments where he puts a young child in a room and places two cookies in front of him, one small and one large. The child is told that if he wants the small cookie he need only ring a bell and the experimenter will come back into the room and give it to him. If he wants the better treat, though, he has to wait until the experimenter returns on his own, which might be anytime in the next twenty minutes. Mischel has videotapes of six-year-olds, sitting in the room by themselves, staring at the cookies, trying to persuade themselves to wait. One girl starts to sing to herself. She whispers what seems to be the instructions -- that she can have the big cookie if she can only wait. She closes her eyes. Then she turns her back on the cookies. Another little boy swings his legs violently back and forth, and then picks up the bell and examines it, trying to do anything but think about the cookie he could get by ringing it. The tapes document the beginnings of discipline and self-control -- the techniques we learn to keep our impulses in check -- and to watch all the children desperately distracting themselves is to experience the shock of recognition: that's Nassim Taleb!

There is something else as well that helps to explain Taleb's resolve -- more than the tics and the systems and the self-denying ordinances. It happened a year or so before he went to see Niederhoffer. Taleb had been working as a trader at the Chicago Mercantile Exchange, and developed a persistently hoarse throat. At first, he thought nothing of it: a hoarse throat was an occupational hazard of spending every day in the pit. Finally, when he moved back to New York, he went to see a doctor, in one of those Upper East Side prewar buildings with a glamorous façade. Taleb sat in the office, staring out at the plain brick of the courtyard, reading the medical diplomas on the wall over and over, waiting and waiting for the verdict. The doctor returned and spoke in a low, grave voice: "I got the pathology report. It's not as bad as it sounds ?" But, of course, it was: he had throat cancer. Taleb's mind shut down. He left the office. It was raining outside. He walked and walked and ended up at a medical library. There he read frantically about his disease, the rainwater forming a puddle under his feet. It made no sense. Throat cancer was the disease of someone who has spent a lifetime smoking heavily. But Taleb was young, and he barely smoked at all. His risk of getting throat cancer was something like one in a hundred thousand, almost unimaginably small. He was a black swan! The cancer is now beaten, but the memory of it is also Taleb's secret, because once you have been a black swan -- not just seen one, but lived and faced death as one -- it becomes easier to imagine another on the horizon.

As the day came to an end, Taleb and his team turned their attention once again to the problem of the square root of n. Taleb was back at the whiteboard. Spitznagel was looking on. Pallop was idly peeling a banana. Outside, the sun was beginning to settle behind the trees. "You do a conversion to p1 and p2," Taleb said. His marker was once again squeaking across the whiteboard. "We say we have a Gaussian distribution, and you have the market switching from a low-volume regime to a high-volume. P21. P22. You have your igon value." He frowned and stared at his handiwork. The markets were now closed. Empirica had lost money, which meant that somewhere off in the woods of Connecticut Niederhoffer had no doubt made money. That hurt, but if you steeled yourself, and thought about the problem at hand, and kept in mind that someday the market would do something utterly unexpected because in the world we live in something utterly unexpected always happens, then the hurt was not so bad. Taleb eyed his equations on the whiteboard, and arched an eyebrow. It was a very difficult problem. "Where is Dr. Wu? Should we call in Dr. Wu?"

4.

A year after Nassim Taleb came to visit him, Victor Niederhoffer blew up. He sold a very large number of options on the S. & P. index, taking millions of dollars from other traders in exchange for promising to buy a basket of stocks from them at current prices, if the market ever fell. It was an unhedged bet, or what was called on Wall Street a "naked put," meaning that he bet everyone on one outcome: he bet in favor of the large probability of making a small amount of money, and against the small probability of losing a large amount of money-and he lost. On October 27, 1997, the market plummeted eight per cent, and all of the many, many people who had bought those options from Niederhoffer came calling all at once, demanding that he buy back their stocks at pre-crash prices. He ran through a hundred and thirty million dollars -- his cash reserves, his savings, his other stocks -- and when his broker came and asked for still more he didn't have it. In a day, one of the most successful hedge funds in America was wiped out. Niederhoffer had to shut down his firm. He had to mortgage his house. He had to borrow money from his children. He had to call Sotheby's and sell his prized silver collection -- the massive nineteenth-century Brazilian "sculptural group of victory" made for the Visconde De Figueirdeo, the massive silver bowl designed in 1887 by Tiffany & Company for the James Gordon Bennet Cup yacht race, and on and on. He stayed away from the auction. He couldn't bear to watch.

"It was one of the worst things that has ever happened to me in my life, right up there with the death of those closest to me," Niederhoffer said recently. It was a Saturday in March, and he was in the library of his enormous house. Two weary-looking dogs wandered in and out. He is a tall man, an athlete, thick through the upper body and trunk, with a long, imposing face and baleful, hooded eyes. He was shoeless. One collar on his shirt was twisted inward, and he looked away as he talked. "I let down my friends. I lost my business. I was a major money manager. Now I pretty much have had to start from ground zero." He paused. "Five years have passed. The beaver builds a dam. The river washes it away, so he tries to build a better foundation, and I think I have. But I'm always mindful of the possibility of more failures." In the distance, there was a knock on the door. It was a man named Milton Bond, an artist who had come to present Niederhoffer with a painting he had done of Moby Dick ramming the Pequod. It was in the folk-art style that Niederhoffer likes so much, and he went to meet Bond in the foyer, kneeling down in front of the painting as Bond unwrapped it. Niederhoffer has other paintings of the Pequod in his house, and paintings of the Essex, the ship on which Melville's story was based. In his office, on a prominent wall, is a painting of the Titanic. They were, he said, his way of staying humble. "One of the reasons I've paid lots of attention to the Essex is that it turns out that the captain of the Essex, as soon as he got back to Nantucket, was given another job," Niederhoffer said. "They thought he did a good job in getting back after the ship was rammed. The captain was asked, `How could people give you another ship?' And he said, `I guess on the theory that lightning doesn't strike twice.' It was a fairly random thing. But then he was given the other ship, and that one foundered, too. Got stuck in the ice. At that time, he was a lost man. He wouldn't even let them save him. They had to forcibly remove him from the ship. He spent the rest of his life as a janitor in Nantucket. He became what on Wall Street they call a ghost." Niederhoffer was back in his study now, his lanky body stretched out, his feet up on the table, his eyes a little rheumy. "You see? I can't afford to fail a second time. Then I'll be a total washout. That's the significance of the Pequod."

A month or so before he blew up, Taleb had dinner with Niederhoffer at a restaurant in Westport, and Niederhoffer told him that he had been selling naked puts. You can imagine the two of them across the table from each other, Niederhoffer explaining that his bet was an acceptable risk, that the odds of the market going down so heavily that he would be wiped out were minuscule, and Taleb listening and shaking his head, and thinking about black swans. "I was depressed when I left him," Taleb said. "Here is a guy who goes out and hits a thousand backhands. He plays chess like his life depends on it. Here is a guy who, whatever he wants to do when he wakes up in the morning, he ends up better than anyone else. Whatever he wakes up in the morning and decides to do, he did better than anyone else. I was talking to my hero . . ." This was the reason Taleb didn't want to be Niederhoffer when Niederhoffer was at his height -- the reason he didn't want the silver and the house and the tennis matches with George Soros. He could see all too clearly where it all might end up. In his mind's eye, he could envision Niederhoffer borrowing money from his children, and selling off his silver, and talking in a hollow voice about letting down his friends, and Taleb did not know if he had the strength to live with that possibility. Unlike Niederhoffer, Taleb never thought he was invincible. You couldn't if you had watched your homeland blow up, and had been the one person in a hundred thousand who gets throat cancer, and so for Taleb there was never any alternative to the painful process of insuring himself against catastrophe.

This kind of caution does not seem heroic, of course. It seems like the joyless prudence of the accountant and the Sunday-school teacher. The truth is that we are drawn to the Niederhoffers of this world because we are all, at heart, like Niederhoffer: we associate the willingness to risk great failure -- and the ability to climb back from catastrophe--with courage. But in this we are wrong. That is the lesson of Taleb and Niederhoffer, and also the lesson of our volatile times. There is more courage and heroism in defying the human impulse, in taking the purposeful and painful steps to prepare for the unimaginable.

Last fall, Niederhoffer sold a large number of options, betting that the markets would be quiet, and they were, until out of nowhere two planes crashed into the World Trade Center. "I was exposed. It was nip and tuck." Niederhoffer shook his head, because there was no way to have anticipated September 11th. "That was a totally unexpected event.""[/hide]

Tim Harford's argument on this was as follows: These outrageous paycheques at higher managerial level are paid to sufficiently motivate the employees at the level below to get into his (or rarely her) position. And less so as a fair compensation compared to other people's work further down the hierarchy. If you already get $ \$$ 200K  a year than another $ \$$ 500 annually will provide no incentive in the race of greed. You need to add a way higher sum to get the incentive structure right.

Let me talk a bit about the UK academic perspective. Below I appended an article by Stephen Court who discusses the history of UK academic tenure until up the present. Especially interesting is the section on "current trends in employment of academic staff" starting at page 7/9. It discusses the casualization of academic staff. For a large part of the 20th century academics of all levels had job security of tenure except for certain legal cases, but this certainty to be most likely employed until retirement is gone now for most academic staff. Before 1990 86% academics were employed on permanent contracts. In 1994 60% of the academic staff had permanent contracts. And this number is actually assumed to be even lower as Higher Education Statistics Agency (HESA) does not consider staff to be contracted on less than a quarter of a full-time contract. And for the first time there were more new appointments on fixed-term than permanent contracts (49.5 percent vs 48.3 per cent). If this development continues most of staff will be employed on fixed-term contract basis and the shift from job security to insecurity will have taken place. Will these fixed-term contracts make academia less attractive in the long run?

My experience from talking to UK academic staff is that they even can dismiss whole departments if it does not make enough money. And you are most likely not appointed as academic staff if you did not prove as post-doc to be able to secure grants in academia or funded private/government projects in industry. And even at the level of senior lecturer, reader or even professor you will run the risk of getting kicked out if you do not succeed in securing enough incoming grants. A good quantity of papers and placing papers at good conferences or journals is mostly not enough. Unless you are "exceptionally" accomplished at doing that. Another opportunity to be able to stay on is to get involved with politics, administration, teaching etc. You may teach a wide range of courses and many of them a term, become an (under-)graduate tutor, a departmental expert on computing issues as $ \text{\LaTeX}$ or use of grid infrastructure for computationally expensive techniques, tutor and supervise many students etc.

Of course there is also a cost of kicking out staff members for the department. It costs effort, time and money to recruit new staff though there might be plenty of people who are interested in that job. At my university teaching assistants below the lecturer level are allowed to contribute at most 10% to the students' final grade. But at other universities as the London School of Economics & Politics graduate students are asked to teach full courses due to lack of staff, e.g. a friend of mine got asked to teach a course on real analysis. But then preparing such a course requires a significant investment of time, especially if you are not "too fluent" in a certain course anymore you are asked to teach. And it may not coincide with your research area at all. And then again teaching in front of possibly 200+ students for the first time in your life can be quite a daunting experience. To be sufficiently assertive to deal with the students in this novel situation can be really challenging.

But this lack of loyalty may also turn out to be mutual that current staff members have less objections to move on to the next university upon arrival of a better offer. IBM experienced a similar fate. Most staff members were hired straight from university and mostly stayed on for a long time, often even until retirement. People knew they were welcome though at some point there skills may not meet the demands of the economy and they could get training to adopt to this new situation. But this also meant that many staff members were reluctant to easily move on to a different employer if a different company tried to headhunt you.

I am not sure about US but I heard a considerable number of professors are tenured starting at the assistant professor level. Even with the higher-ranked universities that may often start at the associate professor level though they know there often is a long queue of highly accomplished candidates. Maybe somebody from the US can shed more light on the situation there?

A related ML/AoPS thread discusses the [url=http://www.mathlinks.ro/viewtopic.php?t=242401]Economic Downturn in Academia[/url] which makes it even harder to secure an academic position these days.

[quote="gt59"]Why is it that students at the top of the academic heap seem to be attracted to relatively "safe" socialized professions such as finance and academia? Why are they relatively unwilling to take entrepreneurial risks?  [/quote]

Are students at the top of the academic heap any different from everyone else in this regard?  I don't think so.  They simply have access to more comfortable and more secure choices than others.

[quote="gt59"]I'm arguing that the substantially increased size of financial services relative to GDP from 1985-2007 is a clear indication that the costs these activities, even before bailouts, exceed their benefits.  [/quote]

This, I think, is the heart of the danger to the US economy.  As you note, ask the folks in Iceland.  This being said, for whatever reason, we're seeing bubble after bubble now -- dot-coms in the late 90s, real estate/financial products over the last decade, and now alternative energy.  Maybe it was always so, and freedom of capital movement has exacerbated the swings.

[quote="gt59"]As mentioned in the above reference, most traders and investment bankers work very very hard and for very long hours in work environments that have little tolerance for errors.
[/quote]

Long hours, yes.  Little tolerance for errors, I'm not so sure about.

[quote="gt59"]Why should traders, bankers, and fund managers throughout the industry receive 6-10 digit annual dollar compensation without long-term results?  Where are the maluses or clawbacks for losing long-term bets or taking excessive risks with other people's money that one might expect in a capitalist industry?
[/quote]

The incentive structure is a huge problem, to be sure.  I'm not sure how you can fix it, though.  Over time, firms tend this direction to attract talent.

[quote="gt59"]  I don't buy rrusyck's argument that the high compensation will always be there just because of the amount of money that is being managed/traded.  Wealthy people don't pay more for housekeeping than others - why should they pay more for investment services?
[/quote]

They pay more for investment services than poorer people because those investment services are worth much more to them than to others.  If you can convince a person that you can increase their return by 1%, that's worth way more to a rich person than to a poor person.  This isn't the case in housekeeping (and the rich do pay more for housekeeping, just not nearly as much more, partly due to the effect mentioned above).

Other industries have tried adjusting these things, but I haven't seen much success.  For example, some lawyers tried a flat fee arrangement for sports representation.  The percentage agents crushed them like a bug in competition.  I don't know if it was based in fact, but it sure was easy for the agents taking a cut of the action to argue that they'd fight harder and get a better deal than the flat fee folks.  (In general, I think the percentage people are correct here, though this easily may differ from industry to industry.)

[quote="gt59"] I'm not sure that barriers to entry are really high enough to support obscene compensation levels we've seen in the past.  If they are, the Obama government will surely place caps on comp.  [/quote]

And the industry will move offshore.  Or completely stagnate.  Government determining wages and prices in the private sector has very rarely been successful.  (Of course, for the time being, banking can hardly be considered the private sector anymore :) )  Outright nationalization will be the only way to achieve this, and even if that happens, it would be a temporary state, I think.

[quote="gt59"]In the past, there's been a lot more luck than skill involved in short term trading/banking results.  I suspect that compensation for FS professionals will eventually fall in line with that of other socialized sectors (academia, gvt,...) even if the industry somehow escapes effective nationalization.
[/quote]

I'll take the other side of that.  I'm guessing you know the old Willie Sutton saw.  Sutton was a bank robber who allegedly was asked why he robs banks, and answered, "because that's where the money is".  Managing money will always have high compensation because.... that's where the money is.

[quote="gt59"] The FS problem is still far from solved, virtually every industry is being negatively impacted by the crisis, and the US government's response has placed us on a path that appears to be leading to economic hardships for quite some time.[/quote]

I'll agree with the first statement (FS mess not over), but not the second (government's response placed on a bad path).  I think it's very hard to tell what's going to happen, and what the government's culpability is, at this point.  We're 70 years removed from the Great Depression, and there's still widespread dispute over the government's role in it.  I don't think anyone has a really good handle on either what is happening or how to deal with it.  I don't mean to be defending government -- some of their moves have clearly been disastrous.  Banning short selling = moronic.  And if they bail out the car companies over and over, I'm getting my pitchfork.  They're clearly injecting a lot of uncertainty into the market, which is one thing the market doesn't need more of.  But are they making things worse than doing nothing?  That's a hard case to make.  Yes, they're making things worse than a perfect government would, but this statement can be made about any action.

[quote="gt59"] Hopefully, some of the students on this site will study these problems and develop future systems that address the difficulties we're now having.  Opportunities abound.[/quote]

I just hope they don't believe in them too much -- I think excessive belief in what is "right" is the root of many difficulties in any complex system.  Witness the current mess.

And I still think that the news leans too heavily on the financial service professionals for their role in this mess, and not heavily enough on the individual borrowers.  They both should shoulder their share of the blame.  We talk about the ills of the FS profession, but there's no discussion above about people taking out mortgages they clearly can't afford (or don't understand).  I think the systemic and personal failures in both situations are essentially the same -- incentives structured to exacerbate a short term perspectives, and a belief in being able to get something for nothing.  I guess I mainly think that we're wrong to think of this as simply an FS industry failure.  It's much broader than that.

[quote="gt59"]My gripes about the financial system are mainly with the engineered products developed over that last 20 years or so - not capitalism itself.  Today, credit default swaps, collateralized debt obligations, and other forms of securitizations seem like little more than thinly disguised Ponzi schemes. [/quote]

I don't think the problems with these are so much ones of "Ponzi schemes" as they are of leverage, which is the real demon in this crisis, as it has been in so many others.  These fancy instruments give institutions easy ways to take on great amounts of risk through highly-leveraged bets, just like the fancy mortgage instruments allowed people to leverage up and buy much more house than they could afford.  Were I a regulator, this is what I'd be watching closely in any market.

My impression is that the main devil is in "buying with the future money". The mortgages and other debt obligations that were sold, resold, invested, and reinvested many times didn't really have any other support than the expected future income of individuals and companies (or, which is even worse, the so called "appreciation" of real estate, where absolutely no real value is created over time). So, in effect, we just used up all wealth that was assumed to be created for the next 10-15 years to give credit to the insolvent debtors and pump money into other equally reliable places. Now, even if that wealth is created as expected (which is very doubtful), we'll just get even by the end of that period.

In a sense, the current crisis is a good thing, meaning that it occured early enough to have some hope that we'll be able to get out of the "nose dive" before hitting the ground. Unfortunately, the first sane thing for the government to do would be not to give taxpayers' money to the banks but to pass the law that all TV commercials should be accompanied by the message "Buy what you can afford and learn to count your money" written in big red letters across the screen, which is never going to happen. :(