Come join us as we go back seven months to the apex of the history of American capitalism in the 21st century. We find ourselves in a swarm of fellow starstruck souls outside the Sheraton Hotel on Seventh Avenue in Manhattan, churning, squirming.
To slip past a battalion of cops and a platoon of security operatives in gray suits with small white techno-polyps in their ears attached to coils of white intercom cord trying to keep us under control… as we all but trample the raggedy, homeless-looking ranks of the television crews and every other laggard in our way.
We are ablaze!—ablaze with excitement, burning, yearning for a glimpse of the John Jacob Astor, the Andrew Carnegie, the E.H. Harriman, the John D. Rockefeller, the Henry Ford, the Bill Gates of our century… and that’s him! Look at him! He’s not wearing Astor’s wing collar debouching a silk four-in-hand or John D.’s stiff silk topper and morning coat with a red carnation in the buttonhole of the left lapel and a pair of striped pants, nor even Bill Gates’s off-the-Joseph A. Bank—rack sack suit. No, our man is only 27 years old and attired as a tycoon of our time… His shirt is a gray T-shirt, one of the 30-some gray T-shirts he has on hand in order to make sure he is clad in the same rebelliously fashion-defying teenager garb every day… and over it, a dark-gray sweatshirt with a hood, a garment known familiarly as a hoodie. From this day, May 7, 2012, forward, the hoodie becomes his symbol, his trademark, his battle standard.
In 15 minutes he will be inside the ballroom with an invitation-only crowd of neckties who make up America’s, in fact the world’s, wealthiest potential investors in the initial public offering of an estimated $104 billion worth of stock in his company, a new addition to our most modern industry, known as IT, for “information technology.”
As anyone who has read this far knows before we can say it, his company is called Facebook, and he is our century’s first tycoon of IT, Mark Zuckerberg. As of May 14, Facebook had 901 million customers, one of every eight people on earth (and would soon have one billion, one of every seven). No one had ever dreamed of such a thing, a “social network” that would enable people all over the globe to reach each other instantly, for free, and share pictures of themselves and God only knows what else.
The stock was to go on sale three days later, Thursday, May 17, at 11 a.m. By then 82 million bids were primed and straining against the starting blocks. Zuckerberg had hired five old investment banks to take care of the mechanics of the IPO for him: JPMorgan Chase, Goldman Sachs, Bank of America, Barclays Capital, and the lead bank, overseeing the entire operation, Morgan Stanley, in the persons of James Gorman, the CEO, and Michael Grimes. Grimes had been named the No. 1 Wall Street “dealmaker” on the Forbes Midas List four years in a row, 2004—07. At 11 a.m. sharp—bango!—the 82 million bids hit the market. Our old-line investment bankers are agog. They have never seen anything like the hordes of buyers stampeding straight toward them bearing billions of dollars—billions!—desperate to get their hands on shares of Facebook at the IPOffering price of $38 a share before it rockets up to $76 and who knows how much higher. Unbelievable hordes of them! Our old boys panic. They slip, they slide, they flounder. Without a clue as to what they’re doing, they begin drowning this, the biggest and most publicized IPO in history, beneath wave after wave of incompetence. Flummoxed, the old boys call it a “technical error” when the onrush of bids so overwhelms them, millions of transactions are recorded at the wrong prices. The leader of the lead bank, Gorman of Morgan Stanley, blames it all on NASDAQ, the exchange handling the transactions. Under the circumstances—namely, the biggest IPO in history—it sounds like Napoleon blaming Waterloo on the quartermaster corps for not delivering freshly laundered smalls to the front lines in a timely fashion.
The market was a shambles for hours afterward. Untold numbers of investors who had arrived ready to spend millions took one look at this twisted, grotesque wreck and headed home. Morgan Stanley and the rest of Old Hired Help & Co. managed (at no cost to themselves) to keep the IPO offering price, $38 a share, propped up until the end of the first day. Over the next 10 days it sank almost 25 percent. After 18 days it was down to $25.75, two thirds of the opening price. By Sept. 2 it had sunk to $17.79, less than half the offering price.
On top of that came a barrage of accusations that Facebook had, in fact, done poorly in the first quarter and no better in the second, news Morgan Stanley had not released to the public—known as the “retail” buyers—only to insiders who had invested in Facebook before the IPO. “We did nothing wrong,” said Morgan Stanley. But big insiders such as Goldman Sachs, Accel Partners, and Greylock Partners dumped their shares onto the market the moment NASDAQ opened the trading. Somehow if you’re called Retail, it means there’s somebody else in the game called Wholesale, and he’s… gotcha. They dumped millions of shares, enough to drive the prices down all by themselves. A Cowen Group analyst named Peter Cohen said, “I’ve never in 43 years seen something so bollocksed up.”
But it proved to be more than one unbelievably bollocksed-up IPO. May 17 was the day Wall Street got vaporized. After Facebook Day, all that “Wall Street” had been a metonymy for, the big money, the Big Picture of America’s economy, the excitement, the sense that this is where things are happening, was gone.
Up until 2006 a spirit of manly daring had pervaded Wall Street’s investment bankers. Trading stocks and bonds was the next thing to armed combat. The warriors, i.e., traders and salesmen, told of how fighting in combat—confronting not an armed enemy but a fan-shaped array of computer screens—created a euphoria more exhilarating than any other conceivable state of mind. It was the highest of all highs—and thanks not only to the earth-orbiting ecstasy of the battle. There was also the not inconspicuous fact that these Boomtime Boys—many of them in their 20s, still young enough to blush—were knocking back a million dollars or more a year in bonuses, year after year …
Victory as recorded on those screens made them feel like Masters of the Universe. The phrase came from a 1987 novel, The Bonfire of the Vanities, whose main character, Sherman McCoy, is a 38-year-old trading-floor salesman for an investment bank averaging a million dollars a year in bonuses and living on the top-nob part of Park Avenue. One day his trading-floor telephone rings, and he picks it up and takes a buy order for so many zero-coupon bonds his commission will be $50,000. Took 20 seconds, maybe 30, and—just like that—he’s $50,000 richer! The words suddenly flash into the Broca’s area of his brain: “I’m a Master of the Universe!” Jesus Christ!—came straight from his 6-year-old daughter’s toy set of plastic figurines, the “Masters of the Universe,” who had names like Ahor, Blutong, and Thonk and look like Norse gods who pump iron and drink creatine and human-growth-hormone smoothies.
In real life, young men on trading floors all over Wall Street read that book and got a kick out of that name, Masters of the Universe. They said it aloud only in a jocular way—they weren’t fools, after all—and never mentioned the wave of exaltation that swept through their very souls: I’m a Master of the Universe …
The market crash in November 1987 didn’t diminish that sublime bliss for longer than a few gulps. Likewise the “dotcom” crash of 2000—02. Even after 2002 the Masters of the Universe cast such a spell that an estimated 40 percent of the top 10 percent of the graduates of Harvard, Yale, and Princeton headed for jobs on Wall Street.
In 2004 a well-known trader for Deutsche Bank, John Coates, a Canadian, absolutely baffled his mates, his fellow warriors of the battle screens, by quitting Wall Street and heading off to England to re-up at his alma mater, Cambridge University, as a first-year graduate student in neuroscience. Neuroscience?! In a Second World country, England?!
The truth was, Coates never got Wall Street off of his mind for a moment. He was intrigued by the fact that a bunch of impulsive, juiced-up, howling, heedless young men had their hands on billions of dollars every day. He was turning to neuroscience in hopes of finding out what on earth could possibly account for… the Masters of the Universe.
Lately a member of the pack himself, he managed to persuade 17 traders in London’s version of Wall Street, “the City,” to let him take their endocrine levels in real time, as they worked on the trading floor, just before the action began and just after it ended in the afternoon. The technology was pretty simple. All the 17 had to do was spit 3mm of saliva—that was one half of 1 percent of a lunger and 2.1 percent of a gob and three times one little bit—into polystyrene vials. If they couldn’t get it up, they were given sticks of sugar-free chewing gum. On the verge of, say, an auction of 10 billion pounds’ worth of government 20-year bonds, a trader’s body, his very innards, did a back flip, rebooted, got recharged to make fast decisions—involving billions of pounds.
As Coates put it, the trader’s “metabolism speeds up, ready to break down energy stores of liver, muscle, and fat cells”… breathing accelerates… the heart starts drumming away… cells of the immune system take up positions at “vulnerable points …” his nervous system shunts blood from the stomach—“giving him butterflies”—and from the sexual organs—won’t need them until first thing afterward—and diverts it to the big muscles of the arms and thighs. His testosterone has been building rapidly, and now steroids start pumping from the testes into his bloodstream, along with adrenaline and cortisol, which in turn prompts the release of dopamine—“the most addictive drug known to the human brain.” The rush convinces traders “there is no other job in the world.” He becomes a different person, not merely confident but dominant… a Master. He is ready to take risks that would terrify a lesser man. “He leans into his screen, pupils dilated, breathing rhythmic, muscles coiled, body and brain fused for impending action.”
Which is to say, he becomes the endocrinological double of a male tiger or a mad bull or a Delta Commando, a Navy SEAL, an Air Force fighter jock, an East New York gangbanger, gearing up for mortal combat. At the start, the testosterone and adrenaline and the other endocrine uppers are at his service in getting ready for the fray. In fact, Coates discovered that traders with unusually high levels of testosterone at the start of the trading day could be counted on to turn a profit by the day’s end. Apparently the testosterone and all its endocrine outliers made a trader quicker at spotting an opportunity and more daring in exploiting it. Coates had intended this small study—just 17 subjects—to be the prelude to a much bigger one. But his testosteronorama and other findings were so startling and so consistent among all 17 that the American National Academy of Science published it online (April 14, 2008) before putting it into print as “Endogenous steroids and financial risk taking on a London trading floor.” (Later he did complete a bigger study, with 250 subjects, and last year published a book about it, The Hour Between Dog and Wolf.)
The trader’s rush is such a high, he can’t leave it behind at the office at night. Now, after the battle, an “irrational exuberance” goes out on the town with him… and is still by his side, beneath his very hide, when he returns to the office in the morning. His exaltation of himself, like his testosterone, is at a higher level than ever. He starts acting like he’s part of an elite Special Forces unit. He never waits for some superior in the chain of command to enforce discipline. He takes care of it himself… loudly. You!… yes, you!… No slackers allowed on the trading floor!… No wasting time by going out for a “business lunch.” If you must have something to eat, wimp, order in from the deli… No reading irrelevant material such as The Economist (old news by the time it comes out), much less The Racing Form or tits-and-slits magazines, just the way Sherman McCoy barks it out in The Bonfire of the Vanities.
Like warriors they were—except for one little thing: the chances of a Master of the Universe dying in the line of duty were statistically nil. Most of them were under 40, and the likelihood even of stroking out while cursing Fate with their hands up on either side of their heads, shaking spastically… was remote.
On the trading floor they were slightly older, vastly richer versions of the frat boy. Beneath the frat boy’s wild times, the drinking, the cocaine, the practical jokes, the drinking, the getting laid, the talk about getting laid, the whoring around, the talk about whoring around, the drinking, the sarcastic cracks classified Sarc I, Sarc II, Sarc III, the dilations upon such esoteric topics as the size of turds and the span of projectile vomiting, the drinking… lay a single, simple desire: to present a man’s view of the world.
The Master of the Universe doesn’t worry about manliness. He is manly. He’s got masculinity to burn. His problem is the reverse. He has irrational exuberance under his very skin. Now, after the battle, as the darkness closes in, his exaltation of himself, like his testosterone, is at a higher level than ever. It suffuses all areas of his life, notably his sexual appetite.
Someday soon, let’s hope, some team of enterprising anthropologists is going to pull together the thousands of folk stories—some achieving the level of legend—of the love lives of the Masters of the Universe. Invariably these are tales told by the girls, as the Masters call them all… the girls. To a girl they said that every date consisted of the Master of the Universe holding forth on just two subjects: My Career, and sex. His discourses on My Career they characterized as endless endless endless boring boring boring I can’t take anymore of this! I’M GONNA SET MY HAIR ON FIRE TO END THE BOREDOM!
When it came to sex, on the other hand, his explication never waxed garrulous, never went off on tangents, and his demonstration rarely took more than 60 seconds. It went, pump pump pump pump pump pump pump pump oo-oo-oo-oo-oo-ooooh uh oo agghhh and bingo—roll off, snore like a bear.
Naturally, being so manly, so fast-acting, so… well… so masterful, the Masters of the Universe couldn’t help but feel superior to the common people they had to deal with every day. They tried not to show it… but when the warriors were among themselves, out on the trading floor, let’s say, how could they help but poke a little fun at all the simple souls they ran into in the course of their work? It was like the way New York City police officers called the clueless citizens they ran into “hooples.”
The Masters of the Universe had the same sort of terminology for referring to clueless citizens in their world—but who were they? According to Michael Lewis, a onetime salesman for Salomon Brothers, there was a running joke at Salomon that went:
“What’s the second-lowest form of human being?”
“I don’t know, what?”
“An equities dealer in Dallas.” This was the sub-punchline. At the time, the 1980s, the action, the big money, was not in equities, i.e., stocks, but in the bond market and certainly not in Texas.
“So what’s the lowest form of human being?”
That was Salomon Brothers. At Goldman Sachs they called customers “muppets.” Other investment banks called their customers “guppies,” “suckers,” “marks,” “sheep,” “chumps,” “lambs,” “baby seals”… Words like suckers, marks, and lambs had considerably more bite than hooples. After all, where do lambs go? To the slaughter.
The Masters of the Universe had always thought of their customers as people who should never have been let out of the house with money in their pockets. But here they were and somebody was going to take advantage of them. To turn your palms up and shrug and just watch them walk by, you’d have to be as lame as they were. They were lame; they weren’t stupid. They had money and IQs above 98. So you had to ask yourself, Why would they ever invest in an investment bank? In a hedge fund you at least had a fighting chance. The manager was investing his own money the same way you were. Well… let’s be fair. Not every investment bank would lead its customers to the slaughter. On the other hand what was wrong with shearing the fleece every so often?
Our manly Masters, still gorged with so much testosterone and dopamine, just didn’t get it in 2009 even when the most unlikely thing in the world happened: a bunch of weaklings, a bunch of nerds known as quants, shut the golden door flat in their faces.
Nerds… the nerd has never been precisely defined, thanks to the psychological complexity of the creature. The word has connotations of some level of intelligence. The typical nerd is a male with intelligence but no sense of giving it a manly face. He doesn’t play sports, doesn’t automatically crack up over jokes about slutty girls, doesn’t shore up his masculinity with frequent drops of the f-bomb, doesn’t realize how bad it looks when he shoots his arm into the air and flaps his hand like a flag in his eagerness for the teacher to call on him first to answer the question, doesn’t retaliate against insults from his fellow males in the schoolyard—oh, the schoolyard… the schoolyard… It is there that he learns he is not a Master of the Universe and never will be… not in his whole lifetime… and so he develops interests that are neither male nor not male—just obsessive, such as capturing bugs at night and pinning them up on a push-pin board, studiously arranging them by genus, species, and subspecies. There’s nothing wrong with it… it’s just a little weird and brainy—in short, nerdy. If a nerd was a little weird and not brainy at all, he was known as a dork. There was no connotation of deviant sexual behavior. The Master of the Universe assumed all varieties of nerds—quants, dorks, and plain nerds—were asexual.
Quant was what a nerd could move up in rank to, if he turned out to be a mathematical genius. It was the manly traders’ and salesmen’s condescending contraction of the actual term, quantitative analyst. Quants started showing up on trading floors in the late 1980s to set up computers that could retrieve information and sort it out faster than a trader, thereby freeing the Master of the Universe from a lot of tedious clerk work. At the outset, the traders looked down upon the quants as nerds who didn’t have, in real-manly MasterSpeak, “the balls” it took to go out on the floor and take the big risks required if you wanted to make real money. It was in the early 1990s that the Masters actually coined the word quant, possibly because that was what it sounded like when you squashed a blood-ballooned tick with your thumb. They had no suspicion, none at all, of what these ball-less, sofa-bottomed weaklings were up to.
In 1942, Joseph Schumpeter wrote that stocks and bonds are “evaporated property.” Everybody thought of that as such a witty aphorism, but Schumpeter meant it as a lament. “Substituting a mere parcel of shares for the walls and the machines in a factory,” he said, “takes the life out of the idea of property.” The new owners, i.e., the stockholders, lose the entrepreneur’s, the founder’s, will “to fight, economically, physically, politically, for, ‘his’ factory and his control over it and to die if necessary on its steps.” Instead, at the first whiff of a problem the shareholders bail out and sell their share of the ownership to whoever will buy it on the stock market… and couldn’t care less who it is.
That was how stocks and bonds evaporated property. What the quants had in mind was a quantum leap (so to speak) forward to the next stage: evaporating the stocks and bonds… not the property—that was long gone—but the very stocks and bonds themselves and making some real real money.
It was not a new idea, but even among quants few knew where it came from. Back in 1962 a young (30) mathematics professor at MIT, Edward O. Thorp, had published a mathematically foolproof way of winning at blackjack by counting the numbers of the cards already played. He proved it in live action by playing in a series of Nevada casinos… with a professional gambler’s money. The book—and Thorp himself—infuriated the gambling industry. Now any clueless hoople could walk into a casino and wipe out the house. The casinos had to change the rules of a grand (and lucrative) old game. Naturally, the public ate it all up, and Beat the Dealer became a bestseller. To most mathematicians it was ingenious—they devoutly wished they had thought it up themselves—but pretty simple stuff, when you got right down to it. Five years later however, in 1967, Thorp caught their unqualified attention with a second book, Beat the Market. It described a foolproof way of winning big on the stock and bond markets. His fellow mathematicians had been spellbound at the time… 45 years ago. This one baffled ordinary citizens, however. It had to do with the mispricing of stocks and bonds as compared to their derivatives—futures, warrants, debentures, forwards, options, swaps, convertibles… and selling the stocks and bonds short and buying the derivatives long, or vice versa. It didn’t matter what stocks or bonds, either. Their names, histories, reputations, prospects—irrelevant. All that mattered were the spreads, the lags, and they didn’t have to be large. In fact, a difference of 2 cents was—
Hold on! Hold on!… Did you say derivatives?! and debentures or something?! and selling short?! or vice versa?! It made a hoople’s head hurt. As with his blackjack theory, Thorp put his market theory to the real, live-action test. In 1974 he launched a hedge fund named Convertible Hedge Associates and soon renamed it Princeton-Newport Partners. The administrative office was in Princeton, New Jersey. Thorp himself and a team of quants did the trading and cooked up new strategies in a sequestered money laboratory in Newport Beach, California. In 1983 he set off some StarStreamers over Wall Street when the Bell Telephone Company monopoly broke itself up into eight parts, seven new “Baby Bells,” as they were called, plus the mother company “Ma Bell,” whose name was changed to AT&T. They issued new stock. Each new share was either a blend of Baby Bell shares and shares of AT&T—or else shares that were all AT&T. Their IPOffering prices were identical. But the excitement was over the new Baby Bells, and so the blended shares were where things were happening. As a result, they were selling for three quarters of 1 percent, 75 cents per $100, more than shares of AT&T alone. In 1983 nobody but a quant like Thorp would open his eyes wide as a kid’s at this exciting sight. With the next breath he simultaneously sold short $332.5 million worth of the blended shares that included the exciting Babies and bought $330 million worth of AT&T-alones, for a profit of $2.5 million. It was then the biggest transaction in the history of Wall Street. Outsiders couldn’t believe the man. He bets $332.5 million—virtually one third of a billion—on selling a stock short—and bets another third of a billion buying the same stock to make a profit of one one-hundredth of 1 percent. Think of risking a total of close to two thirds of a billion dollars to make $2.5 million! Sheer madness.
Thorp shook his head and laughed. How could anybody who called himself a financier have failed to see it? That was no bet! It was a mathematical certainty! To sell shares at the high figure short and simultaneously buy an equal number of shares at the low figure—it was a perfect hedge. You pocketed the comparatively tiny difference. Tiny comparatively, yes… but hey, $2.5 million here and $2.5 million there—and in no time you had yourself enough millions to make a mere Warren Buffett blink. And an entire transaction might take all of 10 seconds. That was quantitative trading. It had nothing to do with any stock’s or bond’s value. It was a purely mathematical way to game the markets. Bell happened to be one of the best-known companies in the country. But it might as well have been RadioShack, for all it mattered to Thorp. He wasn’t buying and selling stocks. He was playing a game with the numbers that trailed behind them—and evaporating the whole instrument.
All along it was obvious that Thorp’s real ambition was not to make money—although his hedge fund has racked up profits averaging 20 percent a year ever since, and he does cash his checks, and he has put away a personal fortune of $800 million over the intervening 30 years. He was far more interested in showcasing, upon the Biggest Boards available, the mathematical genius of Edward O. Thorp. Other quants playing the market tended to hide their strategies like gold strikes. Not Thorp… He couldn’t wait to show the bug-eyed world exactly how he had beaten the dealer and the market. He was a gamester eager to astound the world with real-life demonstrations of the higher mathrobatics.
His opposite number in this hot new sport of gaming the stock and bond markets, evaporating them, vaporizing their simple-minded premise—buy lower, sell higher—was one James Simons. Simons was another math swami who had gone from academia into the markets. As an undergraduate he had I’m-a-whizzed through MIT in three years as a math major taking graduate courses when undergraduate courses made him yawn… got his Ph.D. at Berkeley… became a code-breaker for the government’s Intelligence Analysis Division, breaking codes down until they read like cereal-box literature… teamed up with another Berkeley mathematician, Shiing-Shen Chern, in 1974 to create the Chern-Simons theorem, which was somehow useful in string theory and the Big Bang hypothesis. Somehow is the word. Only mathematical cloud-skiers could even begin to understand it. Simons won the American Mathematical Society’s highly prized Oswald Veblen Award in Geometry in 1976… was brought to Stony Brook University on Long Island as a star who would attract other high-level mathematicians to the faculty… became frustrated trying to solve ever more sky-high geometry problems for the edification of the cloud-skiers… and began to go into partnerships with other quants experimenting with hedge funds… and in 1988 he founded his own, the Medallion Fund… leading to an assortment of funds under the umbrella name Renaissance Technologies.
Simons hid his operation so well, it was more than a decade before Wall Street woke up to what Simons had there. For a start, he set up shop with a team of other quants, virtually all strangers to Wall Street, in a town on the north shore of Long Island out in Suffolk County, named East Setauket. East Setauket was the sort of town so small in scale, so given over to little buildings in a colonial—New England style—the first settlers had sailed across Long Island Sound from New England three centuries ago—people went away saying, “Oh, how picturesque.” East Setauket had two advantages: it was very near Simons’s office at Stony Brook—and nobody, nobody, in the Wall Street financial world ever heard of it. Good. Simons didn’t want anybody from Wall Street to come near the place.
With one exception, he hired no one tainted by Wall Street experience or even Wall Street ambitions… such as business-school graduates, M.B.A.s. Their young minds had already been twisted too far. They had been expertly educated to become dim-witted macho blowhard frat-boy losers. Simons wanted only mathematicians and scientists. More than a third of his employees had Ph.D.s. He compartmentalized their assignments, so that none of them knew his grand strategy. Only a precious few way-insiders did. Anytime one of this Elect left East Setauket and showed signs of using his strategies at somebody else’s shop, he didn’t hesitate to sue. In point of fact, Renaissance Technologies had a remarkably low turnover. Simons had set up one hedge fund for employees only, and it poured lots of money straight into their buckets all year long every year.
In its first 24 years, Renaissance Technologies brought its investors—and its help—yearly returns averaging 38.5 percent… net of fees, and his fees were the stiffest in the business: 5 percent of each account each year and 36 percent of the fund’s profits. Simons’s own yearly income ran in the hundreds of millions. In its third year, 1990, the Medallion Fund turned a 55.9 percent profit, again net of fees. In 2000, during the dotcom crash, the Standard & Poor’s 500 Index fell 10.1 percent—and the Medallion Fund rose 98.5 percent, net.
Renaissance Technologies’ headquarters in East Setauket became a regular campus, with a gymnasium, pool, dining hall, library, auditorium, and big quiet offices for everybody. The auditorium was used mainly for lectures by sages in the sciences who couldn’t have cared less about the investment markets. Simons had turned his operation into a quasi-college… a walled-in, gated quasi-college with serious security guards.
By 2007 he was by far the biggest player the markets had. Next to James Simons, Warren Buffett and George Soros were elves of the Old Time variety. Yet news stories about Simons were rare. Interviews were rarer, and even then he didn’t so much answer questions as mock them:
What can you say about Medallion’s trading strategy?
What kind of instruments does it trade?
How many different strategies does it use?
After his eye-popping performance at the very bottom of the dotcom crash, there was no more hiding Simons and his quants behind the gates in East Setauket. A mad rush began. Nobody else seemed to know Simons’s exact strategies, but obviously they were quantitative and required huge rooms full of computers and servers to do the calculations. From that moment on, quants, these nerds cum laude—and not a bunch of noisy traders cum humongous stones—were the stars you had to recruit.
Until the late 1990s Thorp and Simons had the Big Rock Candy Mountain pretty much to themselves. There were only a few hedge funds and investment banks using their purely mathematical system of spotting mispricings and cashing in. In 1983, 10 seconds had been more than enough time to sell short and buy long and complete a transaction. But with several thousand funds and banks quanting up to get into this new trick of gaming the markets by detecting lags in pricing, speed would be of the essence… especially now that the SEC had dispensed with the rule that bids had to be entered on a keyboard. All along, Thorp’s hedge fund had been using so many computers and servers, they filled up an entire room as big as his office itself. By the year 2000 Simons needed so much computing power, the machinery filled up the equivalent of a small warehouse. And that was just the beginning.
Onward! Onward! Faster! Faster! At a thousand, two thousand, three thousand banking operations, investment funds, and exchanges, quants kept adding computers and servers and servers and computers row above row above row on floor-to-ceiling racks that stretched on infinitely like the stacks of the biggest library in the world… wrapped in miles of white fiber-optic cables that interconnected the machines… But these stacks were by no means quiet as a library’s. There were aisles between the stacks so that someone, presumably someone from IT, could get to any machine, every cable connection, if he had to. But any human being who entered, even an IT guy or a quant, was engulfed, oppressed, unnerved, spooked out by an overwhelming droning sound and an X-ray-blue fluorescent light that made your skin look posthumous. The droning seemed to create a pressure upon your skull. Sometimes the drone would rise slightly, then lower… and rise… and lower. It made you think this enormous robo-monster was breathing… If you were knowledgeable enough even to be allowed to enter one of these huge server rooms, you knew that most of the droning came from air-conditioning units high as a wall… that ran constantly to keep this concentration of machines from auto-melting because of their own ungodly heat. In some gigantic facilities they let the heat rise into plenums and piped it from there to heat the entire building. You could know all that, but the robo-monster would ride your head so hard, you would turn anthropomorphic in spite of your superior brain… The robo-monster—it’s breathing… it’s starting to move… it’s got me by the head… it’s thinking with its CPU (Central Processing Unit) mind, thinking in algorithms, sequences of programmed decisions along the lines of “If A261, then G1432, and therefore B5556 or QQ42—” spotting discrepancies, making buy-sell decisions, even deceptive looks-like-a-buy feints to trick competing robo-brains into making foolish calculations. The monster’s human… No, he’s not human… No human brain could possibly think or act as fast, as accurately, as cunningly as a robo-brain.
Thorp’s 10-second transactions during the Bell breakup would have been an eternity in the robo-world. The investment banks, funds—and exchanges—began adding acres of robo-racks in the race to spot mispricing opportunities first and execute transactions in the same instant. It was no longer a matter of oldfashioned split seconds. It came down to millionths of a second. This became known as High Frequency Trading.
By 2006 the robo-monster was huge—not only in the metaphorical sense of its impact, but also literally, physically, in its overwhelming mass. Knight Capital built a robo-monster that took up 1.4 acres in Jersey City, New Jersey. Equinix built one covering 7.4 acres in Secaucus, New Jersey. The New York Stock Exchange, which was now a private corporation called NYSE Euronext, built a 428,000-square-foot High Frequency Trading facility in Mahwah, New Jersey—428,000 square feet. That was 9.8 acres of conjoined machinery and its housing devoted not to investing in the markets but to diddling them. The NYSE was now a private corporation and did “proprietary” trading, too—i.e., became a player, too, and gained its own market and others. These diddling machines, if piled up would have created a structure the size of two Empire State Buildings, one atop the other, 204 stories in all. Every kidney in mid-Manhattan would be vibrating from the droning droning droning droning 24 hours a day, every day. All that was quite in addition to new systems spanning vast distances. The Hibernia Atlantic Corporation was attempting to lay fiber-optic cables across the floor of the Atlantic Ocean that would shave six-thousandths of one second (0.006 seconds) off the time it took a signal to travel from New York to London. Sharks were mysteriously robo-crazy about the fiber-optic cables and tried to eat them—meaning yet more millions of dollars spent on shark-proofing the cables with sheaths.
The Perseus Corporation was building a robo-system that would transmit robo-data from New York to Chicago on a straight sight line. Telegraph and telephone wires had always been laid alongside the railroad tracks. Sight-line transmission would be one thousandth of a second faster. One thousandth of a second saved, New York to Chicago! Six thousandths of a second saved, New York to London! Think of it: one thousandth here and six thousandth there—such speed was a quant’s dream come true. The ultimate dream was to transmit market data faster than the speed of light. Faster than the speed of light? How?
Neutrinos! Neutrinos—academics insist they exist—are described as “sub-atomic particles,” fragile but fast, fast, fast as fairy dust. In 2011 a 170-man team of Italian engineers and scientists called OPERA declared it close to certain, if not all the way there, that neutrinos traveled 0.002 nanoseconds faster than the speed of light. If so, that reduced Einstein, the Darwin-like darling of modern physics, to a solemn old quack like Freud, Mesmer, or Nostradamus. Five different groups of orthodox academics rose up in wrath to shoot holes through the methodology of the OPERA team, and there the matter stands. Nevertheless—neutrinos! The quants desperately wanted it to be true… It meant their robo-monsters really could spot and exploit anomalies on the stock and bond markets before they even happened.
The robo-monster accounted for 10 percent of all trades in 2000. Thereafter, the number rose in a steep, steady climb to a peak of 73 percent in 2009, close to three of every four trades—and nobody in the outside world, not even the press, had ever heard of it! The first mention of it in the press was not until July 23, 2009, in the New York Times.
The majority of men working full-time right here on Wall Street didn’t know much more. They were as innocent as the suckers, the guppies, the muppets. They learned in such tiny steps, they didn’t get the whole picture until very late in the game. Their first inkling came when the investment banks’ trading floors began to calm down… fewer and fewer traders yelling at each other or into the telephone or at Fate. Before long they were sitting at desks behind banks of computer screens and communicating with each other by text message.
The robots cost some old traders and salesmen their jobs but, again, gradually, and intermittently, somebody still had to attend to the muppets and marks who continued to come to Wall Street to invest—to the quants the word seemed so archaic—to “invest” their money. What the Masters didn’t realize was that their muppets, marks, guppies, and chumps provided only the liquidity—i.e., ready money… useful mainly to provide the quants’ robo-diddlers with numbers to play with, discrepancies the robot battle machinery could game and exploit. The Masters didn’t begin to sense that something was up until the heads of the various desks began giving them odd assignments such as taking big customers or potential customers out to lunch. Out to lunch? Assigned to leave the trading floor in the middle of the trading day? No more you… yes, you… if you must have something to eat, wimp, order in from the deli?… What was this? But even then it never became blatant enough to make them realize the new name of the game.
Today the same sort of top Ivy League students who wanted so badly to work on Wall Street even six years ago… now head for the Silicon Valley, because that is now where things are happening. And what is happening there is part of an older, more typical America. A Mark Zuckerberg and his Facebook, and Facebook’s industry, IT, for information technology… and, hoodie or no hoodie, are perfectly traditional in the lustrous economic annals of the United States.
Two things showed quite concretely how lowly the traders and salesmen had fallen. For a hot quant prospect, employers would pay up to five times as much as for a Master of the Universe. Or as a New York Post headline put it recently: “Slick ‘Wall Street’ guys ousted by $1M geeks.” And a quant’s rogue algorithm for a single stock could bring down the entire market, as in the “flash crash” of 2010 and the 1,000-point nosedive of 2012. The dive cost the Knight Capital Group $440 million. They never recovered.
The Masters of the Universe were never able to explain to their children what they did. The standard explanation, “Well, we create markets”—sounded about as exciting as watching Astroturf grow.
The simplest way to see just how far our masters have fallen in our universe is to imagine how Sherman McCoy’s adventures would play out today. Twenty-five years ago he was exhilarated by the great truth that had just dawned on him: “I’m a Master of the Universe!”
If John Coates had been on hand to have him spit into the polystyrene vials, Sherman would have scored off the endocrine chart. He was supercharged with testosterone. John Coates could have easily predicted what happened next. McCoy gets hot hot hotter on the trading floor. He’s so pumped up with testosterone, he’s convinced he deserves what he now helps himself to: a hot hot hot girl named Maria, 15 years younger than his wife, who is 40. Bango!—he’s off on a regular bender of exciting assignations here and risky liaisons there with Maria and her loamy loins, her nice young loamy, loamy loins, oozing lubriciously at every rendezvous.
One night, in McCoy’s Mercedes roadster, they make a wrong turn and wind up in the Bronx and are brought to a stop by a crude barricade of trash cans blocking a ramp. From out of nowhere appear two black youths heading toward them. Panicked, McCoy and his girl go screeching out of the trap in the Mercedes, sideswiping one of the boys, knocking him to the pavement head-first—and they aren’t about to stop. Police track McCoy down through his license plate. The black youth is hospitalized in critical condition. McCoy is arrested on a charge of aggravated assault with a dangerous weapon (his car) and leaving the scene of an accident. A black race troller, Reverend Bacon, and an old 1960s-style white Marxist “civil rights lawyer” recruit a drunken tabloid newspaper reporter and turn the accident into a racist outrage. Hordes of protesters demonstrate in front of McCoy’s co-op apartment building on the classiest stretch of Park Avenue.
How would McCoy fare if John Coates tested him today? There’s an old locution, “He couldn’t get arrested.”
For a start, today he wouldn’t have a high testosterone level. He’d have a high cortisol level, indicating stress. In McCoy’s case it wouldn’t be fight or flight stress, which jacks cortisol levels the highest. But it would be a stress that’s bad enough: status stress. God… think of the old days, when these trading floors roared with the sound of macho young men like him baying for money on the bond market… young men standing and bellowing into telephones held unsheathed in one hand while the other becomes a fist and punches holes in the air… think of the way we used to shout and curse at one another, not very pretty, certainly not genteel, but it sure kept the adrenaline flowing and the testosterone pumping. We needed that! It was all up to us and our nerves and our willingness to hang it over the edge of the Halusian Gulp and take the big risks—now! on the spot!—we, our very selves!—and not hand our masculinity over to robo-monsters dueling over electrical impulses so fast, we haven’t a clue as to what they’re doing, let alone how they’re doing.
Look at us now, all but strapped into our chairs, mute, trying to monitor six screens at once, six screens that fan out three over three, obscuring any connection we have to the real world. There’s not a sound in here! It’s like an insurance office. We’re not fighting anyone about anything.
We couldn’t get arrested! We don’t have the endocrines you need to go after pretty young things and pull off those dangerous rendezvous. We don’t have the testosterone, but we do have more than enough liters of cortisol to make sure we worry, worry worry the whole time. But suppose we did do something today in the Bronx that would have had an old white civil rights lawyer and a black race troller coming after us with raucous sham shows of anger in 1987. Today they wouldn’t bother. Today a Sherman McCoy couldn’t afford Park Avenue and would be hard to depict as a ruthless capitalist—and not worth suing in the first place (on behalf of the victim’s family and taking two thirds of the jury’s huge award, that being their scheme in 1987). Besides, today the trollers have closed down the shop. During the 2008 election campaign, President Obama never said, “Rise up! Break your chains and take what’s rightfully yours!” No, having his head on straight he said, “We must all carefully examine our own lives and see how we can improve them.” This so infuriated Reverend Jesse Jackson that during a commercial break in a Fox TV news show he said—not knowing there was an open microphone—“I’d like to cut Obama’s nuts off.” But he quickly disavowed the statement, realized there was absolutely no percentage in his challenging the first black president. He has said nothing but friendly, polite things ever since. Reverend Al Sharpton got it right away and in effect joined the Obama administration as a minister without portfolio.
As for the crash of 2008… In terms of sheer pride, it was a godsend for the poor Masters of the Universe. In round numbers 460,000 people in the financial industry, employees high and low, lost their jobs in the grim slide that began in 2008. Amid so much debris, it didn’t look so bad, for pride’s sake, when traders, salesmen, heads of desks, even the odd quant here and there, lost theirs. The rubbish covered over the charade, the farce, the diddling, the play-acting, the Masters of the Universe had become part of.
Sherman McCoy held his tongue, but what he said to himself was, “Oh, ye Eunuchs of the Universe.”