(originally published in Science on August 3, 2012)
My son went to a good school, studied physics, and did well. Then, after his junior year, he got a glimpse of the life physicists lead and decided it wasn’t for him. He graduated with a physics degree and then asked himself, “Where do I go now?” I was relieved when he informed me he had no interest in going into my field, quantitative finance.
His physics education alone has not equipped him for what he will find in my field. Although he might have had a successful career as measured by income alone, I don’t want him to come home from work conflicted. Because much of modern economics and finance reads like physics, he will be able to read literature that many others cannot—perhaps not his boss, nor his clients. I would be afraid that he might someday build a financial model that blows up his firm or costs a client loads of money. I know he is a good kid, but I think the environment on Wall Street for people like him is bad.
I came to Wall Street in 1982 as a computer consultant and went for an MBA in finance at night. That is where I first encountered the finance-as-physics mentality of my professors. I bought into it. By the time I graduated in 1986, it seemed likely that the old-timers who understood only markets would not survive because they could not do physics.
By 1987, the hottest innovation to come from finance theory was something marketed as “portfolio insurance.” The idea was that as markets went up, you could increase your exposure, and when they went down, you could decrease it and protect your gains.
In October of 1987, stock markets experienced the worst crash on record. Believers in portfolio insurance discovered that they could not decrease their exposure fast enough, and as they sold, the crash snowballed.
After the crash, I stopped listening to people who understood physics but not markets and went back to doing what I do best: trying to understand things through direct observation and applying my tools to solving the problems at hand.
The theoreticians dusted themselves off and went back to what they do best. They invented exotic financial instruments that nobody can price properly—not even them—and designed complex, misguided risk models that triumphed over common sense. Markets are now so complex and move so fast that humans cannot participate without assistance from supercomputers—programmed, incidentally, to quality standards so low they would shock engineers responsible for things such as airline safety.
Physicists (and most other “quants”) on Wall Street will tell you over a beer that they know that finance is not a science, but they act as if it is. I think the reasons are that: 1) once you are trained to be a scientist it is hard not to act like one, and 2) management and clients want to believe you are one.
There is also something more insidious going on. If you don’t get tricked into thinking you know more than you do, you may not be very employable. Lacking experience standing up to authority—and seeing the opportunity for a very nice salary—a young physicist may find it hard to muster sufficient skepticism of his or her new field. You might be forgiven if you lose money for a client, but you won’t last long saying, “nobody knows” to people who think somebody does.
If you or one of your physics students is considering a career in finance, I recommend you do some reading first. In WARNING: Physics Envy May Be Hazardous To Your Wealth!, Andrew W. Lo, director of the Massachusetts Institute of Technology’s Laboratory for Financial Engineering, and Mark T. Mueller, a senior lecturer at MIT’s Sloan School of Management and a visiting lecturer at MIT’s physics department, warn against the belief that physics tools have more than limited applicability in finance and economics and offer a useful taxonomy of risk and ignorance.
It’s also important to learn about the dire consequences of falling into this trap. A good place to start is with A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation, in which industry veteran and quantitative fund manager Richard Bookstaber argues that the biggest risks our economy faces come from the very complexity of the markets and those “innovative” securities products he had a hand in creating.
I’m happy to say my son got a job as a game developer. His first and only interview lasted less than a minute: He was asked what he studied, and he said, “physics.” His interviewer responded, “Then you’re probably smart enough to learn Ruby on Rails—have a seat.” He began to train my son immediately.
It’s great that universities offer physics students opportunities to learn practical skills that will help them get jobs outside of academia; I wish they would do more of it. Physics professors might insist that their students make things as part of their educations—their own lab equipment maybe, or the software they use to analyze their data. Skills like those translate well to other kinds of jobs. They’ll help students make a living doing valuable and productive things, even if they don’t choose—or aren’t chosen by—a research career.
But if I were a physics professor today, I would not send my students to Wall Street. It’s not that I feel they would not succeed; many will make lots of money. It’s more like how I would feel about sending a poorly equipped son to a dubious war where many generals are in it not for the cause but for the spoils.
the ethical financier 