Explaining Southern California's economy

Rather Short Book Review: Emanuel Derman's 'Models. Behaving. Badly'

Emanuel Derman is a professor of finance at Columbia University and also a physicist. But what' he's probably best known for is his years at Goldman Sachs in the lead-up to the financial crisis and his role as one of the pre-eminent Wall Street "quants" — investment professionals who attempted to use complex quantitative models to drive risk out of making money. These days, some critics blame the quants for nearly destroying the global financial system

Derman chronicled his Wall Street days in a 2004 book, "My Life as A Quant: Reflections on Physics and Finance" — a full four years before the financial crisis truly took hold in late-2008. He's now followed that title up with "Models. Behaving. Badly," in which he looks back on both his life and his life's work and...finds fault with the world that he in part helped to engineer. 

It's an incredibly erudite and humane book. Maybe not the most informative, blow-by-blow account of how Wall Street nearly ruined the world. But an impressive effort in soul-searching combined with real thinking. Derman is what I now think of as an "old-school human": widely versed in the various troves of human expression and inquiry, from philosophy to literature to science, and not afraid to show us what he's got. 

There just aren't that many of them still walking among us. 

The book is a must-read for anyone who wants to understand the limits of finance. As well as the role that finance can and should play in the future. Here's a brief excerpt:

I was motivated to write this book by the global financial crisis that began in 2007. After more than 20 years of hubris, models collapsed. At the end of the cold war we imagined a future with no more history, a smooth stroll into the sunset accompanied by democracy, privatization, and free markets. It hasn't worked out that way. Authoritarian versions of capitalism have spread. Privatization has become oligarchy. The gaps between rich and poor, managers and workers, and owners and employees have widened. Economics models have misfired and financial models have proved to be enormously inaccurate.

[...]

I wasn't surprised by the failure of economic models to make accurate forecasts. Any assurance economists pretend to with regard to cause and effect is merely a pose or an illusion....What did shock and disturb me was the principle that everyone had paid lip service to: the link between democracy and capitalism. We were told not to expect reward without risk, gain without the possibility of loss. Now we have been forced to accept crony capitalism, privatized profits and socialized losses, and corporate welfare. We have seen corporations treated with the kindness owed to individuals and individuals treated pragmamorphically, as things.

 

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