Finance Career: Q&A for Physics PhD Seeking Advice | TwoFishQuant

[mayonaise]

I am probably being naive but I don't understand why students studying physics (or any science for that matter) would choose a field as socially useless as finance.

Two reasons I can think of. First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit. The other is finance actually is useful for something for some people, otherwise you don't get paid.

Instead of channeling your prodigious mental capabilities towards financial work, why not try and develop something useful for the economy and for society? A sure road to wealth is to create productive goods and services that people desire.

Unfortunately, research papers usually are not what people desire. Creating goods and services is not a sure road to wealth, otherwise the 500+ workers who were creating goods would be rich instead of jobless. Or maybe the goods they produced were not desired, then your superior did the right thing and (corporate) finance *is* useful.

 

[NegativeDept]

First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit.

That's the elephant in the room. Many (probably most) of the very smart recent PhDs from my program can't find work as research physicists. The rest of them are temporary adjuncts or postdocs whose meager pay isn't enough to amortize their student loans.

And as mayonaise also mentioned, competent finance workers can produce social value. If a bunch of physics nerds can figure out how to not blow up the financial system - or at least make the crashes smaller and more manageable - that would be very useful. (Whether it's more useful than e.g. biophysics research or solar energy is a tougher question.)

 

[intelwanderer]

Would it be possible for them to find a research position that is like engineering or applied physics? Or in something that is technical, but not related to their dissertation(different subfield of physics or applied physics/matsci/engineering)?

I have a hard time believing someone with a experimental physics Phd(theorists might have it harder, I admit, but I'd imagine they could teach themselves what they don't know) couldn't do something like materials science or semiconductor research. I'd imagine that they could learn what they don't know quickly.

But I do agree. Finance is important. Can you imagine what it would have been like if the economy completely crashed? I just don't want finance to be the ONLY option for physics Phd's...

And in all honesty, I'd rather have a physicist in charge of finance than an MBA/sales guy. Maybe that's not a wise idea(can a physicist sell and have people skills), but I'm admitting my bias. Maybe the thing is that they shouldn't BE PREVENTED from doing something like that because they are scientists, but not automatically get it over a lawyer/sales type.

 

[SolomonX]

Two reasons I can think of. First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit.

Why?

The other is finance actually is useful for something for some people, otherwise you don't get paid.

I'm not disputing the use of finance altogether just the extent to which the industry has grow. A good read about bringing in physicist to Wall Street is Michael Lewis' book Liar's Poker.

Unfortunately, research papers usually are not what people desire. Creating goods and services is not a sure road to wealth, otherwise the 500+ workers who were creating goods would be rich instead of jobless. Or maybe the goods they produced were not desired, then your superior did the right thing and (corporate) finance *is* useful.

Not to be mean, but if you don't think bringing goods and services into the economy is a road to wealth then you have no business in business. I'm not sure what goods were produced in the factory but reducing a nation's industrial base is ruinous in the long run. Many innovations come about by laborers in factories inventing more efficient methods of production. I remember an anecdote like this in the Wealth of Nations.

 

[SolomonX]

But I do agree. Finance is important. Can you imagine what it would have been like if the economy completely crashed? I just don't want finance to be the ONLY option for physics Phd's...

And in all honesty, I'd rather have a physicist in charge of finance than an MBA/sales guy. Maybe that's not a wise idea(can a physicist sell and have people skills), but I'm admitting my bias. Maybe the thing is that they shouldn't BE PREVENTED from doing something like that because they are scientists, but not automatically get it over a lawyer/sales type.

Yes, finance is important but think of a baseball team (soccer, football, hockey etc). All the players have a different role. When one player becomes too important or powerful the cohesion of the team breaks down. Finance is useful but not so useful that everything else depends on them.

I think your last statement shows your bias! I'd rather have someone trained in the field to do the job than someone who is just very intelligent yet doesn't have the relevant background. Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

 

[chiro]

I have no idea why finance has become this super-complicated thing that it is.

Finance at it's core is very boring: it's meant to be about resource allocation and management. You have capital and credit and you worry about managing both and creating credit so that you can allocate resources in the best way possible. You have other things like exchange and so on, but the above is still the basic idea of what banking was and should be.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Constructing products that people don't understand and buying them is absolutely nuts.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance should be boring because it is meant to be boring: it's not meant to be this super creative thing that blows up the economy when the so called "creative products" reek havoc.

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

 

[intelwanderer]

I have no idea why finance has become this super-complicated thing that it is.

Finance at it's core is very boring: it's meant to be about resource allocation and management. You have capital and credit and you worry about managing both and creating credit so that you can allocate resources in the best way possible. You have other things like exchange and so on, but the above is still the basic idea of what banking was and should be.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Constructing products that people understand and buying them is absolutely nuts.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance should be boring because it is meant to be boring: it's not meant to be this super creative thing that blows up the economy when the so called "creative products" reek havoc.

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

Maybe that's why they are paid so much, to make up for that. And why postdocs, etc, are paid so little. Granted, research can be pretty boring too, but...

Shows the priority system here, which I think is rather screwed up. I'm worried whether focusing on stuff like finance rather than science is great for the USA in the long term...

I think your last statement shows your bias! I'd rather have someone trained in the field to do the job than someone who is just very intelligent yet doesn't have the relevant background. Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

I do think that there are better uses for physicists than the ones we have available right now. But if they want to(not just this. Let's say a physicist wants to go into politics or foreign policy/nuclear weapons policy?), no reason they can't learn. Nothing should prevent them from doing so. Of course, whether they are hired over someone with relevant training is a different matter.

 

[mayonaise]

Why?

Because ideally, learning and doing research in physics train a person to think independently and ask important questions. These qualities help maintain a healthy society. It is therefore socially good that we don't starve. It is personally great that I don't starve, because I think I can make a positive contribution to the gene pool.

I'm not disputing the use of finance altogether just the extent to which the industry has grow. A good read about bringing in physicist to Wall Street is Michael Lewis' book Liar's Poker.

Then you should know that what finance looks like, in large part, depends on what regulations look like. Individual physicists turning down finance jobs doesn't change the regulations. You need to persuade the correct people for this.

Not to be mean, but if you don't think bringing goods and services into the economy is a road to wealth then you have no business in business. I'm not sure what goods were produced in the factory but reducing a nation's industrial base is ruinous in the long run. Many innovations come about by laborers in factories inventing more efficient methods of production. I remember an anecdote like this in the Wealth of Nations.

I mean nothing is a sure way to anything.

 

[Locrian]

Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

Nobody sits around doing that. Computers do that. Financial professionals do things computers don't do well.

I'm glad that you think so highly of physicists though. How many do you employ? Hopefully a lot, because very few other people find them very useful. Most of the economy would rather not hire them, even if they pretend to think they're super smart. And I don't blame them.

Why don't you regale us with some stories of how awesome your highly paid employees with physics backgrounds are? This place gets a little sad from time to time, and we could use a few happy stories.

 

[meanrev]

I have no idea why finance has become this super-complicated thing that it is.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance should be boring because it is meant to be boring: it's not meant to be this super creative thing that blows up the economy when the so called "creative products" reek havoc.

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

Because of our commoner, selfish desires. Now, Llyod Blankfein is just a regular human like all of us. He has 24 hours per day, and he is tasked to manage a company. He is just doing his job. Now, most of his employees are honest people who just want to make money for themselves or their families (I don't think most people go into finance with ambitions of cheating other people's money.) Nope, in fact they are running a harmless operation. Instead, it is our collective desires and the political pressures that we've produced for these desires that have led to this demon of our own design.

For example, how did mortgage-backed securities begin to exist? Because we wanted tax breaks for our home savings and loans industry when it was on the verge of collapse... So we gave it to them in 1981 and saved them for a while. But Wall Street just cluelessly stumbled upon treasure when the industry unloaded their portfolios for tax benefits. It wasn't the lobbying - no amount of lobbying would have made MBS profitable. Contrary to what people would imagine, no one on Wall Street really sought to profit out of our mistakes. Mortgage trading was as popular as the music department at an engineering school, and besides no amount of work would have prepared Wall Street to find such an exploit. Instead, it was a seemingly innocuous political decision that started the MBS bubble.

Why? Because we demanded home ownership as a universal right, and no one saw it them that this wasn't sustainable. And because no one likes high inflation and unemployment rates, so the Fed raised the interest rates in 1979 in a bid to end the stagflation crisis - they succeeded - but the home savings and loans began to die because of this.

Why do we have a Fed, you'd then complain... Well, because we wanted to get out of an economic crisis when it became increasingly obvious by 1913 that no amount of family wealth would have kept the banking industry afloat when people made bank runs in the midst of an economic crisis. This made sense - families wanted to protect their savings. And in fact, the Fed did achieve most part of its founding objective, considering how we've reduced the frequency and amplitude of our economic crises. Now, this doesn't sound convincing since we're in the middle of the deepest recession since the Great Depression, but if you looked at it from the bigger picture and a statistical standpoint, it would become clear that there is no logical basis for such doubt. Moreover, we forget that it has taken only a century for the Fed to make this happen. I find this entirely acceptable - after all, I reserve the same respect towards why the Clay Millennium Problems mostly remain unsolved. And who are we to say that a few mathematical conjectures are any more "socially important" than the welfare of the populace and putting an end to economic crises?

Now, on hindsight you can say, we shouldn't have given those tax breaks, we shouldn't have raised the interest rates in the 1970s-1980s, and we shouldn't have given the Fed its powers. You could say that AIG shouldn't have insured those mortgages. I find such a statement exceedingly naive from a scientific point of view. If it isn't already clear from the example above, our political decisions have an effect of increasing entropy. That's like expecting entropy to reverse itself. Now, unless something drastic like an asteroid impact event takes place to wipe out half of our population, don't expect the changes to be as instantaneous and simple as removing the layers of complexity and creating a short rulebook. Taking any single step above out of the picture might well have pushed our economy past its tipping point, to its collapse.

Finance at it's core is very boring: it's meant to be about resource allocation and management. You have capital and credit and you worry about managing both and creating credit so that you can allocate resources in the best way possible. You have other things like exchange and so on, but the above is still the basic idea of what banking was and should be.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Constructing products that people don't understand and buying them is absolutely nuts.

Physics at its core is very boring: it's meant to be about phenomenon and theory. You have observations and hypotheses and you worry about understanding both so that you can model phenomena in the best way possible. You have other things like universities and so on, but the above is still the basic idea of what physics was and should be.

The above is not complicated and physics should never ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

Inventing theories that people don't understand and publishing them is absolutely nuts.

Yes, finance is important but think of a baseball team (soccer, football, hockey etc). All the players have a different role. When one player becomes too important or powerful the cohesion of the team breaks down. Finance is useful but not so useful that everything else depends on them.

I absolutely agree with your premises, but not the conclusion that you have come to. There's a saying: "Vote with your wallet." Cancel your home loans because they generate billions of turnover for finance. Cancel your health and home insurances because insurers pay investment banks a lot of commissions to get their portfolios reinsured. Don't use ATMs or electronic payment methods. Cash in your retirement fund right away. Don't pay tuition to your university. In fact, don't fund programs for child education because much of their assets are managed in hedge funds. Don't fly airlines that buy futures contracts to hedge their losses against the crude oil, because these contracts were created by investment banks or traded on exchanges that pay proprietary trading firms tonnes of money to create liquidity for their products.

The fact that we cannot do without any of these is because the financial industry does indeed generate useful services and products. The claim that they don't is an entirely false. Now, you're going to say, you are not going to throw away your rights to these services simply because the financial industry has become too powerful for you to avoid recourse from your insurances to the pockets of Goldman Sachs. Right. So let's do this instead: have the government buy over and nationalize every service that shouldn't be in the hands of Goldman Sachs, Morgan Stanley and the likes.

Let's give the governments the power to be direct market makers. Let them create the market for treasuries directly - so instead of having a dozen over banks buy the entire stash of US treasuries so that they can resell to smaller buyers, let's pay our taxpayer monies to a whole new department of the government that now has to be hired to make money for the very products that they have created themselves. Or let's give China the right to be a main market maker for US treasury notes. Or let's give Google the chance to invent an algorithm or sole discretion for finding people to fund the national budget.

It will probably work if we tried - I'm evoking a tone of sarcasm not because I don't think it will work, but because I think no one is going to accept such a solution.

So nope, let's also fix how the government works, let's find politicians that can make it all happen. That has to be easy as well right? No - you have to do the dirty work yourself - politics is in need of people with such forward-thinking ideals for the financial industry.

This boils back to my point is that the criticisms of and proposed replacements for the financial industry in this thread are mostly naive, undue and unfounded.

I am probably being naive but I don't understand why students studying physics (or any science for that matter) would choose a field as socially useless as finance. I once had a "superior" tell me he laid off an entire factory (500+) of people to save a few percentage points on a balance sheet for the owner. The man was worked in corporate finance so I believe that is different from the kind of work two-fish quant does, i.e. high finance, the kind many on this forum seem to aspire to.

This sounds to me like management or management consulting instead.

Instead of channeling your prodigious mental capabilities towards financial work, why not try and develop something useful for the economy and for society? A sure road to wealth is to create productive goods and services that people desire. I know this is easier said than done and indeed, you may fail. However, failure is a risk in any enterprise. I'd rather fail at establishing a business or shooting for tenure than failing at being some financial whiz. This is the way I felt after earning my bachelor's degree in economics.
Two reasons I can think of. First, it is socially useful for me or any other physics grad to not perish in the tenure pursuit.
Why?

A majority of "products" that have been created by the financial industry arise because of our aversion towards risk, much like insurance. If you feel that there's something wrong with the statement, "Insurance should not exist," then there is also something wrong with its semantically-sugar-coated version of, "Exotic options should not exist." Farmers need to protect their crops against disaster. Home insurers need to insure themselves against a huge event like Hurricane Katrina that would drive them - and the beneficiaries of these insurance policies - to bankruptcies, which should then spark a chain of catastrophic results (a cascade of homeless and unemployed people). A semiconductor manufacturer needs to protect itself against volatility in silver and copper prices. A university's endowment fund needs some consistent, but low-risk growth. Most of the trades made in the financial industry are done in good nature. Many of these products were created simply because we found a fair and neater way to create them out of cash and the underlying, just as we have found a recipe for a delicious dish. (Of course, chefs are paid extra over the ingredients for making the food, as a market maker is paid a commission for creating such a combination). It's supposed to be a good thing. The aggressive risk-taking, rogue and inside trading that fit well in headline narratives constitute the exception, not the norm, of the financial industry.

Besides, a physicist would, to me, be more valuable than calculating IRR and NPV all day everyday in the back office.

There is much grunt work whether in finance or physics. There are some elegant elements to finance. For one, an abundance of open problems to work on (not necessarily problems of the profiteering kind). For another, there is abundant supply of quantifiable data (typically price time series) for your models. There's less to worry about proper data collection than actual modeling work. Besides, it's human nature to feel a stronger sense of appreciation for your work when you've been paid more for it. In every other field I know of, the question is whether a balance of your personality and desire for money can be met by a particular job - not, in the other way around, whether you meet the requirements of "passion" for a particular job.

A good read about bringing in physicist to Wall Street is Michael Lewis' book Liar's Poker.

I've read Liar's Poker. I think it's a terrible read for this purpose as compared to something like "My Life as a Quant" by Derman.

There is a lack of jobs in physics; there is a recession going on for everyone. I think it is inanely obstinate to shackle ourselves to the dated view that a move from physics to finance is a passionless behavior of penny-pinching. Instead of driving away the scions of our community simply because they have chosen a career in finance, we should support and assist their decisions to do so. If anything, the physics community needs this alliance now more than ever, and easing the demand for tenure positions is probably a good thing for our future generation of physicists.

 

[SolomonX]

Because ideally, learning and doing research in physics train a person to think independently and ask important questions. These qualities help maintain a healthy society. It is therefore socially good that we don't starve. It is personally great that I don't starve, because I think I can make a positive contribution to the gene pool.

Thinking independently and asking important questions is not a result of being trained in physics. Sure, a physics or any STEM degree helps a person to think analytically and tackle an important problem from many different angles. These are very important skills but they are not solely acquired within the domain of physics. I think these abilities are somewhat natural, but can be sharpened by a rigorous degree program.

Can you provide any good reasons why you should not starve other than your physics degree? What exactly is so special about your gene pool?

 

[SolomonX]

Nobody sits around doing that. Computers do that. Financial professionals do things computers don't do well.

Computers do that, eh? No input required? No analysis of the output? When did computers become sentient?

I'm glad that you think so highly of physicists though. How many do you employ? Hopefully a lot, because very few other people find them very useful. Most of the economy would rather not hire them, even if they pretend to think they're super smart. And I don't blame them.

Training in a rigorous field, such as physics, is of high value to the economy. Many innovations of the past 70 years have come about as a result of a interdisciplinary team of law-makers, businesspeople, and scientists (including physicists) innovating products that have lead to the remarkable world we live in today. Advancement can only continue if we channel our resources into productive fields (communications, infrastructure, health care, etc.) Financing is useful tool in this equation but only if confined within its proper bounds.

I agree fully with what chiro noted earlier, that is, that finance should be very boring and vanilla. If you couldn't explain it to your grandmother then something must be fundamentally wrong with whatever it is you are trying to do.

And of course, as an American and someone who believes in free mobility of labor, if a physicists wants to go into finance, go right ahead. Especially if you can't find work within your field and need money. Of course, understand that finance is not physics and the subject matter should be treated differently. I read a few economics research articles when writing my thesis about applying a gravity model used in a financial model and thought that this is madness!

 

[chiro]

Because of our commoner, selfish desires. Now, Llyod Blankfein is just a regular human like all of us. He has 24 hours per day, and he is tasked to manage a company. He is just doing his job. Now, most of his employees are honest people who just want to make money for themselves or their families (I don't think most people go into finance with ambitions of cheating other people's money.) Nope, in fact they are running a harmless operation. Instead, it is our collective desires and the political pressures that we've produced for these desires that have led to this demon of our own design.

What a load of BS: it's not a harmless operation when you have an industry with huge systemic risk that needs money to not become insolvent all because some people made a bad call.

People thought that LTCM were the smartest guys in finance, and people thought Enron were the smartest guys in the room: neither of them were.

Huge amounts were just completely wiped out completely. Evidence has come out that the people who made these products called them crap. Some of these banks even took out insurance policies betting against the very products that were selling to clients.

Just doing his job? What a crock. The nazi's were "just doing their jobs" as well.

For example, how did mortgage-backed securities begin to exist? Because we wanted tax breaks for our home savings and loans industry when it was on the verge of collapse... So we gave it to them in 1981 and saved them for a while. But Wall Street just cluelessly stumbled upon treasure when the industry unloaded their portfolios for tax benefits. It wasn't the lobbying - no amount of lobbying would have made MBS profitable. Contrary to what people would imagine, no one on Wall Street really sought to profit out of our mistakes. Mortgage trading was as popular as the music department at an engineering school, and besides no amount of work would have prepared Wall Street to find such an exploit. Instead, it was a seemingly innocuous political decision that started the MBS bubble.

Again, the idea of what banking was and should be about was that giving credit to someone was not easy.

There were no subsidies and the only way to get easy credit was if you were a solid government or an oil company.

These easy loans where you had no income no assets helped create the mess.

This is really really simple: banks have been doing this kind of thing for a long time (it's what they are meant to be good at) but they threw it all out the window when they gave people loans that could not possibly pay them back.

Again: this is why banking should be boring and why it's important to just stick to the time tested basics.

Why? Because we demanded home ownership as a universal right, and no one saw it them that this wasn't sustainable. And because no one likes high inflation and unemployment rates, so the Fed raised the interest rates in 1979 in a bid to end the stagflation crisis - they succeeded - but the home savings and loans began to die because of this.

The point of a good bank is to say "no" when they should say no, not because it's politically correct or fashionable.

Again it used to be that when you went to a bank for a loan, they would deny you if they didn't feel you had a good chance of giving them a return on their investment. It wasn't a sure thing, but experience tends to help in this regard (i.e. the bank's experience).

Access to unlimited credit when it's clearly not deserved is not a right of any kind and that's the lesson and the whole point of why banking should be boring.

Bankers of all people who are decent and have a brain cell or two should be the first to realize what happens when you give out easy credit: if they have been in the process of funding businesses or mortgage holders then the experience should tell them what happens when you have an environment that is highly subsidized and where credit is given easily and how that affects the market as well the environment for debt.

Why do we have a Fed, you'd then complain... Well, because we wanted to get out of an economic crisis when it became increasingly obvious by 1913 that no amount of family wealth would have kept the banking industry afloat when people made bank runs in the midst of an economic crisis. This made sense - families wanted to protect their savings. And in fact, the Fed did achieve most part of its founding objective, considering how we've reduced the frequency and amplitude of our economic crises. Now, this doesn't sound convincing since we're in the middle of the deepest recession since the Great Depression, but if you looked at it from the bigger picture and a statistical standpoint, it would become clear that there is no logical basis for such doubt. Moreover, we forget that it has taken only a century for the Fed to make this happen. I find this entirely acceptable - after all, I reserve the same respect towards why the Clay Millennium Problems mostly remain unsolved. And who are we to say that a few mathematical conjectures are any more "socially important" than the welfare of the populace and putting an end to economic crises?

The amount of money sloshing around is at an insane level. The first trillion dollars took a very long time to print (and create on a computer since most money in circulation is purely digital) and from that point money has been entering the system at a frightening rate.

Also we have derivatives that are "valued" at many many times the global GDP. This is very dangerous especially if something happens where these products result in a wiping out of value in the same way that happened with the MBS products.

The other thing that is different is the leverage: the so called market cap of a bank is not what it's assets are. A lot of banks are leveraged up to levels like 50:1 and sometimes a lot higher.

A 50:1 leverage means that a 2% price swing can make it completely insolvent. We didn't have situations like this in the 1930's and it means that we have a situation much more fragile and much more frightening.

You talk about bank runs: you might want to find out how many banks have failed around the time of the GFC: the idea of the FED somehow preventing this kind of thing is really naive.

You might want to look also at how the capital requirements of banks have changed throughout the years too.

Also this idea of reducing the crisis is naive I don't know where to begin. Did you forget the Savings and Loans scandal? What about the MF Global scandal where segregated funds were reached into? If you don't understand the MF Global situation, think of it as if you went to the ATM and your deposit account was empty: that's what literally happened.

Now, on hindsight you can say, we shouldn't have given those tax breaks, we shouldn't have raised the interest rates in the 1970s-1980s, and we shouldn't have given the Fed its powers. You could say that AIG shouldn't have insured those mortgages. I find such a statement exceedingly naive from a scientific point of view. If it isn't already clear from the example above, our political decisions have an effect of increasing entropy. That's like expecting entropy to reverse itself. Now, unless something drastic like an asteroid impact event takes place to wipe out half of our population, don't expect the changes to be as instantaneous and simple as removing the layers of complexity and creating a short rulebook. Taking any single step above out of the picture might well have pushed our economy past its tipping point, to its collapse.

Buddy: this is not a physics experiment, this is finance and it affects everybody.

If credit wasn't easy to get across the board, whether it's for a working family to have a home, a small business, a large corporation or even a bank, then a lot of these problems would be averted.

The other thing is that this situation is not like the one where you have one or two loans that default: this is a global practice and you had a global instance of defaults and subsequently a systemic collapse.

The other thing is that right now, interest rates are near zero.

This means that people can borrow money really really cheaply. It also means that the deposits that are used to create the new money don't get a return on the investment.

This encourages depositors to spend and borrow instead of save.

This whole thing is a bomb just waiting to cause chaos.

I'm not saying you have a simple rule book. Decision makers don't use rule-books because they can't cover all the circumstances especially in a dynamic environment, but they do use guidelines in many cases. I have proposed a guideline that has been used time and time again and it's easy to understand.

When people don't understand what they are buying: they shouldn't buy it. When people are selling something they don't understand, or know beforehand that they really should not be selling something, then they shouldn't sell it.

There are some really basic laws that businesses have to follow that incorporate the above and some of them are related to what is known as fraud.

This experiment called our current financial system is a failure, and at the very least, going back to the era where credit was not only hard to get but hard to create should be a key issue on all relevant policy makers mind.

You can do the above in many ways including with central banks or without central banks, but never the less it's important to do for society at large.

 

[twofish-quant]

I have no idea why finance has become this super-complicated thing that it is.

You have one banana that is worth $1. How much are two bananas worth? The answer is roughly $2. If the price is significantly more or significantly less than $2, you can make a great deal of money, buying/selling one banana and two bananas.

Now let's apply this "banana-rule" to stocks. You end up with a partial differential equation. Now let's add interest rates, foreign exchange, and collateral to it. You end up with very, very complicated partial differential equations.

The above is not complicated and finance should never ever ever be that way: if it gets to the point where people don't understand it (I mean any average person in the room) then it's a bad idea: a really bad idea.

The trouble is that reality is very complicated.

The old fashioned idea of going to see the bank manager for a loan and being scrutinized based on your deposits, saving history, and so on was there for a reason: it's simple, easy to understand for both parties, and more importantly: it actually worked in a lot of cases.

Finance was never that simple. It gets more complicated now, because the trouble is that the money for that loan comes from some person in Dubai, and connecting the dots get messy because of the "banana rule."

If you need super-computers and sophisticated algorithms to do finance, then that tells me something is very very wrong and I'm not saying this because I'm a technophobe (I used to be a programmer). I'm saying this because something like finance was meant to be boring for a very good reason.

One loan you can handle without supercomputers. Five million loans, you need some very, very powerful computers.

And it's not just loans. Think about every financial transaction that you do. Most of that is electronic now, and you end up with massive computer issues.

Even *without* the computational issues. Just think of the database issues. Every line in your credit card or transaction in your checking account has to get tracked, and you end up with horrendous computer science issues.

Then take that for each person and apply things like the banana rule and things get very complicated.

 

[chiro]

You have one banana that is worth $1. How much are two bananas worth? The answer is roughly $2. If the price is significantly more or significantly less than $2, you can make a great deal of money, buying/selling one banana and two bananas.

This is exactly what I don't get.

The last item is really the clincher and it is basically "speculation".

You have hedging and then you have speculation. Proper hedging I agree can help economies, but the speculative BS that goes on that is not true "hedging" is not only un-necessary but detrimental.

The idea of buying something at one price and selling at a slightly higher price is really a worrying thing to me, and this kind of mentality is causing a lot of problems.

People may say "well hedge funds gamble with their own money, so they take the risk", but the truth is that it's not just people that are separated from commercial banking anymore that are doing this.

The point of exchange mechanisms is to facilitate the actual exchange itself not to turn the whole thing into a roulette wheel and a craps table.

Insurance has its place, but gambling doesn't and although the two may appear to be "the same", they shouldn't be.

Now let's apply this "banana-rule" to stocks. You end up with a partial differential equation. Now let's add interest rates, foreign exchange, and collateral to it. You end up with very, very complicated partial differential equations.

Again, the issue is with this mentality of gambling.

I am familiar with some of the basic issues regarding using simple PDE's for this kind of thing but again, this mentality of adding this extra incentive is what gets me.

Things are becoming way more complicated than they ought to be. The idea of buying a stock was simply to put up investment money because people thought that the corporation would make profits that would be shared in.

We have absolutely ridiculous liquidity now with computers especially when the computers make their own trades. For things like an instant buy/sell (wash trades) I would love to see any kind of sane justification for that.

This idea of trying to "control risk" is absolutely ridiculous: again the whole point of finance and banking at its core was never to eliminate risk: The point was to come up with some basic principles of attempting to understand where the risks lie so that the decision reflected more of a "calculated risk" rather than an abolishment of risk.

What I am observing is that people are introducing these instruments and collectively they are tearing things apart.

There is no solid reason why anyone should be interested in the elimination of risk or for the sole intent on profit and to gamble on anything from an interest rate move to a commodity price movement only to make a quick profit.

If people want to buy something, they should not have the liquidity relaxations that allow them to buy and sell at the absolutely ridiculous speeds they do with these computers. If you want to buy something with an option contract then buy it: don't buy it and sell it straight away.

Airlines that buy fuel for real hedging don't wait for the maturity of their contract and then turn around and sell it somewhere else for a quick buck: they buy it because it's core to their business of getting people around the world. They don't need some ridiculous liquidity on the asset to do what a lot of these financial hubs do.

If people want do real hedging then that's fine, but these ridiculous liquidity environments that exist for general transactions are more detrimental than ever.

The trouble is that reality is very complicated.

It doesn't have to be.

Finance was never that simple. It gets more complicated now, because the trouble is that the money for that loan comes from some person in Dubai, and connecting the dots get messy because of the "banana rule."

The way stuff can be packaged is really stupid.

This whole thing of having a "chain" of dependencies is again really stupid.

A contract should have ultimately two parties: in a loan situation you have the party taking on the loan and the party giving it.

This idea of having a "chain" in the lending process is ridiculous: if there are multiple links in the chain, then the person who is loaning at the end should have a direct contract with the person they are loaning from. If the chain is bigger then people should be forced to adopt the loan and terminate a contract with the other link in the chain.

This is just common sense: creating a situation like this is going to blow up when you have all these dependencies everywhere. Again the idea is to keep it simple.

One loan you can handle without supercomputers. Five million loans, you need some very, very powerful computers.

And it's not just loans. Think about every financial transaction that you do. Most of that is electronic now, and you end up with massive computer issues.

I should have stated that the complexity was not to do with the computational power only but also in reference to the techniques used.

Of course an infrastructure to do transactions when billions of them are going on all the time requires the appropriate computational, communications, and secure architecture to facilitate this.

But this is not the same as having some complicated numerical simulation or using algorithms to crawl the web or to use these things to execute trades so that a bit of volatility can be created.

I need to emphasize again that the main issue I have is not with the bread and butter stuff like loans: it's with speculation but not real hedging.

Even *without* the computational issues. Just think of the database issues. Every line in your credit card or transaction in your checking account has to get tracked, and you end up with horrendous computer science issues.

My issue is not with the computational power alone per se: it's more to do with the idea of how risk is handled (but more importantly introduced) and what the incentives are with regard to how that ends up motivating business policies for certain financial institutions.

Finance has become a major part of an economy and that is ridiculous: again the point of finance was to facilitate the things that aided real economies: not to be a major part of an actual economy.

Then take that for each person and apply things like the banana rule and things get very complicated.

It really boils down to that speculative element and what the incentives have done to affect finance and the economy.

It used to be that if people wanted to buy a banana from the fruit shop, they bought it to eat it. They didn't buy it so they could create a so called profit.

This is what banks do: it serves absolutely no use socially. Most people that go to the supermarket to buy food buy it because they are buying the very thing they need. They aren't buying it so they can sell it somewhere else and make a few cents profit, but this is entirely what is happening today.

Speculation has no use and is detrimental to the economy. Not only that, these idiots using policies of near zero per cent are encouraging this.

It's always the same story throughout history: some one gets control of something and manipulates without giving a stuff about how it affects other people.

This manipulation in prices affects prices in a way that the price is way higher than it should be. There is no reason for this other than for banks to make profits.

 

[twofish-quant]

I agree fully with what chiro noted earlier, that is, that finance should be very boring and vanilla.

Absolutely. However, it takes a *LOT* of effort to make something boring and vanilla. What makes things boring and vanilla for the customer generally makes things very complicated for the bank. The way that I think about banks is that they are like the power company. If you have to think about the details of power transmission, then there is something wrong.

To give two examples of things that make life complicated for banks, there are two financial products that are insanely complicated to model, checking accounts and 30-year mortgages. It's nice to go to a bank and say "give me my money now", but that puts a lot of complexity on the bank to structure things so that they can give you your money at a moments notice. 30 year mortgages are insanely complicated to model because of prepayment. People will refinance their loans when interest rate go down, and this introduces very, very complex mathematics to model this.

If you couldn't explain it to your grandmother then something must be fundamentally wrong with whatever it is you are trying to do.

Sure, and I can explain what I do to my grandmother. What I basically do is to have models for risk analysis. So suppose the stock market drops X%, what is your net worth, and how likely are you to be unable to pay your bills at the end of the month? If x=1% it's an easy calcuation. We take your current net worth, and apply a small corrrection. Since you are likely to be solvent, a one percent drop in the stock market is unlikely to fundamentally change your financial situation, and your risk of default is likely to stay the same. Now suppose x=30%, then things get complicated because you have other factors that are likely to change your net worth. You may lose your job or interest rates could change making it easier/harder to pay your bills.

Now instead of just you, think of what happens with a group of a million people. At that point things get really messy.

Now we can figure out limits. If x=1% things aren't going to change. If x=99%, you are screwed. There is an x at which you will run into trouble, and a curve that describes your net worth and default probability in relation to financial events.

If you are a bank, then the government who ultimately insures you are then *VERY* interested in what that curve looks like. It so happens that figuring out who to calculated that curve involves basically the same sort of analysis as what makes supernova go boom.

And of course, as an American and someone who believes in free mobility of labor, if a physicists wants to go into finance, go right ahead.

Remember that most people in the world aren't Americans. This makes things complicated. For example, Americans have a very strong cultural aversion to gambling, which causes some huge restrictions on deriviatives trading. UK doesn't have the same cultural aversion, which means that people make agreements in the US, and then virtually do the handshake in London.

Especially if you can't find work within your field and need money. Of course, understand that finance is not physics and the subject matter should be treated differently.

It's the behavior of numbers reacting to events. They aren't the *same* rules as those that you learn in undergraduate physics courses. Much of the challenge is figuring out what the rules are. For example, there are situations in which the "two banana rule" that I mentioned works well, works badly, doesn't work at all.

The fact that you have to figure out the rules is why banks hire physics Ph.D.'s and not physics undergraduates.

I read a few economics research articles when writing my thesis about applying a gravity model used in a financial model and thought that this is madness!

In some situations it works pretty well.

Exchange rate 1 USD= 5 ZEB
What's the reverse exchange rate for 1 ZEB

The answer is probably close to 0.2 USD. Now suppose you have 1 USD=3 GPE=5 ZEB, what are the likely cross exchange rates. You can probably figure them out.

Now the interesting thing is that sometimes you end up with "funny loops". That's when you go USD->GPE->ZEB->USD and the numbers don't match up. But we are dealing with 3 currencies. So you can say it's a special case. Now suppose you are dealing with 100 currencies each with special issues. It turns out that the math for dealing with these "loops" is similar to GR.

 

[twofish-quant]

You have hedging and then you have speculation. Proper hedging I agree can help economies, but the speculative BS that goes on that is not true "hedging" is not only un-necessary but detrimental.

The problem is that if someone hedges, then someone else has to speculate. It's a zero sum contract.

The idea of buying something at one price and selling at a slightly higher price is really a worrying thing to me, and this kind of mentality is causing a lot of problems.

You can avoid that by having government price controls. In fact, one of the reasons that finance was "easier" in the 1960's was that interest rates in most countries was government controlled. The trouble is that that world is gone. You could have the US government set interest rates in the US, but if England doesn't play along then people can just do the deal in London (which is what happened in the 1970's). You theoretically could get around that by making it illegal for people in the US to do deals in London, but if you making it impossible for people to move dollars in and out of the US without permission, then you are talking about changes that would probably make the world worse.

People may say "well hedge funds gamble with their own money, so they take the risk", but the truth is that it's not just people that are separated from commercial banking anymore that are doing this.

Ultimately the government takes the risk, which means that the government is *extremely* interested that the banks don't take stupid risks, which requires a ton of reports to the government about what banks actually are doing, which is where I come in.

The point of exchange mechanisms is to facilitate the actual exchange itself not to turn the whole thing into a roulette wheel and a craps table.

If you let people set prices, then very complicated things happen.

Insurance has its place, but gambling doesn't and although the two may appear to be "the same", they shouldn't be.

X wants to reduce risk. That risk has to go *SOMEWHERE*. You just can't have insurance without someone that is willing and able to absorb losses. If you just have "pure insurance" then you are in a dangerous situation, because that means that the risk is going somewhere, and you don't know where it is.

I am familiar with some of the basic issues regarding using simple PDE's for this kind of thing but again, this mentality of adding this extra incentive is what gets me.

Actually they are very complicated PDE's. Also, it's not "mentality" any more than apples falling have anything to do with mentality. Once you have liquid markets, this *will* happen.

Things are becoming way more complicated than they ought to be. The idea of buying a stock was simply to put up investment money because people thought that the corporation would make profits that would be shared in.

And that turns out to be extremely complex. Once you have an asset without a fixed price, then the math gets very, very messy. The trouble with "simple financial systems" is that they turn out to force a messy complex world to be simple, and that turns out to be usually a bad thing.

We have absolutely ridiculous liquidity now with computers especially when the computers make their own trades. For things like an instant buy/sell (wash trades) I would love to see any kind of sane justification for that.

Easy. People want to be able to go online at a moments notice and sell their stock and get cash. If you go to your online broker and sell stock *right now*, it is extremely unlikely that there will be someone at that exact millisecond that wants to buy the stock. So what you end up with are broker-dealers that are able (and sometimes legally required) to buy that stock, and hold it until someone that is interested in buying that stock comes around.

The value added with brokers is that you can sell your stock in a millisecond. This isn't true with your car or your house.

This idea of trying to "control risk" is absolutely ridiculous: again the whole point of finance and banking at its core was never to eliminate risk: The point was to come up with some basic principles of attempting to understand where the risks lie so that the decision reflected more of a "calculated risk" rather than an abolishment of risk.

Well. Duhhh... What has ended up to be true is that ultimately various major world governments end up holding the ultimate risk. If your checking account and life savings go poof, ultimately it will be the government left figuring out what to do. So in order to make sure that they don't get left holding the bag, governments are imposing pretty tight regulations on banks.

What I am observing is that people are introducing these instruments and collectively they are tearing things apart.

It's dead. No one is introducing new financial instruments. The things that people are working on are mostly risk management.

There is no solid reason why anyone should be interested in the elimination of risk or for the sole intent on profit and to gamble on anything from an interest rate move to a commodity price movement only to make a quick profit.

If you want to be able to sell commodities and interest rate products quickly, then there is. Also, broker dealers usually don't take directional bets. The buy something and then the sell it as quickly as they can. The amounts that they make are tiny. It's only because you are moving billions of dollars that people end up making millions.

Also the quicker the profit, the less the risk and the less the spread. The regulators like it when people buy something and then unwind the position immediately. If you buy 50 shares of stock at $50.00 and sell it five seconds later at $50.01, then you've immediately close the position and you are insensitive to further stock moves.

If people want to buy something, they should not have the liquidity relaxations that allow them to buy and sell at the absolutely ridiculous speeds they do with these computers. If you want to buy something with an option contract then buy it: don't buy it and sell it straight away.

So how to you propose to uninvent the internet?

Also, there are exchange rules that people have put into control the speed of things, so that they are happening in seconds rather than milliseconds.

Airlines that buy fuel for real hedging don't wait for the maturity of their contract and then turn around and sell it somewhere else for a quick buck: they buy it because it's core to their business of getting people around the world. They don't need some ridiculous liquidity on the asset to do what a lot of these financial hubs do.

Right but the person at the other end of the contract wants to be able to resell. Also the airline probably doesn't know how to buy the contract from. They need someone that knows people that are willing to sell. At which point you have banking.

If people want do real hedging then that's fine, but these ridiculous liquidity environments that exist for general transactions are more detrimental than ever.

This idea of having a "chain" in the lending process is ridiculous: if there are multiple links in the chain, then the person who is loaning at the end should have a direct contract with the person they are loaning from. If the chain is bigger then people should be forced to adopt the loan and terminate a contract with the other link in the chain.

Which means that you can't write a check. When you deposit money into your checking account, do you know (or care) who that money gets loaned to? When you swipe your credit card, do you know (or care) who that money comes from?

You could imagine a world in which everyone had direct contact with the people that they loaned money from. That work would be one without checks, mortgages, or even money in any sense that we know of.

And it wouldn't last very long. All you need is to have someone borrow money and relend it, and you have a bank.

This is just common sense: creating a situation like this is going to blow up when you have all these dependencies everywhere. Again the idea is to keep it simple.

You can't keep it simple.

Of course an infrastructure to do transactions when billions of them are going on all the time requires the appropriate computational, communications, and secure architecture to facilitate this.

But this is not the same as having some complicated numerical simulation or using algorithms to crawl the web or to use these things to execute trades so that a bit of volatility can be created.

Yes it is. When someone figures out your credit limit, what do you think happens?

I need to emphasize again that the main issue I have is not with the bread and butter stuff like loans: it's with speculation but not real hedging.

Rule one of physics (and finance) sometimes you can't have what you want. If you can propose a system in which you can have hedging without *someone* speculating, I'd be interested in hearing about it, but right now, it's like someone complaining about quantum mechanics or general relativity because it's just too complicated.

Once you allow people to do market transactions and once you have communication tools, then things *will* become complicated. Personally, I think it's better to just accept that and try to deal with the consequences rather than wishing things were different. At some point it's like wishing that perpetual motion machines existed.

My issue is not with the computational power alone per se: it's more to do with the idea of how risk is handled (but more importantly introduced) and what the incentives are with regard to how that ends up motivating business policies for certain financial institutions.

Sure. But what makes this problem complicated is that you want to avoid financial blowups, but at the same time you want to allow for market transactions, while dealing with the realities like the fact that the internet exists and we do not have a world government.

Finance has become a major part of an economy and that is ridiculous: again the point of finance was to facilitate the things that aided real economies: not to be a major part of an actual economy.

Finance is all about decision making. As the world gets more complex, then you need to spend more time making decisions.

It used to be that if people wanted to buy a banana from the fruit shop, they bought it to eat it. They didn't buy it so they could create a so called profit.

Ummm... What fruit shop?

This is what banks do: it serves absolutely no use socially. Most people that go to the supermarket to buy food buy it because they are buying the very thing they need. They aren't buying it so they can sell it somewhere else and make a few cents profit, but this is entirely what is happening today.

Ummm... What supermarket? Why does the supermarket go through the effort of getting you bananas? (just between you and me, I've heard rumors and fruit shops and supermarkets make some money each time you buy a banana from them.)

This is the thing that I find frustrating about these conversations. The reality is that the financial system works so *well* that most people don't think about it. People talk about money as if it magically appears in banks just as if bananas magically appear in supermarkets.

I want to get rid of risk. I need someone that is willing to assume that risk. You need a broker.

 

[twofish-quant]

This is really really simple: banks have been doing this kind of thing for a long time (it's what they are meant to be good at) but they threw it all out the window when they gave people loans that could not possibly pay them back.

Again: this is why banking should be boring and why it's important to just stick to the time tested basics.

There's this thing called the internet that makes that impossible. You can pass all the laws that you want in the US. As long as the internet is there, someone is going to try something new in Germany. You can't do banking in 2012 the same way you did it in 1965, for the same reasons that you can't build cars or run universities in 2012 the same way that you did it in 1965. In 1965, you could have effective restrictions on interstate banking. You go to the bank, deposit your money, take out a loan. If you didn't like the bank that was in your location, TOUGH. It's not as if you could e-mail the town next door to see what their interest rates were.

The history of banking is incredibly interesting.

Again it used to be that when you went to a bank for a loan, they would deny you if they didn't feel you had a good chance of giving them a return on their investment. It wasn't a sure thing, but experience tends to help in this regard (i.e. the bank's experience).

And in 1965, it was also because the government controlled interest rates so that the bank was guaranteed to make money and have a reserve cushion. Globalization and inflation in the 1970's killed that system.

Also, people did stupid things before the financial crisis, and things blew up. For now, people aren't doing the same sorts of stupid things that they did before the financial crisis.

When people don't understand what they are buying: they shouldn't buy it. When people are selling something they don't understand, or know beforehand that they really should not be selling something, then they shouldn't sell it.

Sure, and I'm actually annoyed about how little people know about how the banking system works. It's a very fascinating story, and I like talking about it for the same reasons that I like talking about astrophysics.

However, the trouble comes in if you start talking about the big bang to a young Earth creationist. When that happens, it quickly becomes a useless discussion. When it becomes obvious that I'm talking to someone that insists that the world must be 6000 years old, then it's a bit pointless.

 

[twofish-quant]

I am probably being naive but I don't understand why students studying physics (or any science for that matter) would choose a field as socially useless as finance.

It's not really a choice

1) Lack of better options. I have a standing offer that if anyone is willing to hire me to do astrophysics at half my current salary, I'd be likely to take it.

2) Also having smart people (i.e. people who really are smart and not people that think they are but aren't) in finance is pretty important. You can really screw up the world with bad finance.

I don't really understand the logic. Bad finance has really screwed up the world, therefore it's better if we discourage people that are supposedly smart from entering it.

Instead of channeling your prodigious mental capabilities towards financial work, why not try and develop something useful for the economy and for society?

Keeping idiots from wrecking the world is useful for the economy. I'm actually quite proud of where I work because I can see where my individual efforts in 2008 kept things from being a *LOT* worse than it was. I'm also happy that what I'm doing now (hopefully) makes the world a better place.

A sure road to wealth is to create productive goods and services that people desire.

Nope. Reality doesn't work that way.

However, failure is a risk in any enterprise. I'd rather fail at establishing a business or shooting for tenure than failing at being some financial whiz. This is the way I felt after earning my bachelor's degree in economics.

The problem is that it's not up to you. You can have a totally wonderful business and then have some idiot blow up the world economy, and destroy your efforts.

 

[atyy]

I don't really understand the logic. Bad finance has really screwed up the world, therefore it's better if we discourage people that are supposedly smart from entering it.

Is it smart people that's required, or moral people?

 

[StatGuy2000]

Nope. Reality doesn't work that way.



The problem is that it's not up to you. You can have a totally wonderful business and then have some idiot blow up the world economy, and destroy your efforts.

I hope you are not seriously arguing above that businesses that create products and services useful to people cannot succeed, are you?

As far as your other quote, of course it's never up to you, the entrepeneur. Whether any new business succeeds is due to many factors only some of which is within your control. However, would you not agree that encouraging those with the inclinations to do so to start new businesses that is a good thing, and is good for the economy?

 

[StatGuy2000]

I don't really understand the logic. Bad finance has really screwed up the world, therefore it's better if we discourage people that are supposedly smart from entering it.

I believe the criticism that is expressed here is not that smart people shouldn't enter finance, but that TOO many "smart" people (e.g. people with a background in science and technology) are directing their considerable talents in applications in finance, instead of directing their energies and talents to, say, start new enterprises or tackling some of the numerous challenges and problems that exist in the world -- for example, ways to mitigate the impacts of climate change. Or at least the perception that too many smart people are being directed to finance, at any rate.

 

[Mute]

I hope you are not seriously arguing above that businesses that create products and services useful to people cannot succeed, are you?

I would imagine that twofish-quant was arguing that creating useful services and products are not a sure path to wealth, which is what the poster he quoted was claiming.

I have no idea why finance has become this super-complicated thing that it is.

Well, the dynamics of a single Ising spin are pretty simple, but once you let spins have even the simplest interactions with other spins, the dynamics become a lot less simple. If on top of that you have an extremely large number of spins, you're going to need some supercomputers to sort out what's going on.

Even if local financial interactions were kept as simple as possible, if the number of entities one is able to interact with financially is a decently sized number, figuring out the dynamics of the system is necessarily going to be complicated. Even in a model where no countries interact with one another and the financial system of a country is just the government acting as a central bank, giving out money to its citizens, the instant you let those citizens exchange money with each other for goods or services, it's not going to be trivial predicting the dynamics of cash flow in that system. Ever new kind of interaction is going to increase the complexity of the situation. (And then on top of that, I haven't even made my favorite assumption, which is that the system is not even close to being in equilibrium!)

I have no idea how finance could have become anything but the super-complicated thing that it is.

 

[Locrian]

Computers do that, eh?

Yup, calculating an internal rate of return or the net present value requires no analysis. Or at least no more than, say, adding two numbers, or dividing a few numbers. Calculating something like that is, thankfully, not something people do much of anymore. Those are your examples, and the word "calculating" was your word choice.

But, while you quoted the rest of my post, you never addressed any of its content.

How many physicists do you employ, and could you please tell us some uplifting stories about them? I'm excited to hear it!

 

[twofish-quant]

I hope you are not seriously arguing above that businesses that create products and services useful to people cannot succeed, are you?

Depends on the economic context. If you are unlucky enough to try to start a small business in the middle of a depression, then you are pretty much stuffed. At that point, you are focusing more on survival than on anything resembling success.

However, would you not agree that encouraging those with the inclinations to do so to start new businesses that is a good thing, and is good for the economy?

Sure, and probably the best way of encouraging people to start new businesses is to not to blow up the world economy.

Even as it is, it's pretty bad. The way that people have reacted to the meltdown is to reduce risk, and once you reduce risk, you aren't going to start a new business, which is probably one of the most risky things you can do financially. If you think that things are going bad, you are going to be putting your wealth in ultra-safe things like gold bars and government treasuries which aren't available for starting new businesses. That leads to a bad cycle.

 

[twofish-quant]

I believe the criticism that is expressed here is not that smart people shouldn't enter finance, but that TOO many "smart" people (e.g. people with a background in science and technology) are directing their considerable talents in applications in finance, instead of directing their energies and talents to, say, start new enterprises or tackling some of the numerous challenges and problems that exist in the world -- for example, ways to mitigate the impacts of climate change.

If the global financial system blows up, then nothing else really matters.

Also a lot of the discussion on this thread misses what physics Ph.D.'s are doing on Wall Street *now* as opposed to what people were doing in 2005.

One nice things about markets is that to some degree they are self-correcting. The firms that did the most objectionable things in 2005 are largely no longer in business, and a lot of the thinking over the last few years has been to figure out ways in which firms and people that do stupid things can blow themselves up without taking down the rest of the world. There is precedent for this sort of thing. LTCM caused huge problems when it blew up, so people put into place new rules so that hedge funds can blow up (which they do all the time) without anyone caring.

The products that caused really bad problems are no longer being sold, because no one is interested in buying them. Most of the new hiring for Ph.D.'s has been in things like risk management and governmental compliance.

Or at least the perception that too many smart people are being directed to finance, at any rate.

One problem with this discussion is it's sort of useless unless we are seriously considering ways of changing the situation. If people are seriously interested in putting up the money in order to creating more jobs for theoretical physicists, then that's a useful discussion. If people aren't (and people don't seem to be), then I really don't see the point in thinking too much about that.

The worst case scenario for me is if people conclude "too many smart people are going into finance so let's make all those people unemployed" which is where the discussion tends to go.

Also, there are certain realities that make finance attractive. One is the reality that the finance people are the people that make the big decisions. You have a factory with technical workers? Who decides whether to close the factory or not? Most likely it's someone with an MBA. How we decide whether to fund a new university, or national lab, or spacecraft ? Most likely there is some budget somewhere.

The other reality is that if you are purely technical, you can and will be screwed over. The fact that I did have a technical position in a firm that decided to ship my job over to some other country gives me some first hand experience in this. In most industrial firms there is a glass ceiling in which you cannot pass if you are technical. In finance, this is much less true, and while I've never negotiated with a government regulator or testified in a Senate committee on banking regulation, I know people with theoretical physics Ph.D.'s who have.

If the focus of the discussion is how to change these realities without screwing me over, then I'm game. Personally, I think it's just a bad thing for everyone to work in one industry. I'm also *extremely* worried that there is a massive rich/poor divide. One thing to look at is the people here who are theory Ph.D.'s + 10-20 years and realize that there really is no "middle class." Either you make scary amounts of money, or you are going from adjunct to adjunct trying to barely pay the rent.

But if it's talking about how society should have fewer people in finance without a willingness to "put up or shut up" then it's not a useful discussion. Also equally useless is whether finance *ought* to be simple. This is another "argue with reality" thing. Finance *isn't* simple, and in some ways arguing about whether it ought to be or not is like arguing whether the second law of themodynamics ought to exist. I'm not sure I see the point.

 

[twofish-quant]

Well, the dynamics of a single Ising spin are pretty simple, but once you let spins have even the simplest interactions with other spins, the dynamics become a lot less simple. If on top of that you have an extremely large number of spins, you're going to need some supercomputers to sort out what's going on.

People have used Ising spin models to model financial securities.

http://arxiv.org/pdf/physics/0603040.pdf

The big take away is the you have collective effects in which the default rates rise very, very quickly. Regulators are interested in this sort of stuff because it gives them metrics to tell when a market is about to blow up.

Here's another example of what people are working on...

http://www.mth.kcl.ac.uk/~kuehn/published/CDS.pdf

One reason I think there is a deep connection between thermodynamics and finance is that people use heat terminology when talking about markets and stocks. People talk about "hot" and "cold" markets and economies. People don't talk about "heavy" or "fragrant" markets.

 

[StatGuy2000]

Depends on the economic context. If you are unlucky enough to try to start a small business in the middle of a depression, then you are pretty much stuffed. At that point, you are focusing more on survival than on anything resembling success.

I agree that starting a small business in the middle of a depression is usually not a good idea (or at any rate is extremely risky), although it is worth pointing out that there are numerous highly successful businesses that were founded during major recessions.

HP, for example, was founded near the end of the Great Depression. FedEx was founded during the middle of the 1970's oil crisis which brought the US economy to a standstill.

You may argue that these are exceptional cases, but opportunties can often arise even in the middle of downturns to those who are willing to take the risk, and entrepeneurs are risk-takers by nature.

Sure, and probably the best way of encouraging people to start new businesses is to not to blow up the world economy.

Even as it is, it's pretty bad. The way that people have reacted to the meltdown is to reduce risk, and once you reduce risk, you aren't going to start a new business, which is probably one of the most risky things you can do financially. If you think that things are going bad, you are going to be putting your wealth in ultra-safe things like gold bars and government treasuries which aren't available for starting new businesses. That leads to a bad cycle.

What you state above is all true, certainly for many investors and large, established businesses. But there are also people who are busy creating new businesses, including those in the mobile apps area spawned by the success of the smart phone and Facebook, as well as those in renewable energies.

Many of these businesses will fail, but some will succeed beyond any measure we can really predict. Even failure of these startups is not necessarily a bad thing -- it provides a useful experience to those entrepeneurs when they are able to start new businesses again or seek other employment in the future.

 

[StatGuy2000]

One problem with this discussion is it's sort of useless unless we are seriously considering ways of changing the situation. If people are seriously interested in putting up the money in order to creating more jobs for theoretical physicists, then that's a useful discussion. If people aren't (and people don't seem to be), then I really don't see the point in thinking too much about that.

The worst case scenario for me is if people conclude "too many smart people are going into finance so let's make all those people unemployed" which is where the discussion tends to go.

I agree with you that much of the criticism of "too many smart people in finance" isn't particularly constructive without providing some career alternatives for theoretical physics PhDs (as well as other related fields such as applied math). Careerwise, people tend to go where the opportunities exist.

However, an assumption in your quote above is that physics graduates are somehow unable to influence the outcome of their own career prospects. This belies the fact that (a) scientists, engineers, and other technical fields have the ability to form a coalition to lobby for more funding towards science & technology in the argument that investment in these areas will promote economic growth, and (b) among the ranks of physics PhDs will exist those with an entrepeneurial bent who can found new start-ups willing to hire other physics PhDs (as has happened with computer science PhDs -- take Google, for example).

Also, there are certain realities that make finance attractive. One is the reality that the finance people are the people that make the big decisions. You have a factory with technical workers? Who decides whether to close the factory or not? Most likely it's someone with an MBA. How we decide whether to fund a new university, or national lab, or spacecraft ? Most likely there is some budget somewhere.

What you state above is true, but ignores the fact that those who are making the big decisions are not those with physics PhDs currently working in finance; the people who are making these decisions are more often than not accountants or other "bean counters", so to speak.

I'm sure you would agree that those physics PhDs currently working in finance (as you are currently) are for the most part working in a purely technical position.

The other reality is that if you are purely technical, you can and will be screwed over. The fact that I did have a technical position in a firm that decided to ship my job over to some other country gives me some first hand experience in this. In most industrial firms there is a glass ceiling in which you cannot pass if you are technical. In finance, this is much less true, and while I've never negotiated with a government regulator or testified in a Senate committee on banking regulation, I know people with theoretical physics Ph.D.'s who have.

The reality is that if you are in any position within a company, technical or otherwise, you can and will be screwed over. As for a glass ceiling in most industrial firms, I'm sure that would depend very much on the individual corporate culture of the said firms.

 

[Keile]

I don't understand the argument.

So we shouldn't hold negative connotations about physicists going into finance because it's "where the opportunities lie". In analogy, we shouldn't hold negative connotations about physicists working for the Death Star if that is infact where the opportunities exist. I know the two are only tangentially related -- one might actually use germane physics knowledge on the Death Star -- but in general am I right?

Also, when twofish-quant implies that quant types stop the financial house of cards from crashing down upon itself, why does he neglect to mention that esoteric quant products were the things which spurred the 2008 downfall?

 

[Mute]

I don't understand the argument.

So we shouldn't hold negative connotations about physicists going into finance because it's "where the opportunities lie". In analogy, we shouldn't hold negative connotations about physicists working for the Death Star if that is infact where the opportunities exist. I know the two are only tangentially related -- one might actually use germane physics knowledge on the Death Star -- but in general am I right?

No, the argument is that we shouldn't hold negative connotations about physicists going into finance because some of them may actually be doing important work that's useful to the economy and is hopefully helping keep things away from another crash. Assuming that all physicists are going into finance to cash out and are going to screw everything up is silly. A physicist in finance can just as well keep things from blowing up just as much as he/she can blow them up. How do you know we'd be better off if there there were no physicists in finance? How do you know that without people actively working to understand the finance system people wouldn't just be doing dumb things that would lead us to some other disaster? I don't see how not hiring people to try and understand the financial system is better than having people trying to understand it. Sure, some company might hire a physicist to make some bad model, but that doesn't mean all physicists are going to make bad models.

Also, when twofish-quant implies that quant types stop the financial house of cards from crashing down upon itself, why does he neglect to mention that esoteric quant products were the things which spurred the 2008 downfall?

Because he's talking about what "quant types" are doing now, as opposed to back in 2005:

Also a lot of the discussion on this thread misses what physics Ph.D.'s are doing on Wall Street *now* as opposed to what people were doing in 2005.

One nice things about markets is that to some degree they are self-correcting. The firms that did the most objectionable things in 2005 are largely no longer in business, and a lot of the thinking over the last few years has been to figure out ways in which firms and people that do stupid things can blow themselves up without taking down the rest of the world. There is precedent for this sort of thing. LTCM caused huge problems when it blew up, so people put into place new rules so that hedge funds can blow up (which they do all the time) without anyone caring.

The products that caused really bad problems are no longer being sold, because no one is interested in buying them. Most of the new hiring for Ph.D.'s has been in things like risk management and governmental compliance.

 

[Mute]

People have used Ising spin models to model financial securities.

http://arxiv.org/pdf/physics/0603040.pdf

The big take away is the you have collective effects in which the default rates rise very, very quickly. Regulators are interested in this sort of stuff because it gives them metrics to tell when a market is about to blow up.

Here's another example of what people are working on...

http://www.mth.kcl.ac.uk/~kuehn/published/CDS.pdf

One reason I think there is a deep connection between thermodynamics and finance is that people use heat terminology when talking about markets and stocks. People talk about "hot" and "cold" markets and economies. People don't talk about "heavy" or "fragrant" markets.

It doesn't surprise me that people would use Ising models in finance contexts, although I would expect that most economic systems are not necessarily in equilibrium and so dynamical models would have to be used to model the financial situation properly. The first reference approaches the problem using equilibrium statistical mechanics. Perhaps that's good enough for the particular problem they are looking at, but I would expect that for looking for signals of approaching crashes a non-equilibrium kind of model would be necessary. Then again, that's the sort of thing I've done in other contexts, so perhaps I'm biased in my approach (although I would still be skeptical about using equilibrium stat mech unless someone can provide good reasons as to why the system has equilibrated).

 

[twofish-quant]

HP, for example, was founded near the end of the Great Depression. FedEx was founded during the middle of the 1970's oil crisis which brought the US economy to a standstill.

The **end** of a depression is pretty much the best time to start a company. Also the oil crisis lasted for only a two years, and to large part it was self-inflicted. The basic problem wasn't so much lack of oil as price controls.

You may argue that these are exceptional cases, but opportunties can often arise even in the middle of downturns to those who are willing to take the risk, and entrepeneurs are risk-takers by nature.

Someone has got to win the lottery...

But it seems to me unwise to base your financial planning on it. Also, it seems even more unwise to base your economy on it.

The other thing is that the stereotype of entrepreneurs as risk takers is one of those fun stereotypes that are questionable. Malcolm Gladwell has written a few articles (that fit my personal observations of entrepreneurs) which argue that entrepreneurs are actually quite *risk-averse*. They often *seem* like they are taking big risks when in fact they aren't. (see http://www.newyorker.com/reporting/2010/01/18/100118fa_fact_gladwell)

But there are also people who are busy creating new businesses, including those in the mobile apps area spawned by the success of the smart phone and Facebook, as well as those in renewable energies.

And they all end up begging from money from some bank or venture capitalist.

 

[twofish-quant]

However, an assumption in your quote above is that physics graduates are somehow unable to influence the outcome of their own career prospects. This belies the fact that (a) scientists, engineers, and other technical fields have the ability to form a coalition to lobby for more funding towards science & technology in the argument that investment in these areas will promote economic growth

They can. But they don't necessarily do. Also the groups that have the power to lobby Congress tend to be professional societies, and they have interests that can be quite at odds with newly graduated physics Ph.D.'s. For example, one very strong thing that could be done is to unionize graduate students and post-docs, but if you do that you will be fighting tooth and nail against AAUP and the professional societies which are dominated by established folks.

The other thing is that lobbying requires money and political skill. This gets you back to finance. One of the things that I like about my job is that I got to see the process of political lobbying first hand so I've learned some tricks that may be useful to me later.

(b) among the ranks of physics PhDs will exist those with an entrepeneurial bent who can found new start-ups willing to hire other physics PhDs (as has happened with computer science PhDs -- take Google, for example).

If they can find a venture capital willing to fund them. This all boils back to money.

What you state above is true, but ignores the fact that those who are making the big decisions are not those with physics PhDs currently working in finance; the people who are making these decisions are more often than not accountants or other "bean counters", so to speak.

Not true. I know of several physics Ph.D.'s at the managing director level, and a few who are government regulators.

I'm sure you would agree that those physics PhDs currently working in finance (as you are currently) are for the most part working in a purely technical position.

No I don't agree with this. Even at my level a great deal of my time involves what would be considered politics. I'm not a manager, but I do have to negotiate access to resources from other groups at a day to day basis.

The reality is that if you are in any position within a company, technical or otherwise, you can and will be screwed over.

Your odds of getting screwed over are much less if you are on the committee that does the screwing.

As for a glass ceiling in most industrial firms, I'm sure that would depend very much on the individual corporate culture of the said firms.

Or industry. There are several theory physics Ph.D.'s that have made it to the top (the head of Renaissance Technology for one).

 

[twofish-quant]

So we shouldn't hold negative connotations about physicists going into finance because it's "where the opportunities lie". In analogy, we shouldn't hold negative connotations about physicists working for the Death Star if that is infact where the opportunities exist. I know the two are only tangentially related -- one might actually use germane physics knowledge on the Death Star -- but in general am I right?

No you aren't. It would be a bad thing that physics Ph.D.'s going into finance were doing work that was actively socially destructive, but I don't we are. Of course, I'm not unbiased at this. Having someone give you large sums of money changes your view of them.

Also, I really don't care if you have negative connotations about me. If I'm doing the "right thing" and you have negative opinions of that, then I don't care. I'm not running for public office, and because I'm not, I have a bit more freedom to say what I think even if those things are unpopular.

Conversely, if you have a positive opinion of me, it's not going help me to pay my rent, and if you have positive opinions of me and we both are wrong, that's bad.

Also, when twofish-quant implies that quant types stop the financial house of cards from crashing down upon itself, why does he neglect to mention that esoteric quant products were the things which spurred the 2008 downfall?

1) Because everyone knows that.
2) Because *I* quite intentionally didn't work on those products.

Because of 2) there was a "negative Darwin" effect that happened before 2008. People with half a brain and some moral sense ended up not working for firms and in areas were stupid stuff was going on, which made those firms even more stupid and amoral. I know of some people that worked for bad firms that tried to change things from the inside, got disgusted and quit.

You can ask why people didn't alert the media or the government. Simple, before 2008, people didn't care, and it would have gotten you in a lot of trouble and done no good. Things are *very* different since 2008. There are government regulators monitoring things and they have put in management changes, and those bad firms killed themselves in the end. Too bad they took down the rest of the world.

The other thing is that it's often not obvious what the "right thing" is. If you put yourself in 2005, there was a prevailing opinion of "markets good/government bad", and most of the people that believed that were quite sincere and well-meaning, just like most Communists that I've met are nice well-meaning people, notwithstanding that it lead to things like Stalin and Mao. One thing that I makes me nervous is that I *think* that I'm doing socially positive things, but it will be up to historians to judge.