Fooled by Randomness (7 page)

I had a strong bias in favor of Russian scientists; many can be put to active use as chess coaches (I also got a piano teacher out of the process). In addition, they are extremely helpful in the interview process. When MBAs apply for trading positions, they frequently boast “advanced” chess skills on their résumés. I recall the MBA career counselor at Wharton recommending our advertising chess skills “because it sounds intelligent and strategic.” MBAs, typically, can interpret their superficial knowledge of the rules of the game into “expertise.” We used to verify the accuracy of claims of chess expertise (and the character of the applicant) by pulling a chess set out of a drawer and telling the student, now turning pale: “Yuri will have a word with you.”

The failure rate of these scientists, though, was better, but only slightly so than that of MBAs; but it came from another reason, linked to their being on average (but only on average) devoid of the smallest bit of practical intelligence. Some successful scientists had the judgment (and social graces) of a doorknob—but by no means all of them. Many people were capable of the most complex calculations with utmost rigor when it came to equations, but were totally incapable of solving a problem with the smallest connection to reality; it was as if they understood the letter but not the spirit of the math (we will see more on such dual thinking with the two systems of reasoning problem in
Chapter 11
). I am convinced that X, a likeable Russian man of my acquaintance, has two brains: one for math and another, considerably inferior one, for everything else (which included solving problems related to the mathematics of finance). But on occasion a fast-thinking scientific-minded person with street smarts would emerge. Whatever the benefits of such population shift, it improved our chess skills and provided us with quality conversation during lunchtime—it extended the lunch hour considerably. Consider that I had in the 1980s to chat with colleagues who had an MBA or tax accounting background and were capable of the heroic feat of discussing FASB standards. I have to say that their interests were not too contagious. The interesting thing about these physicists did not lie in their ability to discuss fluid dynamics; it is that they were naturally interested in a variety of intellectual subjects and provided pleasant conversation.

Solon Visits Regine’s Nightclub

As the reader may already suspect, my opinions about randomness have not earned me the smoothest of relations with some of my peers during my Wall Street career (many of whom the reader can see indirectly—but only indirectly—portrayed in these chapters). But where I had uneven relations was with some of those who had the misfortune of being my bosses. For I had two bosses in my life of contrasting characteristics in about every trait.

The first, whom I will call Kenny, was the epitome of the suburban family man. He would be of the type to coach soccer on Saturday morning, and invite his brother-in-law for a Sunday afternoon barbecue. He gave the appearance of someone I would trust with my savings—indeed he rose quite rapidly in the institution in spite of his lack of technical competence in financial derivatives (his firm’s claim to fame). But he was too much a no-nonsense person to make out my logic. He once blamed me for not being impressed with the successes of some of his traders who did well during the bull market for European bonds of 1993, whom I openly considered nothing better than random gunslingers. I tried presenting him with the notion of survivorship bias (Part II of this book) in vain. His traders have all exited the business since then “to pursue other interests” (including him). But he gave the appearance of being a calm, measured man, who spoke his mind and knew how to put the other person at ease during a conversation. He was articulate, extremely presentable thanks to his athletic looks, well measured in his speech, and endowed with the extremely rare quality of being an excellent listener. His personal charm allowed him to win the confidence of the chairman—but I could not conceal my disrespect, particularly as he could not make out the nature of my conversation. In spite of his conservative looks he was a perfect time bomb, ticking away.

The second, whom I will call Jean-Patrice, in contrast, was a moody Frenchman with an explosive temper and a hyperaggressive personality. Except for those he truly liked (not that many), he was expert at making his subordinates uncomfortable, putting them in a state of constant anxiety. He greatly contributed to my formation as a risk taker; he is one of the very rare people who have the guts to care only about the generator, entirely oblivious of the results. He presented the wisdom of Solon, but, while one would expect someone with such personal wisdom and such understanding of randomness to lead a dull life, he lived a colorful one. In contrast with Kenny, who wore conservative dark suits and white shirts (his only indulgence was flashy equestrian Hermès ties), Jean-Patrice dressed like a peacock: blue shirts, plaid sports coats stuffed with gaudy silk pocket squares. No family-minded man, he rarely came to work before noon—though I can safely say that he carried his work with him to the most unlikely places. He frequently called me from
Regine’s,
an upscale nightclub in New York, waking me up at three in the morning to discuss some small (and irrelevant) details of my risk exposure. In spite of his slight corpulence, women seemed to find him irresistible; he frequently disappeared at midday and was unreachable for hours. His advantage might have been in his being a New York Frenchman with steady bathing habits. Once he invited me to discuss an urgent business issue with him. Characteristically, I found him mid-afternoon in a strange “club” in Paris that carried no nameplate and where he sat with documents strewn across the table from him. Sipping champagne, he was simultaneously caressed by two scantily dressed young ladies. Strangely, he involved them in the conversation as if they were part of the meeting. He even had one of the ladies pick up his constantly ringing mobile phone as he did not want our conversation to be interrupted.

I am still amazed at this flamboyant man’s obsession with risks, which he constantly played in his head—he literally thought of everything that could possibly happen. He forced me to make an alternative plan should a plane crash into the office building (way before the events of September 2001)—and fumed at my answer that the financial condition of his department would be of small interest to me in such circumstances. He had a horrible reputation as a philanderer, a temperamental boss capable of firing someone at a whim, yet he listened to me and understood every word I had to say, encouraging me to go the extra mile in my study of randomness. He taught me to look for the invisible risks of blowup in any portfolio. Not coincidentally, he has an immense respect for science and an almost fawning deference for scientists; a decade or so after we worked together he showed up unexpectedly during the defense of my doctoral thesis, smiling from the back of the room. While Kenny knew how to climb the ladder of an institution, reaching a high level in the organization before being forced out, Jean-Patrice did not have such a happy career, a matter that taught me to beware of mature financial institutions.

It can be disturbing for many self-styled “bottom line”–oriented people to be questioned about the histories that did not take place rather than the ones that actually happened. Clearly, to a no-nonsense person of the “successful in business” variety, my language (and, I have to reckon, some traits of my personality) appears strange and incomprehensible. To my amusement, the argument appears offensive to many.

The contrast between Kenny and Jean-Patrice is not a mere coincidence that I happened to witness in a protracted career. Beware the spendthrift “businesswise” person; the cemetery of markets is disproportionately well stocked with the self-styled “bottom line” people. In contrast with their customary Masters of the Universe demeanor, they suddenly look pale, humble, and hormone-deprived on the way to the personnel office for the customary discussion of the severance agreement.

GEORGE WILL IS NO SOLON:
ON COUNTERINTUITIVE TRUTHS

Realism can be punishing. Probabilistic skepticism is worse. It is difficult to go about life wearing probabilistic glasses, as one starts seeing fools of randomness all around, in a variety of situations—obdurate in their perceptional illusion. To start, it is impossible to read a historian’s analysis without questioning the inferences: We know that Hannibal and Hitler were mad in their pursuits, as Rome is not today Phoenician-speaking and Times Square in New York currently exhibits no swastikas. But what of all those generals who were equally foolish, but ended up winning the war and consequently the esteem of the historical chronicler? It is hard to think of Alexander the Great or Julius Caesar as men who won only in the visible history, but who could have suffered defeat in others. If we have heard of them, it is simply because they took considerable risks, along with thousands of others, and happened to win. They were intelligent, courageous, noble (at times), had the highest possible obtainable culture in their day—but so did thousands of others who live in the musty footnotes of history. Again I am not contesting that they won their wars—only the claims concerning the quality of their strategies. (My very first impression upon a recent rereading of the
Iliad,
the first in my adulthood, is that the epic poet did not judge his heroes by the result: Heroes won and lost battles in a manner that was totally independent of their own valor; their fate depended upon totally external forces, generally the explicit agency of the scheming gods (not devoid of nepotism). Heroes are heroes because they are heroic in behavior, not because they won or lost. Patrocles does not strike us as a hero because of his accomplishments (he was rapidly killed) but because he preferred to die than see Achilles sulking into inaction. Clearly, the epic poets understood invisible histories. Also later thinkers and poets had more elaborate methods for dealing with randomness, as we will see with stoicism.

Listening to the media, mostly because I am not used to it, can cause me on occasion to jump out of my seat and become emotional in front of the moving image (I grew up with no television and was in my late twenties when I learned to operate a TV set). One illustration of a dangerous refusal to consider alternative histories is provided by the interview that media person George Will, a “commentator” of the extensively commenting variety, conducted with Professor Robert Shiller, a man known to the public for his bestselling book
Irrational Exuberance,
but known to the connoisseur for his remarkable insights about the structure of market randomness and volatility (expressed in the precision of mathematics).

The interview is illustrative of the destructive aspect of the media, in catering to our heavily warped common sense and biases. I was told that George Will was very famous and extremely respected (that is, for a journalist). He might even be someone of the utmost intellectual integrity; his profession, however, is merely to sound smart and intelligent to the hordes. Shiller, on the other hand, understands the ins and outs of randomness; he is trained to deal with rigorous argumentation, but does sound less smart in public because his subject matter is highly counterintuitive. Shiller had been pronouncing the stock market to be overpriced for a long time. George Will indicated to Shiller that had people listened to him in the past they would have lost money, as the market has more than doubled since he started pronouncing it overvalued. To such a journalistic and well-sounding (but senseless) argument, Shiller was unable to respond except to explain that the fact that he was wrong in one single market call should not carry undue significance. Shiller, as a scientist, did not claim to be a prophet or one of the entertainers who comment on the markets on the evening news. Yogi Berra would have had a better time with his confident comment on the fat lady not having sung yet.

I could not understand what Shiller, untrained to compress his ideas into vapid sound bites, was doing on such a TV show. Clearly, it is foolish to think that an irrational market cannot become even more irrational; Shiller’s views on the rationality of the market are not invalidated by the argument that he was wrong in the past. Here I could not help seeing in the person of George Will the representative of so many nightmares in my career; my attempting to prevent someone from playing Russian roulette for $10 million and seeing journalist George Will humiliating me in public by saying that had the person listened to me it would have cost him a considerable fortune. In addition, Will’s comment was not an off-the-cuff remark; he wrote an article on the matter discussing Shiller’s bad “prophecy.” Such tendency to make and unmake prophets based on the fate of the roulette wheel is symptomatic of our ingrained inability to cope with the complex structure of randomness prevailing in the modern world. Mixing forecast and prophecy is symptomatic of randomness-foolishness (prophecy belongs to the right column; forecast is its mere left-column equivalent).

Humiliated in Debates

Clearly, this idea of alternative history does not make intuitive sense, which is where the fun begins. For starters, we are not wired in a way to understand probability, a point that we will examine backward and forward in this book. I will just say at this point that researchers of the brain believe that mathematical truths make little sense to our mind, particularly when it comes to the examination of random outcomes. Most results in probability are entirely counterintuitive;we will see plenty of them. Then why argue with a mere journalist whose paycheck comes from playing on the conventional wisdom of the hordes? I recall that every time I have been humiliated in a public discussion on markets by someone (of the George Will variety) who seemed to present more palatable and easier-to-understand arguments, I turned out (much later) to be right. I do not dispute that arguments should be simplified to their maximum potential; but people often confuse complex ideas that cannot be simplified into a media-friendly statement as symptomatic of a confused mind. MBAs learn the concept of clarity and simplicity—the five-minute-manager take on things. The concept may apply to the business plan for a fertilizer plant, but not to highly probabilistic arguments—which is the reason I have anecdotal evidence in my business that MBAs tend to blow up in financial markets, as they are trained to simplify matters a couple of steps beyond their requirement. (I beg the MBA reader not to take offense; I am myself the unhappy holder of the degree.)