Robert Rubin - Putting stars in the eyes of the Quants!
Rahul Bhattacharya
January 11, 2009
Robert Rubin recently resigned from the post of an advisor of Citigroup.
Rubin, as everyone knows, is the rainmaker and the fixer of the yesteryear who has reportedly made over $100 million in compensation and fees in the last few years. Rubin is remembered for many things, dealmaker, fixer, partner at Goldman Sachs, Secretary of Treasury under Bill Clinton, etc. etc. But very few today will realize that in the nineteen eighties Robert Rubin, while at the investment bank Goldman Sachs, was instrumental in importing physics and mathematics into Goldman Sachs. This act of his would eventually transform the world of finance.
Robert Rubin, more than any other banker, became our modern day Oppenheimer and in the eighties and nineties Goldman Sachs became the Los Alamos of the new millennium. It ran hundreds of "Manhattan projects" that would generate so many funky and esoteric financial products. Some of these products, with unimaginable destructive power, would ultimately cripple millions of investors, small shareholders, depositors all over the world, annihilate the dreams and illusions of rocket scientists, derivatives traders and salesman and render the entire global financial system impotent.
In 1983, or thereabouts, a handful of physicists and mathematicians were looking to migrate to the world of finance. Why? A lot of them were allured by the potential of higher salaries – they needed to cash in their Ph.D.s. Some thought that a couple of areas of quantitative finance, especially the problems of asset pricing and newly re-discovered areas of financial options, opened up interesting vistas for analysis and a few, perhaps mistakenly believing that all problems in physics have been solved, needed bigger challenges. Whatever the case maybe, the field of finance was ripe for revolution.
These physicists were looking for a vocation, something to do to keep them engaged in their intellectual pursuit. In 1984 Robert Rubin of Goldman Sachs gave them a religion.
That year, Fischer Black quit MIT and joined Goldman Sachs. It was Rubin who hired Black. Rubin believed that the world of finance was on a cusp of an intellectual revolution, a revolution that depended upon a new world view of the asset markets. He believed that the mathematical constructs and physics like theories could be applied to "scout out the subtle forms of mis-pricings in the markets."* It was perhaps Rubin’s belief in a probabilistic world that could have motivated him towards looking for answers in the world of physics, or, more precisely, statistical physics. It has been his long cherished belief that nothing in this world is a "provable certainty". It is as if his entire life has been one giant risk arbitrage trade; there is mis-pricing somewhere, there is uncertainty in the markets around us, there is absence of information somewhere and these needed to be exploited. This master risk arbitrage trader of Goldman Sachs, this man who lived and thrived “In an Uncertain World” became convinced in the mid eighties that there was more to the world of stocks and bonds than what met the eye and a complete theoretical and a philosophical overhaul was needed to unify the many disjointed axioms, models, formulas and numerical relationships that defined the theory of finance at that time. Of course, the objective was to make more money, make his bank more profitable and open up new areas of revenue generation.
It could also have been that, as the master dealmaker he was, Rubin thought that the mother of all deals would be to marry physics and finance in an attempt to create a religion that would forever, and for generations to come, put Wall Street one notch below God’s own paradise; a religion that would immortalize Goldman Sachs and perhaps, him.
Whatever the motive, whatever the motivation, Robert Rubin, together with Stephen Friedman, would single handedly transform Goldman from a "sheepdog into a wolf." And in the process the discipline of Quantitative Finance was born.
It would be no less than a religion. This was the beginning of an exodus that would continue for the next two decades flooding Wall Street and the world of finance with freshly minted Ph.D.s in physics, mathematics and engineering from the academia and Ivy League schools; it would be a an exodus that would perhaps, metaphorically speaking, dwarf the Biblical Exodus in its importance. Quantitative finance would not just become a discipline, a subsidiary of financial economics or finance, it would become a religion, opium for the "rocket scientists" or "quants" as these Ph.D.s came to be called. Graduate students in physics, mathematics and engineering all over the United States and beyond would have only one aim in life – to join Wall Street. Young kids in colleges would revere these Wall Street machos, the whiz kids who were scientists and engineers and who made million dollar bonuses and drove Ferraris.
Close on the heels of Black in the mid eighties would come Emanuel Derman, a Ph.D. in Theoretical Physics from Columbia, who along with Black and Bill Toy would become the gatekeepers of Goldman Sachs and the men who would bring Rubin’s dreams to fruition. They would man the Quantitative Strategies Group within Goldman and turn it into a research powerhouse. But what research were they doing? These guys would be the first breed of millionaire scientists, the financial alchemists who were in search of fame, money and a world that existed only in their heads. Many others would come to Goldman and many others would go to other investment banks on Wall Street.
Piotr Karasinski, another theoretical physicist from Yale, and a contemporary of Fischer Black on Wall Street, who is now the Head of Quantitative Development at HSBC quotes Freeman Dyson in one of his presentations. Dyson wrote, "I gazed at the stars as a young boy. That's what science means to me. It's not theories about stars; it is the actual stars that count."
We now know that all the math and all the physics that these alchemists have been trying to peddle to their shareholders, investors, depositors, regulators and the banking and finance community at large don’t work. But it was not so much about making the theories of physics and math work in the world of finance as it was about the romance of these subjects that mattered. It was like making love on an exotic, deserted beach. Who wouldn’t want to do it?
Dyson was right; it isn't the theories of stars that move and motivate us, that give us the orgasm. It's the actual stars with which we fall in love and around which we weave our dreams.
Robert Rubin is the man who first put stars in the eyes of the Quants.
*http://www.economicprincipals.com/issues/2006.09.17/215.html
http://www.bankingscience.com/ucljobs/files/hsbc.ppt#256,1,From Physics to Finance
http://www.vdare.com/jb/ltcm.htm
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