The Quants Part 9

The hike, in and out, typically took at least two or three days. Once Muller and a few friends hiked the entire trail, start to finish, in a day.

He looked back from the ocean to the trail ahead, wiping the sweat from his brow, and pushed on, moving quickly out of the Hanakoa Valley into a dry, open stretch of land, tiring but lured on by a panoramic view of fluted cliffs and the coastline of the Kalalau Valley beyond.

Muller was living a life few people could imagine. With little need to work as his quant machine cranked out profits in New York, he was free to travel the world. He'd become interested in heli-skiing, jumping out of helicopters in high, off-trail locations. Among his favorite spots were the dizzy verticals of the Rocky Mountains near Jackson Hole, Wyoming, where he would stay at the expansive ranch of Ken Griffin's friend and longtime investor Justin Adams. He took kayaking trips to getaways as far afield as New Zealand and river trips in Arizona and Idaho.

At the same time, he was working on an alb.u.m of songs. In 2004, he self-produced More Than This More Than This, a collection of sentimental, saccharine ballads, such as "In This World," that seemed a mix between Barry Manilow and Bruce Hornsby. He also started hosting a "songwriters' circle" on Tuesday nights from his Tribeca apartment, which featured a grand piano. He maintained a personal website, petemuller.com, featuring pictures of himself at his piano with his golden retriever, Mele. A press release about the alb.u.m says: "Pete Muller woke up more than 6 years ago and realized that he could no longer find happiness in the corporate world. While he felt accomplished and satisfied, he couldn't find a new challenge, a goal to aspire to, and turned his attention wholly to his music."

Meanwhile, PDT continued to churn out hundreds of millions in yearly profits for Morgan Stanley. By the early 2000s, PDT had become so successful that it commanded the largest proprietary trading book in Morgan Stanley's mammoth equities division. Its traders were treated like hothouse flowers, allowed to ditch the standard attire of an investment banker-the bespoke suits, the polished Italian leather shoes, the watch worth more than a minivan. Traditional bankers at Morgan started sharing elevators with slacker nerds in ripped jeans, torn T-s.h.i.+rts, and tennis shoes. Who the h.e.l.l are these guys? Who the h.e.l.l are these guys? When queried, PDTers would respond vaguely, with a shrug. When queried, PDTers would respond vaguely, with a shrug. We do technical stuff, you know, on computers. Quant stuff We do technical stuff, you know, on computers. Quant stuff.

"Whatever," the banker would say, adjusting his Hermes tie. Little did the banker realize that the nerdy slacker had made ten times his bonus the previous year.

Despite Muller's phenomenal success, he had kept PDT so secret that few employees at Morgan were even aware of the group's existence. That was fine with Muller, who had grown paranoid about outsiders copying PDT's strategies.

As PDT's success took off in the late 1990s, Muller's private life became more complicated. Elsesser had introduced him to a friend named Katie, a trim, dark-haired catalog designer for an antique restoration retailer called Urban Archaeology Urban Archaeology. The two hit it off. Katie was the kind of person who wrapped herself up in the life of whomever she was dating, and Muller loved the attention. She helped him decorate his Tribeca apartment as well as his new beachfront cottage in Westport.

But Muller often seemed distracted. He'd disappear at work for days on end and didn't seem dedicated to the relations.h.i.+p. As PDT grew, generating huge profits, the pressure to keep delivering by Morgan's bigwigs began to ramp up. Muller was feeling the heat.

Out of the blue, Katie left Muller for a mutual friend who'd just been through a tough divorce. Worse, the two had been staying together at Muller's Westport cottage.

Muller became an emotional wreck. Officemates would find him at times weeping at his desk. He'd talked about ending the relations.h.i.+p himself to colleagues in the office, but he seemed unnerved by the idea that she would leave him. It seemed a matter of control, and he'd lost it.

He threw himself into his music, especially heartfelt ballads, and distributed the songs around a firm known for its rough-edged trading culture. Behind Muller's back, traders made cracks about the songs. His colleagues at PDT were mortified. One song was called "Plug and Play Girl," a tune only a brokenhearted quant could dream up: I miss my plug and play, plug and play, plug and play girl Plug and play, plug and play, didn't have to end that way girl.

In the late 1990s, Muller went to a derivatives conference in Barcelona, attended by luminaries such as Myron Scholes of LTCM. After Muller gave his talk, he grabbed his five-pound electronic keyboard and took a cab to La Rambla, the city's funhouse pedestrian avenue that slopes down to the edge of the Mediterranean. He set up his keyboard in the midst of the milling crowd and lurched into song. It was the first time he'd sung in public.

It was just a warm-up for his next venue: the subway stations of New York City.

Soon after his Barcelona adventure, Muller packed up his electronic keyboard and walked outside his Tribeca apartment. his Barcelona adventure, Muller packed up his electronic keyboard and walked outside his Tribeca apartment.

He was nervous. Still self-conscious about singing in public, he was trying to work out the jitters. He went to a nearby subway stop and briskly took the steps down into the underground station, plopping a token into the booth and moving through the turnstiles, lugging his keyboard case behind him.

The air was dry, and it stank. A few commuters lingered along the platform, glancing anxiously at their watches, reading books and newspapers. Muller took a breath and plunked down his case, snapped open the catches, and quickly set up the keyboard. He flipped on the switch and, beginning to sweat, tried a few notes. The commuters looked idly his way. Subway buskers were common in New York, a sideshow in the city's energetic bustle and flow. That was exactly what Muller was counting on.

He closed his eyes and started playing, a tune by one of his favorite lyricists, Harry Chapin, "Cat's in the Cradle."

My child arrived just the other day He came to the world in the usual way A few onlookers tossed some spare coins into the instrument's case splayed beside him-with no idea the sandy-haired singer was a hotshot trader for one of the most powerful Wall Street firms in the world.

Muller, who never actually rode rode the subway, didn't see many of his fellow investment bankers in the subway system. But one evening a colleague from Morgan walked by and glanced at Muller hunched over his keyboard. the subway, didn't see many of his fellow investment bankers in the subway system. But one evening a colleague from Morgan walked by and glanced at Muller hunched over his keyboard.

He did a double take.

"Pete, what are you doing down here?" he said, shocked, looking Muller up and down. Recovering slightly, he added, "I guess you've done well enough-you can do whatever you want."

But he didn't toss any money in the piano case.

Everyone thought Muller was cracking up. A man who made money controlling the chaotic flow of the market through mind-bending math seemed to be losing control of his own life. Eyebrows were raised, but who cared? Muller's group made money, buckets of money. That was all that mattered. Let him crack up. He deserves it Let him crack up. He deserves it.

All the success seemed to weigh on Muller, who thought of himself as a carefree California child of the sun, a collector of crystals, singer of songs, lover of women and complex algorithms, not a ruthless, self-absorbed banker. He began to disappear from the office for weeks at a time, then months, only to pop up one day with a sweeping critique of PDT's operations before vanis.h.i.+ng again just as abruptly. One PDT trader labeled it seagull management: swoop by every now and then, s.h.i.+t all over everything, and fly away.

Around 2000, Shakil Ahmed took over the reins. Muller became a paid advisor, though he remained a partner at Morgan. He traveled the world, visiting the most exotic locales he could find: Bhutan, New Zealand, Hawaii. He sang during regular gigs in Greenwich Village cabarets and grungy lounges such as the Cutting Room and Makor Cafe. Old colleagues from PDT would swing by for the performances from time to time and wonder: What the h.e.l.l happened to Pete? What the h.e.l.l happened to Pete?

Muller stayed in touch with his fellow quants, however, and often spoke at industry events. In May 2002, he attended the wedding of Neil Chriss, one of his poker buddies whom he'd met at Morgan Stanley in the 1990s. One of the most respected mathematical minds in quantdom, Chriss was marrying a stunning, tall blonde named Natasha Herron, who was on the verge of completing a medical degree in psychology at Cornell University. The wedding was held at Trout-beck, a tony, aging resort in the Berks.h.i.+re foothills that in its heyday had seen guests from Ernest Hemingway to Teddy Roosevelt. in touch with his fellow quants, however, and often spoke at industry events. In May 2002, he attended the wedding of Neil Chriss, one of his poker buddies whom he'd met at Morgan Stanley in the 1990s. One of the most respected mathematical minds in quantdom, Chriss was marrying a stunning, tall blonde named Natasha Herron, who was on the verge of completing a medical degree in psychology at Cornell University. The wedding was held at Trout-beck, a tony, aging resort in the Berks.h.i.+re foothills that in its heyday had seen guests from Ernest Hemingway to Teddy Roosevelt.

At the reception, Chriss's quant friends were seated together. They included John Liew of AQR, whom Chriss knew from his days at Chicago; Muller; and Na.s.sim Nicholas Taleb, a New York University professor and hedge fund manager who'd just published a book, Fooled by Randomness Fooled by Randomness, which claimed that nearly all successful investors were more lucky than skilled.

Stocky, balding, with a salt-and-pepper beard, Taleb had little patience for quants and their fine-tuned models. His peripatetic life had shown him that little was permanent in the affairs of men. Born in 1960 in Amioun, Lebanon, a Greek Orthodox town north of Beirut, Taleb first encountered extreme randomness in the mid-1970s with the outbreak of the fifteen-year-long Lebanese civil war. To escape the violence, he left Lebanon to attend the University of Paris, where he studied math and economics. He then moved to the United States, earning a master's in business administration from Wharton.

When he was twenty-eight, he joined the investment bank First Boston, working out of the bank's Park Avenue office in New York. He started acc.u.mulating a large position in out-of-the-money Eurodollar futures contracts, one of the largest, most liquid markets in the world. On October 19, 1987-Black Monday-stocks crashed. Panicky investors fled into the most liquid a.s.sets they could find, including Taleb's Eurodollars. The value of his position exploded, giving Taleb an estimated one-day profit of about $40 million. He was well aware that the gains had nothing to do with why he'd been investing in Eurodollars. He'd been very, very lucky, and he knew it.

Over the next decade, Taleb, wealthier than he'd ever dreamed he'd become, bounced from firm to firm, at the same time earning a Ph.D. from the University of Paris Dauphine, writing a textbook on option trading, and working as a pit trader at the Chicago Mercantile Exchange. In 1999, he started teaching graduate courses in finance at NYU, at the same time launching a hedge fund called Empirica for its focus on empirical knowledge.

By the time of Chriss's wedding, Taleb had gained a reputation as a gadfly of the quants, constantly questioning their ability to beat the market. Taleb didn't believe in the Truth. He certainly didn't believe it could be quantified.

Due in part to his experience on Black Monday, Taleb believed that markets tended to make moves that were much more extreme than had been factored into quant.i.tative models. As a teacher of financial engineering at NYU, he was well aware of the proliferation of models that attempted to take account of extreme moves-the "jump diffusion" model that allowed for sudden leaps in price; the tongue-twisting "generalized autoregressive conditional heteroscedasticity model," or GARCH, which doesn't look at prices as a coin flip but rather takes into account the immediate past, and allows for feedback processes that can result in sudden jumps that create fat tails (Brownian motion with a kick); and a number of others. Taleb argued that no matter what model the quants used-even those that factored in Mandelbrot's Levy fat-tailed processes-the volatility in market events could be so extreme and unpredictable that no model could capture it.

The conversation at the table was cordial at first. Then people started noticing Taleb getting agitated. His voice was rising, and he was pounding the table. "It is impossible," he shouted at Muller. "You will be wiped out, I swear it!"

"I don't think so," Muller said. The normally calm and collected Muller was sweating, his face flushed. "We've proven we can beat the market year after year."

"There is no free lunch," Taleb boomed in his thick Levant accent, his forefinger wagging in Muller's face. "If ten thousand people flip a coin, after ten flips the odds are there will be someone who has turned up heads every time. People will hail this man as a genius, with a natural ability to flip heads. Some idiots will actually give him money. This is exactly what happened to LTCM. But it's obvious that LTCM didn't know s.h.i.+t about risk control. They were all charlatans."

Muller knew when he was being insulted. LTCM? Hardly. PDT could never never melt down. Taleb didn't know what he was talking about. melt down. Taleb didn't know what he was talking about.

At the end of the day, he didn't care about Taleb. He knew he had alpha. He knew the Truth, or a respectable slice of it. But he still didn't want to trade every day. There was more to life than making money, and he'd already proven he could do that in spades. He became more serious about his music and about poker.

In 2004, Muller pocketed $98,000 in a tournament on the World Poker Tour, often bringing his golden retriever to the table as a tail-wagging good-luck charm. When he won the Wall Street Poker Night challenge in March 2006, beating Cliff Asness in the final round, he didn't collect any money, but he did gain a healthy dose of bragging rights over his fellow poker-playing quants.

Once or twice a month, Muller, Weinstein, Asness, and Chriss, among other top-tier quants and hedge fund managers, would meet in ritzy New York hotels for private poker games. The buy-in was $10,000, but the pots were often much higher.

The money was chump change to all of them. It was all about the game: who knew when to raise, when to fold, when to bluff like there was no tomorrow. Asness loved playing, and he hated it. He couldn't stand folding, taking the small, incremental losses so essential to success at poker. He was too compet.i.tive, too aggressive. But he knew that the only way to win was to fold until he had a hand he could really believe in, until the odds s.h.i.+fted in his favor. But it seemed like he never got that hand.

Muller, however, had mastered the art of knowing exactly when to fold, when to raise, when to go all in. He never lost his cool, even when he was down. He knew it was only a matter of time before he was back on top. The quant poker games lasted late into the night, at times stretching into the following morning.

In 2006, Muller took the PDTers on a ski trip to an exclusive ski resort out west, flying the gang on a NetJets private plane. His treat. It would be one of the last few such trips they would make in years. A credit crisis brewing on Wall Street would put an end to such carefree jaunts. But that was a worry for another day.

Muller, meanwhile, was getting restless. Playing endless rounds of poker, hiking exotic trails in Hawaii, kayaking in Peru, shooting off on private jets to the Caribbean, dating models-it was all fun, but something was missing: trading, making millions in the blink of an eye, watching the winnings tick up like a rocket. He had to admit it. He missed it.

Muller decided he wanted back in. He had a steady girlfriend once again and was thinking about settling down. Plus PDT's returns weren't what they used to be. It had put up just single-digit gains in 2006 as a flood of copycats plowed into stat arb strategies, making it harder to discover untapped opportunities. Morgan's higher-ups wanted more. Muller said he could deliver.

A power struggle over control of PDT ensued. Shakil Ahmed, who'd been running PDT for the past seven years, quit the firm, outraged that Morgan would hand over the reins to their absentee leader. He soon took a job as head of quant strategies and electronic trading at Citigroup. Vikram Pandit, his former boss, had recently taken charge at Citi after Chuck Prince left in disgrace amid ma.s.sive subprime losses. Pandit was quick to hire Ahmed, long considered one of the secret geniuses behind PDT.

Back at Morgan, Muller was on top again at his old trading outfit. He had bold plans to expand the operation and increase its profits. Part of his plans included juicing returns by taking on bigger positions. One portfolio at PDT with the capacity to take more risk was the quant fundamental book, longer-term trades based on a stock's value, momentum-AQR's bread and b.u.t.ter-or other metrics used to judge whether a stock will go up or down. Such positions were typically held for several weeks or months, rather than the superfast Midas trades that usually lasted a day or less.

"They skewed the book much more toward quant fundamental," said a onetime PDTer. "They basically turned a large part of PDT into AQR." The size of the book grew from about $2 billion to more than $5 billion, according to traders familiar with the position.

Ken Griffin, who ran strategies similar to PDT's, wasn't overjoyed by Muller's return. He was overheard telling Muller that he was sorry to hear he'd come back-a typical double-edged dig by Griffin. Muller took it as a compliment. He was eager to get back in the mix of things, eager to start making money. Big money.

He wouldn't have much time to enjoy himself. Just months after he returned, Muller would face the biggest test of his career: a brutal meltdown that nearly destroyed PDT.

[image]ASNESS[image]

On November 13, 1998, shares of a little-known company called Theglobe.com Inc. debuted on the Nasdaq Stock Market at $9 apiece. Founders of the Web-based social networking site were expecting a strong reaction. Inc. debuted on the Nasdaq Stock Market at $9 apiece. Founders of the Web-based social networking site were expecting a strong reaction.

The frenzy that greeted the IPO defied all expectations and common sense. The stock surged like a freight train, hitting $97 at one point that day. Theglobe.com, formed by Cornell students Stephan Paternot and Todd Krizelman, was, for a brief moment, the most successful IPO in history.

A few days earlier, EarthWeb Inc., perhaps feeling the force of gravity, merely tripled in its IPO. Investors gobbled up EarthWeb's shares despite the following warning in its prospectus: "The company antic.i.p.ates that it will continue to incur net losses for the foreseeable future."

A few months before the dot-com IPO frenzy began, LTCM had collapsed. Alan Greenspan and the Federal Reserve swept in, orchestrating a bailout. Greenspan also slashed interest rates to salve the wounds to the financial system left by LTCM's implosion and flood the system with liquidity. The easy money added fuel to the smoldering Internet fires, which were soon raging and pus.h.i.+ng the tech-laden Nasdaq to all-time highs on an almost daily basis.

While minting instant millionaires among dot-com pioneers, this series of unlikely events proved a disaster for AQR, which had started trading in August 1998. Asness's strategy involved investing in cheap companies with a low price-to-book-value ratio, while betting against companies his models deemed expensive. In 1999, this was the worst possible strategy in the world. Expensive stocks-dot-com babies with no earnings and lots of hot air-surged insanely. Cheap stocks, sleepy financial companies such as Bank of America, and steady-as-she-goes automakers such as Ford and GM were stuck, left in the blazing wake of their futuristic New Economy betters.

AQR and its Goldman golden boys were hammered mercilessly, losing 35 percent in their first twenty months. In August 1999, in the middle of the free fall, Asness married Laurel Fraser, whom he'd met at Goldman, where she was an administrative a.s.sistant in the bond division. As AQR's fortunes plummeted, he complained bitterly to her about the insanity of the market. What is wrong with these people? They are so monumentally stupid. Their stupidity is killing me What is wrong with these people? They are so monumentally stupid. Their stupidity is killing me.

Asness believed his strategy worked because people made mistakes about value and momentum. Eventually they wised up, pus.h.i.+ng markets back into equilibrium-the Truth was restored. He made money on the gap between their irrationality and the time it took them to wise up.

Now investors were acting far more stupidly and self-destructively than he could possibly have imagined.

"I thought you made money because people make mistakes," his wife chided him. "But when the mistakes are too big, your strategy doesn't work. You want this Goldilocks story of just the right irrationality."

Asness realized she was right. His Chicago School training about efficient markets had blinded him to the wilder side of human behavior. It was a lesson he'd remember in the future: People could act far more irrationally than he'd realized, and he had better be ready for it. Of course, it's impossible to prepare for every kind of irrationality, and it's always the kind you don't see coming that gets you in the end.

By early 2000, AQR was on life support. It was a matter of months before it would have been forced to shut its doors. Asness and company had coughed up $600 million of its $1 billion seed capital, in part due to investors pulling out of the fund. Only a few loyal investors remained. It was a brutally humbling experience for Goldman's wonderquant.

Adding to the misery for AQR's leading lights was Goldman's highly lucrative initial public offering. It was too easy for Asness to do the math in his head. By leaving when he had, he'd missed out on a fortune. His hedge fund was on the brink of disaster. Worthless dotcom stocks were sucking in obscene sums. The world had gone mad.

His response? Like any good academic, he wrote a paper.

"Bubble Logic: Or, How to Learn to Stop Worrying and Love the Bull" is a quant's cri de coeur, Asness's protest against the insanity of prices ascribed to dot-com stocks such as Theglobe. Or, How to Learn to Stop Worrying and Love the Bull" is a quant's cri de coeur, Asness's protest against the insanity of prices ascribed to dot-com stocks such as Theglobe.

The stock market's price-to-earnings ratio hit 44 in June 2000-more than doubling in just five years and triple the long-term average. The t.i.tle's nod to Stanley Kubrick's black-humor satire of the Cold War, Dr. Strangelove, or, How I Learned to Stop Worrying and Love the Bomb Dr. Strangelove, or, How I Learned to Stop Worrying and Love the Bomb, gives a clue to Asness's dark mood as he banged away at "Bubble Logic" late at night from the confines of AQR's offices near Rockefeller Center (the fund later moved to Greenwich, Connecticut). The bubble was about as welcome to Asness as an atomic bomb. AQR has "had our a.s.sets handed to us," he writes in the introduction. "Have pity on a partially gored bear."

"Bubble Logic" began by making a rather startling argument: the market of early 2000 was not like the market of the past. Of course, that was exactly what the dot-com cheerleaders were claiming. The economy was different. Inflation was low. Productivity had surged thanks to new advances in technology, such as laptops, cell phones, and the Internet. Stocks should be given higher values in such an environment, because companies would spit out more cash.

Asness, however, was turning this argument on its head. Yes, things were different this time, in a bad way. History has shown that the stock market has almost always been a good investment over the long run. Asness trotted out numbers showing that stocks beat inflation in every twenty-year period since 1926. Stocks beat bonds, and stocks beat cash. So investors should always invest in stocks, right?

Wrong. Stocks generally perform better than most other investments "not because of magic, but largely because throughout the period we study they were generally priced reasonably, or even cheaply vs. their earnings and dividends prospects," Asness wrote. "That is not necessarily the case anymore."

As a sample case, Asness examined the New Economy darling, Cisco Systems, which makes Internet routers. He systematically demolished the case for investing in Cis...o...b.. showing that there was no possible way that the company's earnings prospects could match its valuation. And yet, despite the obviousness of the case, he noted, "Cisco is on almost every 'must own' recommended list I see. Go figure."

In the paper's conclusion, the agitated hedge fund manager made an argument that flew in the face of Fama's efficient-market hypothesis. According to the EMH, it's impossible to know when a bubble is occurring, since current prices reflect all publicly known available information. Only in retrospect, when the bubble has popped (on new information about how c.r.a.ppy those companies were, or how little those new homeowners could actually pay), is it clear that prices were overinflated. Asness, however, wrote that the case was already clear: the market was in a bubble. "Unless we see 20-year growth for the S&P far, far in excess of anything ever seen for 125 years starting from similar good times, long-term S&P returns become quite ugly," he wrote.

Such a negative outcome seemed impossible to investors experiencing dot-com dipsomania in late 1999 and early 2000. Of course, Asness was right all along.

"Bubble Logic" was never published. By the time Asness finished writing it, in mid-2000, the dot-com bubble was imploding in spectacular, horrific fas.h.i.+on. The Nasdaq peaked in March 2000 at more than 5,000. By October 2002, it had crumbled to 1,114.

Time, and reality, had overtaken stupidity. And AQR rebounded magnificently. Investors who'd ridden out the storm were rewarded for their patience as value stocks gained a new lease on life. AQR's flags.h.i.+p Absolute Return Fund would gain roughly 180 percent in the three years following its low point.

Asness would wear AQR's horrific performance during the dotcom bubble as a bloodied badge of courage, a clear sign that supports the fund's claims that it is completely "market neutral." When the market crashed, AQR was still standing. Hedge funds that had plowed into Internet stocks crashed and burned.

Still, other quant.i.tative funds such as Renaissance Technologies, D. E. Shaw, and PDT soared through the Internet bubble largely unscathed. Their models weren't as exposed to the destruction of value stocks as were AQR's. What's more, their trading strategies were based on capturing extremely short-term changes in market prices and benefited from the volatility as the bubble expanded, then burst. Losses could also be limited, since such "high-frequency" funds, as they're called, could dump a.s.sets that moved against them in rapid order. AQR's strategies were focused on price changes that take place over the course of weeks or even months, rather than over the course of an afternoon. That meant that when the fund's models were wrong, the pain was more intense. When the models were right, of course, the gains were ma.s.sive.

The dot-com flameout was a watershed event for the hedge fund industry. Sophisticated investors started to buy into the case Asness made in "Bubble Logic" that stocks aren't necessarily a one-way road to riches. Rock-bottom interest rates forced pension funds and endowments to find new areas to invest in. a.s.sets under management by hedge funds surged, rising to $2 trillion by early 2007 from about $100 billion two decades earlier.

At the head of the pack were the quants. It all seemed so perfect. Their quant.i.tative models worked. The theories describing how the market behaved had been tested and appeared to be accurate. They knew the Truth! The computers were faster, more powerful than ever. A river of money flowed in until it became a torrent, making many who bathed in it rich beyond their wildest dreams. In 2002, Asness personally pulled down $37 million. The following year, he raked in $50 million.

Helping to drive the returns at quant funds such as AQR was a highly lucrative tactic known as the carry trade. The trade had its roots in j.a.pan, where interest rates had been lowered to below 1 percent to help pull the country out of a debilitating deflationary spiral. A bank account in j.a.pan would yield about half a percent a year, compared with about 5 percent in the United States or 10 percent or more in some other countries.

This dynamic meant firms with the know-how and financial dexterity could borrow yen in j.a.pan-practically for free-and invest it in other a.s.sets with higher interest rates, such as bonds, commodities, or other currencies. And the extra cash that kicked out could be deployed into even more investments, such as commodities or subprime mortgages. Add a healthy dose of leverage, and you have a perfect recipe for a worldwide speculative binge.

Indeed, by early 2007, about $1 trillion was staked on the carry trade, according to The Economist The Economist. The tactic was especially popular at Asness's old quant shop, Goldman's Global Alpha fund.

The trouble was, nearly all the investors in the trade, mostly hedge funds but also banks and some mutual funds, were putting their money in similar corners of the market, including high-yielding currencies such as the Australian and New Zealand dollars. Traders talked nonstop about tidal waves of "liquidity slos.h.i.+ng around," pus.h.i.+ng up the price of stocks, gold, real estate, and oil.

But who cared? The trade was so perfect, so incredibly profitable-about as close to a free lunch in the market as possible-that there was no stopping it.

Asness, meanwhile, had been running AQR from cramped Manhattan offices, boxes full of files and computer equipment spilling out of spare rooms and lining the hallways. As the firm grew, and the partners married and started to raise families, he decided it was time for a change. He scoped out several locations in Greenwich and finally decided on Two Greenwich Plaza, a squat office building next to the town's train station, allowing easy access to the Big City for the fund's growing legions of twentysomething quants.

One day in 2004, he rented out a car on the Metro North railway and took AQR's staff on a field trip to the new digs. Later that year, the move was complete. Flush with hedge fund riches, Asness purchased a 12,500-square-foot mansion on North Street in Greenwich for $9.6 million. In 2005, he was the subject of an extended article in the New York Times Magazine New York Times Magazine. When the article's author asked him what it was like to be incredibly rich, Asness quoted Dudley Moore's character from the movie Arthur: Arthur: "It doesn't suck." "It doesn't suck."

As his imperial ambitions soared, so did his lifestyle. The firm bought a fractional share in NetJets, giving its partners access to a fleet of private jets at their beck and call. Asness decided the North Street mansion was too constricting and purchased a twenty-two-acre property in Greenwich's sw.a.n.k Conyers Farm community. A team of architects would visit Asness at AQR's headquarters and lay out their plans for a sprawling new mansion. Estimates of the cost of the project ran as high as $30 million.

Asness and company started to think about the next big step for AQR. The IPOs of Fortress and Blackstone hadn't gone unnoticed at Two Greenwich Plaza. Asness's friend Ken Griffin was also mulling over an IPO at Citadel.

So was AQR. By late July 2007, the papers were drawn up. The IPO was essentially a done deal. All AQR needed to do was mail the doc.u.ments to the Securities and Exchange Commission and wait for the money to roll in.

The billions.

[image]WEINSTEIN[image]

One day in 2005, Boaz Weinstein was patrolling the endless, computer-swathed tables of Deutsche Bank's fixed-income flow desk. A Russian trader on the desk had heard that Weinstein was known for his chess skills. As Weinstein paused by his terminal, the Russian said, "I hear you play a mean game of chess." "I suppose," Weinstein said.

"I too play chess." The Russian smiled. "We play, you and I."

"Let's go," Weinstein responded without skipping a beat.

Fl.u.s.tered, perhaps, by Weinstein's calm retort, the Russian trader made a strange demand: he'd play only if Weinstein was "blindfolded." Weinstein knew what that meant. He didn't actually need to wear a blindfold, but he did have to sit with his back to the chessboard. Weinstein agreed.

After the closing bell, Weinstein and the Russian met in a conference room. Word about the match started to spread, and a few traders gathered to watch. As the match wore on, more and more Deutsche employees showed up. Soon there were hundreds, cheering on every move as Weinstein and the Russian went head-to-head-and making side bets on who would win. The match lasted two hours. By the time it was over, Weinstein was victorious.

Those were heady days for Weinstein. The money was rolling in. He was dating beautiful women. And it was only the beginning. As his success grew at Deutsche Bank, he started thinking about making the very same step Cliff Asness had made at Goldman Sachs in 1998: breaking away from the mother s.h.i.+p and launching a hedge fund.

The credit trading operation he'd created at Deutsche had become one of the elite outfits on Wall Street. Top traders would ring Weinstein on the phone to pick his brains on the latest action in credit default swaps, bonds, stocks, you name it. His group had become a true multistrategy hedge fund inside the bank, trading every kind of security imaginable and juggling upward of $30 billion in positions.

Weinstein was gaining a reputation as a mult.i.talented savant, a Renaissance man of Wall Street. His prop trading team was also becoming known as a force to be reckoned with. Like PDT, they were also developing their own odd rituals, testing one another's mental skills in ways only a nerdy band of hothouse quants could dream up.

Take the Maptest ritual. The Maptest website shows a layout of all fifty states in America. The trick: the states are unlabeled. Columns arrayed below the map include the state names. The task is to drag the names onto the appropriate state within a certain time. Players receive a score for how quickly the task is completed. To spice things up, the veterans, including Weinstein, would place bets on the newbies' scores. "Look at the tiny size of his cranium," a Deutsche Bank trader might crack as a new recruit feverishly dragged state names across the computer screen. "Bet a hundred he doesn't know where Wyoming is."

"You're on."