Sometimes, though, the quants get too clever for their own good, with potentially devastating effects. Such a moment occurred in the second week of August 2007, when a wave of selling by a group of quant funds using the same trading strategies led to terrible losses, as the firms all tried to sell the same stocks at the same time. As Andrew Lo, a professor at MIT's Sloan School of Management, observed in a September 2007 paper on the event, an "apparent demand for liquidity" that week "caused a fire sale liquidation." Patterson estimated that AQR lost $500 million in a single day, and close to $1 billion in the four-day rout before the markets steadied and started to recover on August 10.
(AQR doesn't dispute this estimate.) "No one really knows how much money was lost over this one-week period," he said. "But I've heard estimates that $100 billion evaporated out of these quant funds. It could be more, it could be less. No one ever really knows."
Things were so bad, in fact, that AQR, which was pursuing an initial public offering, soon dropped the idea. "They knew these strategies worked and they deluded themselves into thinking that they would always work," Patterson said. "And that's a very dangerous way of looking at the world, because it allows you to take more risks. That's why I think the quants sort of represent the entire financial system in a way. They got blinded by science."
Asness thinks this assessment is far too simplistic. He told the New York Post that he blamed the sudden losses not on AQR's computer models but on "a strategy getting too crowded ... and then suffering when too many try to get out the same door" at the same time. He told me he finds the argument that quants are "black boxes" of dangerously opaque trading strategies annoying and wrong. "We don't think of ourselves as 'black box,' " he said. "It is a great irony to us that even though a quant can, if willing, fully describe his investment process, it's often called 'black box,' even as the fundamental investor, who can never accurately describe his process, is not tagged with that label. A friend of ours, who is both a quant and fundamental investor, thinks quant is more accurately called 'glass box.' We think that's pretty accurate."
Asness abhors the idea of increased quant regulation. With some reluctance--given the vitriol with which he typically condemns Washington on his blog--Asness conceded that the government bailouts in September and October 2008 saved AQR by rescuing the firms with which AQR trades, an outcome at odds with his Chicago-school economic training, which champions Milton Friedman, free markets, and the survival of the fittest. The bailouts "saved any levered fund's bacon," he said. (Of the $33 billion that AQR currently manages, $13 billion is in levered funds, which use borrowed money to increase returns on the equity invested.) Nevertheless, he remains unapologetically critical of the bailouts. He thinks the government should have let the banks fail and the chips fall where they would. "Look, if Hank Paulson proposes, 'I'm gonna hand Cliff $50 million,' " he said, "Greedy Cliff could go, 'I kinda like that plan.' But if you ask me, 'Is this good for the country?,' I will publicly tell you, 'No, it's not good for the country.' "
Asness was born in Forest Hills, a ritzy Jewish section of Queens. His father, Barry, was a lawyer and a former Golden Gloves boxer. Early on, the family moved to a tract home in Roslyn Heights, on Long Island. His mother worked as a public-school teacher and later became president of World Health Communications, a pharmaceuticals marketing and education company. Both parents commuted to Manhattan, leaving Cliff and his brother, Brad, to fend for themselves. "Largely, I was latchkey," Cliff explained. (Brad is now AQR's general counsel.) At Herricks High School, Asness was a classic underachiever. His grades were middling. He quit or was fired from so many jobs that in his high-school yearbook, under the category of "Always seen at," Asness was described as "at a new job." He skipped a lot of classes. The turning point came when he scored the highest in the school on the SATs. "That actually had a weird kind of effect on me and I was like, 'Wait, I can do something.' " He was a mediocre calculus student but got a 5, the highest grade, on the AP Calculus exam. "That was kind of classic me," he told me.
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