The Sciences

The physicists killed Wall Street

Cosmic VarianceBy Daniel HolzMar 22, 2009 7:55 PM

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A couple of weeks ago there was an interesting opinion piece in the NYTimes about how physicists are the harbingers of doom, and are responsible for the end times. Or, more specifically, it's because of physicists that the financial markets are in tatters all around us. The basic idea is that greedy physicists have gone to Wall Street, cooked up all sorts of arcane derivative products, and subsequently unleashed these weapons of mass destruction on the financial markets. This sentiment is best epitomized by a statement from none other than Warren Buffett (perhaps the world's most successful investor, and certainly the world's richest): "beware of geeks bearing formulas"

Undoubtedly there is some truth underlying this sentiment, in the sense that there are plenty of (mostly lapsed) physicists working on Wall Street. And these physicists have indeed helped develop fairly mathematical and esoteric models for the markets. These models made it possible to leverage excessively (i.e., invest significantly with very little money down), and made it exceedingly difficult to evaluate risk. And it sure is convenient to find scapegoats on which to blame the global recession. But, fundamentally, the markets are in free-fall because of rampant and unfettered greed. And it turns out there was plenty of that to go around. For the last few years it was simply too easy to make huge sums of money by taking on large risk. So long as the markets went up, all was good. But when there's the possibility to make vast sums of money, there's an equal and opposite possibility of losing vast sums of money. Newton's 3rd law of finance, I suppose. And this law has been much in evidence as of late.

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