The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It (27 page)

The speed of the collapse of Sowood was stunning. On Friday, July 27, the fund was down 10 percent. By the end of the weekend, it was down 40 percent. Larson picked up the phone and called the one investor he knew who could bail him out: Ken Griffin.

Griffin, vacationing in France with his wife, called a team of thirty Citadel traders at their homes and ordered them into the office to begin poring over Sowood’s books, sniffing for value. They liked what they saw. On Monday, Citadel purchased most of Sowood’s remaining positions for $1.4 billion, more than half of what the fund had been worth a few months prior. In an email sent to clients the week before, Griffin had opined that the markets were acting irrationally and that the robust U.S. and global economy would soon soar to new heights. That meant it was time for some deal making to capitalize on all those foolish investors who couldn’t see the rebound coming. Sowood fit the bill.

Citadel swept in on the distressed fund and picked it clean, profiting as many of the positions rebounded as Larson had expected. Just as he had done with Amaranth, Griffin had amazed Wall Street once again with his ability to make quick judgments and deploy billions in the blink of an eye. By the start of August 2007, Citadel seemed poised for even greater triumphs. It had $15.8 billion in assets, a huge leap from the $4.6 million Griffin had started with in 1990.

Little did he realize that a year later, Citadel itself would be teetering on the edge of collapse.

MULLER

Peter Muller, sweating hard, gazed down upon the expansive blue Pacific Ocean. Palm trees rippled in the warm breeze. He was standing high up on the winding Kalalau Trail, a rugged eleven-mile trek on the west coast of the lush island of Kauai in Hawaii.

Wall Street seemed so far way. In the late 1990s, Muller was running away from Wall Street. The Kalalau Trail, a place he’d visited repeatedly since working at BARRA years before, was about as far as he could get.

Muller was doing what he loved most: hiking. And not just hiking anywhere—he loved being on the Kalalau Trail, an ancient path that winds through five valleys and past high green waterfalls and overgrown terraces of taro along the steep Na Pali cliffs of the oldest Hawaiian island, ending at Kalalau Beach, a remote hangout for hippies and drifters, but not a typical haunt of megamillionaire Wall Street traders.

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 album of songs. In 2004, he self-produced
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 album 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-shirts, and tennis shoes.
Who the hell are these guys?
When queried, PDTers would respond vaguely, with a shrug.
We do technical stuff, you know, on computers. Quant stuff
.

“Whatever,” the banker would say, adjusting his Hermès 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
. 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 relationship. 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 relationship 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:

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.

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.”

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
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
.

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 vanishing again just as abruptly. One PDT trader labeled it seagull management: swoop by every now and then, shit 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 hell 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 Berkshire 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 Nassim Nicholas Taleb, a New York University professor and hedge fund manager who’d just published a book,
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 accumulating 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 assets 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.