proprietary trading – The Baseline Scenario

I spend a lot of time in the car driving to and from school, so I end up listening to a lot of podcasts (mainly This American Life, Radio Lab, Fresh Air, and Planet Money). I was catching up recently and wanted to point out a few highlights.

Last week on Fresh Air, Terry Gross interviewed Scott Patterson, author of The Quants, and Ed Thorp, mathematician, inventor of blackjack card counting (or, at least, the first person to publish his methods), and, according to the book, also the inventor of the market-neutral hedge fund. These are some of Thorp’s comments (around 24:20):

“As far as you can tell now, how are quants being used on Wall Street? Are these mathematical models being relied on as heavily now after the stock market crash as they were before?”

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The financial reform bill that passed the House recently is full of surprises, not all of them bad. A contact pointed me toward an amendment introduced in committee by Brad Miler and Ed Perlmutter; it’s number 61 on this list. Basically, the amendment gives the Federal Reserve (“Board” in the text refers to the Board of Governors of the Fed) the power to prohibit a financial institution from engaging in proprietary trading not only if it decides that proprietary trading threatens of the soundness of the institution itself, but also if the Board of Governors decides that it threatens the financial stability of the country.

While this may seem overzealous, the point is to prevent a large financial institution with a government guarantee (of any kind) from putting most of its capital to work on its proprietary trading desks and taking lots of risks that might require a government bailout. The amendment does have exceptions allowing firms to, for example, make a market in securities that they underwrite, so securities underwriting is not in question here.

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