Science in Society Archive

Investment Banks and Financial Maths

Investment bankers are to blame for the credit crunch that has beggared nations, but what about financial mathematicians? Prof. Peter Saunders and Dr. Mae-Wan Ho

Time to call the bankers’ bluff

As the result of the credit crunch, most workers in the UK are watching their real incomes fall and their pension rights eroded. Those out of work have little prospect of finding a job in the foreseeable future. There is a big squeeze in expenditure on education, health, welfare, and almost every essential service we have come to expect the state to provide. Worst of all, young people finishing their education are finding it very hard to get started in the jobs market. In the three months to December 2011, unemployment among 16-24 year olds was 22.2 % [1]. By the end of the first quarter in 2012, UK is back in recession [2]. Meanwhile, the bankers largely responsible for what has happened, and who would be out of business if the taxpayers hadn’t handed over £90 billion to bail them out [3] continue to draw huge salaries with bonuses on top.

Why should those who are the most responsible for the financial disaster continue to see their standard of living rise year by year when the rest of us get poorer and poorer?

The answer is simple if unedifying, so we are told. Ever since the deregulation “Big Bang” of 1986, the UK economy has become more and more dependent on financial services. Successive governments have talked about promoting industry but it has been the City that got what it wanted, including the “light touch” regulation that encouraged the bubble to expand so dangerously. That doesn’t seem as good an idea today as it did at the time, but the hard fact is that now we have to give the investment bankers everything they want or they’ll pack their bags and go, taking what remains of our economy with them.

Or will they?  According to the financial pages of the London papers at the end of February 2012, the UK division of the international recruiting agency Hays lost £3 million in 2011. A major reason was the recruitment squeeze in banking, not just in the UK but around the world. Hays’ chief executive Alistair Cox told the press [4]: “A year ago we said that a lot of bankers were looking for jobs out in Asia. We still see that, but the banking sector has slowed down globally. Banking started to get worse four to five months ago. I don’t think it will get any better soon.” He added, “It’s quite uniform worldwide, not just focused on the UK. We see the impact in Hong Kong and Singapore and particularly in investment banking, as opposed to retail banking.”

That is good news for the vast majority of ordinary people that do not make their living gambling with other people’s money as investment bankers do. We need a return to high street banks and cooperatives that serve local communities and the real economy of goods and services (see [5] New Economy Now, SiS 53).

It is now clear that if those self-styled masters of the universe really do leave the City, they’re not going to better jobs abroad because there aren’t any. Their threats are bluffs, something we would expect people in investment banking to be good at.

While Hays’ UK division lost money last year, the company as a whole made a profit of £60 million for the six months up to December 2011. That is because it earns 70 % of its fees outside the UK, and recruitment in professions such as engineering is holding up well in Germany, the US, the Middle East and East Asia [4], again, a sign that those countries are taking the real economy very seriously. It looks like it will be better making things rather than just pushing money around. And if sanity ever returns to the world of finance, the banks may well move to the Far East, not to avoid taxes and regulation but because that is where the centre of the world’s economy will be.

In the end, that might not be such a bad thing for the UK, which has become too dependent on the financial services sector and not on the real economy. That had made it especially vulnerable in the crash following the sub-prime mortgages collapse, and also to any threat by the banks to move.

Characteristically, the government’s reaction to the credit crunch was to pour massive amounts of money into the banks. They apparently believed this would somehow trickle down into the real economy, but it has simply disappeared into the banks’ coffers (see [6]“Shut Down Wall Street!” SiS 53).  With healthier balance sheets, the banks have felt able to continue to pay massive bonuses, but not to lend to the small and medium enterprises (SMEs) who need the money to build up the industrial strength that the government says it wants.

The UK needs to focus its attention on the real economy, a move that has already started to some extent in the US, at least at state and local levels [5].

Is financial maths to blame?

It is ironic that at a time when there is high unemployment especially among young people, industries are complaining of skill shortages. Too few young people are graduating as engineers and too many of those (almost half, according to the Institution of Mechanical Engineers [7]) move into other careers. In contrast, there are far too many being trained to do ‘financial’ mathematics for devising and manipulating the complicated derivatives that were a major cause of the crash [8], and serious questions have been asked as to whether financial maths and mathematicians are to blame as much as investment bankers [9].  

Are financial mathematicians responsible?

Incredibly, the ‘blame’ is limited to losing trillions. The debate focussed on whether the mathematical models or data they used as input were good enough; the question of whether it is ethical to provide the mathematical instruments for creating credits out of repackaged debts and to gamble with people’s live savings and livelihoods never entered into consideration. As one investment banker was quoted saying [10]: “Banks need high level maths skills because that is how the bank makes money.” Those deals that spiralled so badly out of control would not have been possible in the first place without the collusion of financial maths and financial mathematicians, known affectionately and awe-inspiringly as “quants” in the trade, commanding salaries typically in millions and above [9].

It is no use saying, as Professor William Perraudin, Chair of Finance at Imperial College London’s Tanaka Business School did to the BBC [8]: “The quants are a fairly innocent part of all this. It is the senior people who make decisions about taking on risk who bear the responsibility.” Perraudin even went as far as to laud what the quants do as a great favour to society: “The quants have enabled financial institutions to behave in a super-efficient way, committing as little capital as possible to their activities.” This has allowed relatively small competitors to take on the larger institutions in the provision of financial services and led, in turn to cheaper loans, he explained. Of course, that was also precisely responsible for the financial bubble.

Similarly, Chris Rogers, Professor of Statistical Science and head of the Quantitative Finance Group at the University of Cambridge, told a journalist [9]: “The role of mathematicians in a bank is essentially a subordinate one, they are the servants of the business imperative.”

Tim Johnson, Academic Fellow in Financial Mathematics based at Heriot-Watt University and the Maxwell Institute for Mathematical Sciences in Edinburgh, said in his own defence [10]: “I was drawn into financial maths not because I was interested in finance, but because I was interested in making good decisions in the face of uncertainty...One of the key objectives of financial maths is to understand how to construct the best investment strategies that minimise risks in the real world.”  But he has not asked himself: minimise risks for whom and for what purpose that would serve humanity, or at least do them no harm.

However much the doyens of financial mathematics like to absolve themselves from blame, they bear major responsibility for providing the tools that enable one group of people (themselves included) to get prodigiously rich and beggar the rest of society.

It is time for aspiring mathematicians to wake up and consider their social responsibility and ideals as well as the beauty of mathematics. If financial bankers are losing their jobs, there certainly are not going to be many more jobs in financial mathematics either.

Article first published 01/05/12



References

  1. Office of National Statistics (2012). Characteristics of young unemployed people – 2012.  http://www.ons.gov.uk/ons/rel/lmac/characteristics-of-young-unemployed-people/2012/rpt-characteristics-of-young-unemployed-people.html#tab-Youth-unemployment-highest-since-the-1980s-
  2. “Bailed-out banks still aren't ready to sell, even after three years and £90bn.” Jill Treanor. The Observer, 19 February, 2012. http://www.guardian.co.uk/business/2012/feb/19/bailed-out-banks-arent-ready-to-sell   
  3. “Profits at UK arm of recruitment firm Hays slump by £3m as banking sector continues to feel squeeze.” Daily Mail, 22 February, 2012. http://m.dailymail.co.uk/money/markets/article-2104761/Profits-UK-arm-recruitment-firm-Hays-slump-3m-banking-sector-continues-feel-squeeze.html 
  4. Ho MW. New economy now. Science in Society 53, 18-19, 2012.
  5. Ho MW. “Shut down wall street”. Science in Society 53, 16-17+23.
  6. Institution of Mechanical Engineers (2011). Meeting the Challenge: Demand and Supply of Engineers in the UK.  http://www.imeche.org/Libraries/Position_Statements-Education/Skills_Report_-_September_2011_1.sflb.ashx 
  7.  “Mathematicians’ role in market mayhem”, Innes Bowen, BBC Radio 4, 26 November 2007, http://news.bbc.co.uk/1/hi/business/7109805.stm
  8. Is maths to blame? Rachel Thomas, +plus magazine, 6 October 2008, http://plus.maths.org/content/maths-blame
  9. What is financial mathematics? +plus magazine, Tim Johnson, 1 September 2009, http://plus.maths.org/content/what-financial-mathematics?src=aop

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There are 3 comments on this article so far. Add your comment above.

George Hewitt C Eng Comment left 1st May 2012 16:04:13
Yes, this is indeed what most people at street level feel. If a banker wishes to go to Switzerland or Singapore, let them go. Firstly, you DON'T need high level maths to be a banker. Secondly, there are any number of bright young people who can learn the necessary skills in months, not years. Recent Governments have squandered billions on tertiary education for "soft" options - ignoring experts' advice for decades that what we need are applied scientists - engineers - who design and build and make real things from a better widget to whole infrastructures. The Victorian Engineers' legacy is just about on its last legs. We need to follow the proven German model where engineers run the major businesses and bankers are on the board to participate - not run - the development of sustainable business models. Look at the mess retail banks are making of funding SME's in the UK - from whence the next cycle of growth will come. They don't know about the real world and cannot evaluate true risk. We are in a mess and even Vince Cable can't dig us out!

Todd Millions Comment left 4th May 2012 05:05:52
I tend too take a longer veiw of these matters but this is an exellent current situational report. Some notes NOT sounded that should be- 1-acting PM Brown's campain financing came from London hedge funds.(globalresearch.ca) 2-Iceland was turned over to vulture funds with its current goverment and IMF and world bank complicity(Same source as above),our medias(including public) won't dwell on nor bring up this wee item,as they are revenue dependent from the vulture funds involved.And(vital) the exact model they are trying in Iceland is the same model being planned for the rest of the world.You have being warned. In the longer run-none comment that the publicly acessable preambles too Nafta style trade agreeements are(in translation)Identical in phrasing too the come hither offers of Nazi industrial cartels(who all survived the sequel to the great war-quite nicely thank you),too useful infuential idiots in finance and industry,too join them-just before the tanks rolled in. This can't be a coincedence,after the first half dozen times.I draw attention too the recent Canaduh/Isreal iiteration. This is too be kept in mind with german industrial model calls-the supply of nuk subs to the middle easts only foaming mad nuke armed theocracy(in FACT), was skillfully done by germany indeed.But volkwagens not putting +200mpg cars in production,is accompanied by BS excuses that would make a BP pr whore blush(though not stop them).Having grown up in what was then the only country that would put up with the legal mafia of-"Bank Advisary Boards"(see;Towers of Gold Feet of Clay-Stewart),and their deadly Actual innovation killing effects,a feature that is now international-The future short a total collapse of this whole pile of pr and high speed automated legal robbery seems bleak too me. In a world where russian mobsters leave old london banks with arm loads of toaster ovens(LeCarre-cbc book interveiw),its a good idea too recall the Nash poem(attributed) Buckminister Fuller included describing the 1930's crash in Critical Path-See"president of the National Silly Bank"its worh a Google.Low times when the 'ink well cash' doesn't have too be backed with ink.

David Llewellyn Foster Comment left 9th May 2012 08:08:55
Timely article, thank you Prof. Saunders and Dr Ho. Clearly "quants" are at the root of the problem, but where are the "quals"? We need two distinct changes of conceptual perspective: in the first instance a clarification of the distinction between credit and debt, and the implications in practical terms; and secondly, a total review of the ethos of finance and the morality of economic governance ~ what is it is all for, who benefits and who does it really serve? Are we fixated on individual well-being as synonymous with personal wealth, or should we strive to envisage planetary well-being as our prerequisite criterion, without which we are all impoverished and diminished as human beings? The latter takes educated vision, experiential understanding, genuine insight and bio-empathy. The former is rather primitive, and doesn't need intelligence, just cleverness. It makes no moral demands on us as mindless consumers, but it imposes increasingly impossible demands upon our environment as our supreme provisioning agent and benefactor. Perhaps we should be advocating the advantages of maturity for any society that aspires to dwell in the real world of living organisms; that is to say, perhaps we should extol the contextual capacity to think beyond our own very selfish (and unenlightened) desires, and more in terms of inter-generational equity...years ago you wrote most exquisitely about coherence Dr Ho. This is a message we need ever more urgently today.

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