Wall Street Bets Its Future on Computer Whizzes : Markets: But some find there is economic peril when intelligence is substituted for wisdom. O.C.’s bankruptcy is often cited as a case in point.
Peter Muller directs a cadre of people with advanced degrees in engineering and operations research. His office sports powerful computers run with custom-designed software that can crunch vast amounts of data instantaneously.
This isn’t a university lab, IBM or Boeing, nor is Muller a scientist.
The setting is Morgan Stanley & Co., the New York investment bank, where the Princeton-trained mathematician heads a group that trades stocks and bonds.
Want a job on Wall Street? These days you’d better come equipped with more than just an Ivy League MBA and a pair of wing tips. The securities industry, once a genteel, paper-based business, is now an electronic realm where a mastery of computers and strong quantitative skills are required.
A technological revolution under way in the world’s financial markets--an upheaval fueled by cheap and abundant computers and high-speed telecommunications--brings many benefits but also new perils to the way in which Wall Street and Main Street invest.
Traders use computers to manage a torrent of information and handle customer accounts, to measure risk and perform other tasks, some of which weren’t possible a few years ago. Electronic networks permit them to move money across international borders at the touch of a button.
With technology, firms can provide new investment products and services offering more choices and potentially higher returns for pension and mutual funds. They also can provide ways for companies to reduce the risks of operating overseas, for example.
But these tools can cause trouble. They helped bankrupt Orange County, sink the Mexican economy and cause the collapse of Britain’s oldest investment bank.
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Technology has made financial markets bigger, faster and globalized. And more volatile than ever, many analysts say.
Electronic networks now deliver price data, news, company earnings and other information to computer screens everywhere.
“Quick dissemination of information makes things fairer for all market participants, big and small,” said David Bostian, chief economist for the New York-based investment firm Herzog, Heine, Geduld.
Moreover, traders using desktop computers can zap billions of dollars between markets around the world.
“Because these markets are electronic, they’re all linked together,” said Boston-based economist Joel Kurtzman, author of books on high-tech finance. “There are no more local markets, we have global markets.”
Computer automation of stock, bond and commodity trading and the advent of proprietary dealer-broker systems that operate outside of organized exchanges present new challenges to the Securities and Exchange Commission and other agencies overseeing U.S. financial markets.
The most vivid example of the power that technology has transferred to the markets is nations’ loss of control over the value of their currencies.
Fifty years ago, the Federal Reserve could dictate the dollar’s rate of exchange vs. other currencies by placing orders with commercial banks to buy or sell $10 million. As recently as the late 1980s, dealers feared the power of the central bank.
Today, the market is a $1-trillion-a-day juggernaut, a sea of money in which rates are set by the aggregated actions of currency traders working at computer terminals from London to Tokyo. This market influences the price of goods from Swiss watches to Japanese sewing machines.
This year, the Fed and other central banks spent billions trying to bolster a sagging dollar. But the greenback tumbled as traders rejected Washington’s economic policies, fretted about U.S.-Japan trade friction, or simply joined in speculative attacks on the dollar.
“There is a sea change in international finance,” said former Citicorp chairman Walter Wriston, who helped pioneer the use of high-tech in financial services. “You have what amounts to a giant election in which people vote on financial policies.”
On the other hand, traders are overloaded with information.
“Having everything on the screen makes traders very short term in focus,” said Bostian. “Some lose a lot of money because they get so wrapped up in the short-term trend they lose sight of things that change the long-term trend.”
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On the whole, Wriston and others argue, technology has had a positive impact.
In developing countries, companies and governments can sell stocks and bonds to finance roads, schools and factories; U.S. investors get higher returns than at home by purchasing Latin American and Asian securities.
The expansion of the arteries of international finance has helped world trade double in the past decade, creating jobs and improving livelihoods across the globe.
But there is little room for error: The electronic networks can whisk money away just as swiftly as they deliver it, as Mexico’s government painfully found in 1994.
A bull market fueled with foreign--mainly American--buying of stocks and government bonds came to an abrupt end in late December after the Mexican government devalued the peso. U.S. fund managers, worried about the value of their peso-denominated holdings, yanked their money. The peso collapsed, markets crashed and the Mexican economy has yet to recover.
“If money surges to point A to point B, for example out of Mexico, it makes it difficult for people to conduct day-to-day activities. Money, credit can become scarce,” said Bostian, noting that in pre-electronic days, when paper money and securities had to be moved, governments had time to adjust.
Electronic money transfer and new forms of financial betting that computers make possible also have endowed individual market players with unprecedented power, and in some cases their actions can literally make or break the bank.
A lone Singapore-based trader with a desktop computer, Nick Leeson, brought down Barings PLC, Britain’s oldest investment bank, in February by losing $1.38 billion in a bad bet on the Japanese stock market.
Computers also enabled Wall Street to create complex derivative securities sold to then-Orange County Treasurer Robert L. Citron, whose $1.69 billion in losses forced the Southern California county into bankruptcy last year.
However, “technology is the implementer and not the cause of anything,” said Wriston. “Guns don’t kill people, people do. It’s the same principle.”
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The lesson of Barings is that, as more powerful technology is deployed, there’s a greater need for oversight of traders and people who use computers to create new derivatives to sell to clients.
“Technology has to be supplemented by strong management,” said Phillip Vasan, head of options trading in New York for CS First Boston. “Some players have been lulled into a false sense of security from their technology.”
Indeed, for some young traders with huge sums of money at their disposal, the electronic markets have become “a high stakes version of the video games teen-agers play in arcades,” Bostian argued.
“When money becomes electronic blips on CRT screens, it tends to remove people from the fundamental reality.”
But are the 50- and 60-year-olds who head the financial houses of New York, London and Tokyo sufficiently cyber-savvy to control young techies?
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Part of the problem is that Wall Street firms face declining income in their traditional activities of underwriting and trading stocks and bonds. Those have become virtual commodity businesses as all players gain access to technology and information that once could provide a competitive edge.
Meanwhile, they’ve found lucrative sources of revenue in newer products like derivatives--financial contracts based on the value of an underlying asset, such as a stock, bond or currency.
Many of the people creating derivatives for Wall Street have advanced degrees in subjects like engineering and physics and are applying the theories and techniques of physical sciences to finance.
But financial markets and economic policy are still dominated by humans, whose behavior doesn’t always conform to the models. That’s when the bets they’re based on go bust, as in the case of Orange County.
“You can’t substitute data for wisdom, or intelligence for wisdom,” said Jeff Duncan, an aide to Rep. Edward Markey (D-Mass.), former chairman of the House panel responsible for financial market regulation.
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Morgan Stanley’s Muller uses computers to automate many trading decisions. Machines permit the simultaneous trading of hundreds of stocks.
But, he said, computers are only as effective as their users.
“In the hands of people who know how to use them, there’s no better way [than using computers] to limit risk and curtail losses. In the hands of the wrong people, there’s nothing more dangerous.”
