Martin Fridson, CFA, is, according to the New York Times, “one of Wall Street’s most thoughtful and perceptive analysts.” The Financial Management Association International named him its Financial Executive of the Year in 2002. In 2000, Fridson became the youngest person ever inducted into the Fixed Income Analysts Society Hall of Fame. He has been a guest lecturer at the graduate business schools of Babson, Columbia, Dartmouth, Duke, Fordham, Georgetown, Harvard, MIT, New York University, Notre Dame, Rutgers, and Wharton, as well as the Amsterdam Institute of Finance. Fridson's writings have been praised widely for their humor, rigor, and utility. He holds a BA in history from Harvard College and an MBA from Harvard Business School.
No one who reads this book will ever again regard risk management as a necessary but unproductive appendage of the financial industry. Other authors have chronicled how quantitative finance influenced investment management, but Aaron Brown has made a compelling case for a far more profound economic impact.
In August 2007, the head of AIG’s financial products division stated, “It is hard for us, without being flippant, to even see a scenario within any kind of realm of reason that would see us losing one dollar” in any credit default swap (CDS) transactions. Five months later, AIG disclosed that it had lost not $1.00 but $5 billion on its CDS exposure. This turn of events is just one example of sophisticated financial institutions’ hugely misjudging the risk of “financial weapons of mass destruction.” The reasons for their systematic failure deserve thoughtful and rigorous study.
In a lecture presented in 2004, John Bogle, founder of the Vanguard Group, documented a direct and substantial relationship between management costs and mutual fund returns. Stratifying all funds by expense ratio, from lowest to highest, he reported the following 10-year average annual returns by quartile: 10.7 percent, 9.8 percent, 9.5 percent, and 7.7 percent. A presumption of market rationality would lead one to expect that investors demanded reduced fees in response to this negative correlation. According to Bogle, however, the average equity fund’s expense ratio was on a long-run rise, which represented a gain for mutual fund operators but an aggregate loss for the consumers they served.
Effective 1 January 2011, the International Financial Reporting Standards (IFRS) became mandatory for Canadian public companies. Proponents of IFRS adoption argued that it would enhance global comparability of financial statements. The authors of Swindlers: Cons & Cheats and How to Protect Your Investments from Them argue, on the contrary, that “differences in laws, regulations, taxes, cultures, education, ethics, training, traditions, enforcement, and optimism make uniformity an opium dream.”
Emanuel Derman spent two decades at Goldman Sachs, making valuable contributions to financial modeling. Before that, as recounted in My Life as a Quant (John Wiley & Sons, 2004), he was a physicist. Today, Derman is the head of risk management at Prisma Capital Partners and directs Columbia University’s financial engineering program. He also devotes energy to combating the belief that security markets can be analyzed with the same mathematical precision as heavenly bodies and subatomic particles.
In the crisis that engulfed the global financial system in 2008, the collapse of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) inflicted the heaviest losses of all on U.S. taxpayers. The Congressional Budget Office has estimated that the cost of bailing out the government-sponsored enterprises (GSEs) could ultimately total $350 billion. Unlike the banks that received massive government loans, guarantees, and insurance, Fannie Mae and Freddie Mac have little prospect of ever repaying Uncle Sam. Notwithstanding this stark evidence of fundamental flaws in the structure and mission of the GSEs, the sweeping legislative response to the financial crisis — the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 — dealt with the GSEs only by calling for a study of how they could be reformed.
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