TR: So why aren’t we safer?
RM: You have to ask, What have we done with all of these improvements? We’ve gone to much greater complexity. We have many more instruments. Firms and individuals have been more willing to cut back on their equity cushions and leverage more. To go back to our car analogy, we’re more willing to drive faster because of the better tools at our disposal and great transparency.
TR: So where does complexity come into all this?
RM: Sometimes the term “complex” is used as a euphemism for “less-well understood.” People sometimes say, “Things have gotten more complex,” but what they’re really saying is, “I understand things less well.”
TR: But in your time, have things gotten a lot more complex?
RM: Yes, they have. Let me give you an extreme example. For certain very specialized hedge funds that do what’s called very high frequency trading, the location of the outsider’s server and the exchange’s server matters.
TR: It’s that tight.
RM: Yes–speed of light. So in fact one of the exchanges used to delay just slightly the information going out from the East Coast to allow a little more parity for those on the West Coast. Today, they rent or auction space for people to put their servers near the exchange server, so the speed of time between exchanges is reduced by that metric. And the number of trades that get offered in this thing is vastly greater than the number of trades that actually get done. So the volume of activity is orders of magnitude greater than the number of trades you would record as the actual volume. The reason I’m taking you into all this is to say that there is no one who can sit and watch those trades directly and apply anything to them. So what do we do? We build computer programs to extend our human skill, and we try to audit what’s going on, but at the end of the day, the computers do the trading. Yes, there can be a dysfunctional aspect to that, but it’s not as if people are setting things on their computers and then going to the Bahamas.
TR: So do you not think that the complexity of what the quants are building is a problem?
RM: There’s no question it can have dysfunctional aspects. Anything we do can have a dysfunctional side effect. That doesn’t mean that, net, it’s not worth doing. Of course, when you have this speed of transactions and executions going on, there can be times, because they are driven by a computer, that if something happens that is not understood, the programs are going to end up continuing to try to trade, and that can affect markets. But that’s not prima facie saying it’s out of control–that these people don’t know what they’re doing, or that it was better before. Things used to get out of control without computers.
TR: So how do you think about technology generally, as it affects the functioning of markets?
RM: Well, first of all, it’s very important to it. Second–and I say this a bit tongue in cheek–the people who are in the chip business ought to be very, very happy. If anyone worries about whether, with the advance of Moore’s Law, we’ll get to the point where computing is so excessively fast that we don’t need anything faster: any time we think we get there, at least in the financial applications, all we have to do is add one more variable in our equations we want to solve, and you move yourself to the frontier of computing. But that’s just an aside. Technology is a huge thing. If you look at the costs of transferring risk around the world, it’s just remarkable what technology has done. That’s the good side. The bad side is that things are much more complex and much faster. Does that say it’s riskier than before? No.