The Quants: How a New Breed of Math Whizzes Conquered Wall Street and Nearly Destroyed It (12 page)

But trading was becoming increasingly quantitative, and more and more mathematicians were migrating to Wall Street, inspired by Thorp and fresh waves of research sprouting from academia. Jim Simons’s firm Renaissance Technologies was launching its soon-to-be-legendary Medallion Fund. David Shaw was setting up shop over a communist bookstore in Greenwich Village with his stat arb white lightning. Investors in Thorp’s fund, after losing their golden goose, were on the hunt for new talent. For many, Ken Griffin fit the bill.

Thorp also handed over a gold mine to Meyer and Griffin: cartons of prospectuses for convertible securities and warrants, many of which could no longer be obtained due to the passage of time. It was an incomparable archive of information about the industry, a skeleton key to unlock millions in riches from the market. By scanning the kinds of deals Thorp had invested in, Griffin learned how to hunt down similar deals on his own.

The information helped Griffin better discern what kind of trades were possible in the convertible bond market. While Thorp’s records didn’t provide every nugget of every trade, they did provide something of a treasure map. With the records in hand, Griffin had a much better notion for which parts of the market he should focus on, and he quickly developed strategies that were in many ways similar to those Thorp had pioneered decades before.

To learn more, Griffin flew out to Newport Beach for a meeting with Thorp, hoping to study at the feet of the master. Thorp walked Griffin through a series of bond-arbitrage trades and passed on priceless know-how gathered in more than two decades of trading experience. Griffin, an eager apprentice, gobbled it all up.

Thorp also described for Griffin Princeton/Newport’s business model, which involved “profit centers” that would evolve over time
depending on how successful they were, a concept Citadel copied in the following years. Griffin adopted Thorp’s management fee structure, in which investors would pay for the fund’s expenses rather than pay the flat management fee most hedge fund managers charged, usually around 2 percent of assets.

Meyer promised to back Griffin under one condition: he had to set up Citadel in Chicago. Griffin, a Florida native, agreed. In November 1990, he started trading with $4.6 million using a single, esoteric strategy: convertible bond arbitrage, the very same strategy Ed Thorp had used.

The son
of a project manager for General Electric, Griffin had a high-tech mechanical bent and was always interested in figuring out how things worked. Known for his unblinking, blue-eyed stare, Griffin always seemed to be able to peer deeply into complex issues and take away more than anyone else, a skill that would serve him well in the chaotic world of finance.

As a student at the Boca Raton Community High School, he’d dabbled in computer programming and got a job designing computer codes for IBM. His mother would ferry him to the local Computerland, where he would spend hours chatting up the salespeople about new gizmos and software. In 1986, when Griffin was not yet eighteen, he came up with the idea of selling educational software to schools, teaming up with some of his pals from Computerland to launch a company called Diskovery Educational Systems. Griffin sold out a few years later, but the company is still in business in West Palm Beach.

During his first year at Harvard, after reading a
Forbes
magazine article arguing that shares of Home Shopping Network were overpriced, he purchased put options on the stock, hoping to profit from a decline. The bet was a good one, earning a few thousand dollars, but it didn’t pay off as much as Griffin had hoped: commissions and transaction costs from the market maker, a Philadelphia securities firm called Susquehanna International Group, cut into his winnings. He realized the investing game was more complex than he’d thought, and started reading as many books about financial markets as he could get
his hands on. Eventually, he came upon a textbook about convertible bonds—the favored investment vehicles of Ed Thorp. By then, Thorp’s ideas, laid out in
Beat the Market
, had filtered into academia and were being taught in finance classrooms across the country. Of course, Griffin eventually went to the source, devouring
Beat the Market
as well.

Like Thorp, Griffin quickly discovered that a number of convertible bonds were mispriced. His computer skills came into play as he wrote a software program to flag mispriced bonds. Hungry for up-to-the-minute information from the market, he wired up his third-floor dorm room in Harvard’s ivy-draped Cabot House with a satellite dish—planting the dish on top of the dorm and running a cable through the building’s fourth-floor window and down another floor through the elevator shaft—so he could download real-time stock quotes. The only problem with the scheme: the fourth-floor window could never be completely shut, even in the frigid Cambridge winters.

During his summer vacation in 1987, between his freshman and sophomore years, he frequently visited a friend who worked at the First National Bank of Palm Beach. One day, he was describing his ideas about convertible bonds and hedging. A retiree named Saul Golkin happened to step into the office. After listening to Griffin’s spiel for twenty minutes, Golkin said, “I’ve got to run to lunch, I’m in for fifty.”

At first, Griffin didn’t understand, until his friend explained that Golkin had just forked over fifty grand to the young whiz kid from Harvard.

Eager to raise more funds from friends and relatives, including his mother and grandmother, he eventually stockpiled $265,000 for a limited partnership, which he called Convertible Hedge Fund #1 (strikingly close to Thorp’s original fund, Convertible Hedge Associates). After returning to Harvard in the fall, he started to invest the cash, mostly buying underpriced warrants and hedging the position by shorting the stock (Thorp’s delta hedging strategy).

His timing proved auspicious. On October 19, the stock market crashed, and Griffin’s short positions hit the jackpot, tumbling much further than the warrants.

Having weathered the storm, he quickly raised $750,000 for another fund, which he called Convertible Hedge Fund #2.

Griffin’s ability to ride through Black Monday unscathed—and even with a tidy profit—was something of a revelation. The pros on Wall Street had been clobbered, while the whiz kid trading out of his Harvard dorm using satellites, computers, and a complex investing strategy had come out on top. It was his first inkling of the incredible possibilities that lay ahead.

But there was much more work to do. He needed access to more securities. And that meant an institutional trading account—the kind of account used by professional traders such as mutual funds and hedge funds. In 1989, Griffin, just nineteen years old, approached a Merrill Lynch convertible bond expert in Boston named Terrence O’Connor and presented what must have seemed like an insane plan:
Give me, Ken Griffin, a nineteen-year-old college kid, access to your most sophisticated trading platform, which will allow me to dabble in nearly every instrument known to God
.

Somehow he pulled it off, wowing the bond expert with his technical know-how. O’Connor agreed to bring Griffin on, despite the fact that the average institutional account ran around $100
million
at the time.

Griffin started trading, and calling everyone on Wall Street who would speak with him. A typical reaction: “You’re running two hundred grand out of your dorm room? Don’t ever call me again.”
Slam
.

But some were intrigued by the young Harvard phenom and would explain certain trades they were engaged in—arbitrage trades, why hedge funds were doing them, why the bank itself was involved. Griffin started making trips to New York and sitting at the feet of seasoned traders, sucking up knowledge. He was particularly interested in stock-loan desks, which gave him a peek at which funds the bank was lending shares to—and why.

Shortly before Griffin graduated from Harvard with a degree in economics, he met Justin Adams, a manager for Triple I. The two met over breakfast in a restaurant in West Palm Beach and discussed the market. Over a steaming omelet, Griffin explained how he’d developed
contacts with traders at brokerage firms across Wall Street and had learned many of the inner secrets of the trading world.

A former member of the Army’s Special Forces who’d served in Vietnam before venturing into the world of high finance, Adams was agog. Griffin was smart and focused, and he asked penetrating and coherent questions about the market—questions that were so pointed they made Adams stop and search for a coherent answer.

Adams arranged a meeting in New York between Griffin and Frank Meyer, an investor in Triple I as well as Princeton/Newport. Meyer too was floored by Griffin’s broad understanding of technical aspects of investing, as well as his computer expertise, an important skill as trading became more mechanized and electronic. But it was his market savvy that impressed Meyer most. “If you’re a kid managing a few hundred thousand, it’s very hard to borrow stock for short selling,” Meyer recalled. “He went around to every major stock loan company and ingratiated himself, and because he was so unusual they gave him good rates.”

Griffin set up shop in Chicago in late 1989 with his $1 million in play dough, and was quickly making money hand over fist trading convertibles with his handcrafted software program. In his first year of trading, Griffin posted a whopping 70 percent return. Impressed, Meyer decided to help Griffin launch his own fund. He thought about other funds with similar strategies, and that’s when Ed Thorp came to mind.

Griffin had his office. He had his seed money. He hired a small group of traders, some of whom must have been shocked to be working for a kid who still smelled like a dorm room. The only thing he needed was a name. Griffin and several of his new employees wrote down their nominations on a list, then voted on their favorites.

The winner was Citadel. By 1990, the start of a decade that would see phenomenal growth in the hedge fund industry, Griffin’s fortress of money was ready for battle and on its way to becoming one of the most feared money machines in all of finance.

MULLER

When he was ten years old, Peter Muller went on a tour of Europe with his family. After visiting several countries, he noticed something strange: exchange rates for the dollar varied in different countries. He asked his father, a chemical engineer, whether he could buy deutschmarks in London and make a profit by exchanging them for dollars in Germany.

The young Muller had intuitively grasped the concept of arbitrage.

Born in 1963 in Philadelphia, Muller grew up in Wayne, New Jersey, a half hour’s drive west of Manhattan. He showed an early aptitude for math and loved to play all kinds of games, from Scrabble to chess to backgammon. As a senior at Wayne Valley High School, Muller mixed his obsession with games with another growing interest, computer programming, and designed a program that could play backgammon. It was so effective his math teacher claimed the program cheated.

At Princeton, he studied theoretical mathematics, fascinated by the crystalline beauty of complex structures and by the universal patterns that abound in the more esoteric realms of number theory. Muller also grew interested in music, taking classes and playing piano for a jazz band that performed at student functions and college clubs.

After graduating in 1985, he drove across the country to California. A job in New York at a German software company called Nixdorf was waiting for him, but he kept putting off his starting date for various reasons. He wasn’t sure he wanted to go back to the East Coast anyway. Muller had fallen in love with California.

He soon found himself in a gymnasium playing an electric piano as several tightly muscled women danced balletically in leotards while twirling plastic hoops and tossing around brightly colored rubber balls. He was trying, somewhat desperately, to pursue his music career and had landed a job playing background tunes for a rhythmic gymnastics team.

Apparently the job as a rhythmic gymnastics maestro didn’t pull down enough for food and shelter, including the $200-a-month rent Muller was paying to stay at a friend of a friend’s house. There was also the annoying habit of a roommate who liked to blast off random shotgun rounds in the backyard when he got the blues.