Readers of the brilliant, Brooklyn-based journal n + 1 have been enjoying editor Keith Gessen’s interviews with an anonymous hedge fund manager for the last three years.
Because Gessen (below, left) is just a smart guy with a limited grasp on the world of finance, he asked HFM (as the source came to be known) lucid and common-sense questions about the disasters of 2007 and 2008.
The result was like taking a well-guided trip through a very foreign country (if, like me, you have a hard time grasping concepts such as “stat arb” or statistical arbitrage).
HFM is neither a cheerleader nor a doom-and-gloom type so his dispatches from the front were all the more scary because of his cool explanations of things like the sub-prime mortgage meltdown, the collapse of Bear Stearns and the dangers of automatic computer trading that can crunch numbers and buy and sell things much faster than any team of human beings.
Now Harper Perennial has published “Diary of a Very Bad Year: Confessions of an Anonymous Hedge Fund Manager” which brings together all of the n + 1 interviews as well as some new material. It’s a terrific one-volume explanation of what went wrong and what might happen next.
In addition to our education in “stat arb” the book fills us in on “zombie banks” and “black box trading” (the latter is a computer system that sends out orders and makes trades faster than any human being).
“People call it ‘black box trading’ because sometimes you don’t even know why the black box is doing what it’s doing, because the whole idea is that if you could, you should be doing it yourself,” the fund manager tells Gessen.
“But it’s something that is done on such a big scale that a human brain can’t do it in real time,” he adds.
In August of 2007, “you had an avalanche where everyone’s black box was being shut off, causing incredibly bizarre behavior in the market…we had a loss over the course of like three days that was a ten-sigma event, meaning it should never happen based on the statistical models that underlie it. Why? 
Because the model doesn’t assume that everybody else is trading the same model as you are. So that’s sort of a meta-model factor. The model doesn’t know that there are other black boxes out there.”
And what’s a “ten-sigma” event?
“…It’s ten standard deviations from the mean…Meaning it’s basically impossible, you know?”
The HFM is “a friend of a friend” of Gessen’s who was introduced to the n + 1 editor in late 2006.
Although the man was described as a “financial genius” Gessen was “a little skeptical. I’d been to college with a great many people who later went into finance, but this was mostly so they could keep working a lot and drinking beer and watching football afterward.”
As Gessen writes in his introduction, “HFM was not like these folks at all. Finance was not a social event but an intellectual vocation for him; he spoke quickly, often too quickly to follow, and told very funny stories about the world he was in.”
The two men started meeting in a Brooklyn coffee shop in 2006 and the meetings continued through last year when HFM decided to cash out and relocated to Austin, Texas.
HFM is consistently witty and explains things without the insider lingo you hear on MSNBC and Fox Business Network.
When the market began improving last year, HFM noted “you hear a lot of talk about green shoots and recovery, and that we’re bottoming out. Like after a winter there are green shoots. A botanical metaphor. I guess they’ve never seen or read ‘Being There.’”
