Mon, May 04, 2009 page9

• The UK number cruncher who foresaw the crash

  Financial mathematician Paul Wilmott feels vindicated after warning banks not to believe their own mathematical models

  • THE GUARDIAN
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  Paul Wilmott, one of the world’s leading financial mathematicians, looks like a 30-something, although he is 49. Mathematics keeps him in shape, he says, relaxing in his jeans and trainers in his west London apartment.

  Wilmott has made his name and fortune by applying mathematics to finance and now claims to run the biggest “quantitative analysis” Web site in the world. So-called “quants” combine maths and finance to produce many of the models that underlie the complex derivatives blamed for causing the credit crunch.

  Wilmott had been warning for years that the models used by banks to value their assets were wrong.

  “Reality has vindicated meA,” he says. “I stood up in front of paying audiences and told them that they trusted the formulas too much and that they were also paid too much.”

  A few people stormed out of his conferences, slamming the door, he adds.

  The banking system crash has seen US$1 trillion wiped off banks’ assets worldwide after the complex formulas were proved wrong: the assets had been overpriced and the relationships between them were different from that which was initially thought. If a sub-prime mortgage collapsed, millions of others followed suit.

  “Following the formulas was like relying on your seatbelt to drive crazily: it’s not going to save your life. People in risk management don’t know a fraction of what they should; they’re not skeptical, they haven’t tested the data or used their imagination to find solutions,” he says.

  Wilmott is also critical of the British government’s approach to the crisis. He claims its plan to insure more than £500 billion (US$745 billion) of banks’ toxic assets is based on a model and won’t work as it only involves two banks (the HBOS bank and the Royal Bank of Scotland) leaving others outside the program. Involving only a few banks won’t kick-start the circular nature of inter-bank lending as all banks need to be involved.

  “Governments know nothing of this subject, they spent two minutes thinking about it, without considering the consequences or getting [advice from] consultants,” Wilmott says. “They’re like rabbits caught in headlights. They are only talking to the bankers who got us into this mess, or lords or ladies who know nothing. They should be getting advice from people like me, who saw this coming.”

  According to Wilmott, the UK Financial Services Authority isn’t much better.

  “They can’t afford to pay the best people; we should send regulators to derivatives courses so they could ask questions to the banks,” he says.

  Wilmott is angry about the amount of “idiots” who got the world into the present financial crisis. He was one of the thousands of protesters against the recent G20 summit.

  “Why weren’t there more people there?” he wondered.

  Wilmott is an evangelist for math and its application to everyday life. His book on quantitative finance is used around the world by hordes of bankers who run the world’s top trading desks.

  Wilmott goes one step further than most of his peers, as he also tries to integrate into his analysis the financial world’s biggest challenge to rationality: human behavior.

  “You can model electromagnetic waves: a mathematical model that shows molecules of air moving around a plane, making it fly,” he says.

  “But in a financial model, you need more than numbers. The models in finance are not very good. In this field, it matters if you’re not psychologically synchronized; people don’t behave rationally. You can’t rely on people following equations. It’s half maths and half human,” he says.

  The son of an accountant and an entrepreneurial mother, both Paul and his brother became mathematicians. From an early age at school, Wilmott says he was always good at math — and business.

  As a child, he put together his vast collection of pets and organized a zoo that neighbors paid to visit. As an undergraduate at Oxford, he earned his pints of beer from street performing with his juggling clubs. Ventures followed as the years went by, including a £170 million hedge fund, which closed about four years ago after a fall-out between the partners.

  Wilmott’s two sons are also interested in math; Zachary, 17, is preparing for his final school exams in math and Oscar, 19, is studying math at Imperial College, London. His children may have followed his path because “I am an enthusiast, and they are intelligent,” he says, adding that he didn’t flood his sons with numbers from an early age.

  “Mathematicians don’t use numbers. Mathematics is about abstraction, all we use are symbols. If we keep educating in adding numbers, they won’t go beyond a McDonald’s desk,” Wilmott says.

  “Calculus and algebra, which deal with concepts such as links between variables, are much more practical and important in life,” he says.

  “Politicians say maths needs to be more practical, but you have to be more abstract. Mathematics makes your brain think in a very different way; a lot of people are afraid of it, but it’s fun and intellectually satisfying,” Wilmott says.

  Wilmott has focused on practical — and financial — rewards, since his days at Oxford, where he read math and also got a doctorate in fluid mechanics. At university, Wilmott designed a model that analyzed the speed and efficiency of a double-razor shaving machine aimed at determining how far apart the blades should be, and which angle and speed would make the shaving most effective.

  As the years went by, he also designed models on turbine plates for jet engine maker Rolls Royce, and other models for British Steel, British Telecom and for an explosives company that needed to calculate how to best blow up a mountain — “close to the edge of the mountain, but not too close,” Wilmott remembers.

  He travels the world lecturing bankers and regulators about quantitative finance and valuation methods. He also focuses on his teaching in 7City, a City-based professional training center, and on his quants book, which he published in 1993 for the first time and keeps updating. His next challenge would be to develop a product that can make life more comfortable, and turn it into a business, he says.

  “I’d never go and work for a bank, I am not an employee type. I don’t respond well to orders. I am spoiled, I’ve done all my life what I wanted, my parents didn’t stop me, so I’ve had an interesting life with lots of variety,” Wilmott says.

  Business and math are the two constants in his life — the professional one, at least.

  “Maths ruins your personal life,” he concedes. “Some mathematicians have no connection with the real world and it’s very hard to talk to them. But I am a fairly normal human being even if I am a mathematician. Others don’t have any empathy, but I am in tears in half of the movies that I see.”

  He plugs into life by spending time with his American wife and his two children, skiing, or driving one of his three cars. Other mathematicians forget the real world, or see it in their own terms, Wilmott says.

  “I am talking the colors of the rainbow and they only see black and white,” he says.

  Still, he admits applying math to his personal life: while arguing with his wife, he sometimes uses the reductio ad absurdum principle to prove a point. In a delicate or tense conversation, bringing up extremes may not be the best way towards consensus, he acknowledges.

  But the mathematical habit of challenging assumptions has always been a constant in his life, and he swears it always will be.

  “The natural thing for me is to think there is something wrong if everybody is agreeing,” he says.
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