The Fear Index

7





It can’t continue forever. The nature of exponentials is that you push them out and eventually disaster happens.




GORDON MOORE, INVENTOR OF MOORE’S LAW (2005)




THE RISK COMMITTEE of Hoffmann Investment Technologies met briefly at 11.57 a.m., according to a note drawn up subsequently by Ganapathi Rajamani, the company’s chief risk officer. All five members of the senior management team were listed as present: Dr Alexander Hoffmann, president of the company; the Hon. Hugo Quarry, chief executive officer; Lin Ju-Long, chief financial officer; Pieter van der Zyl, chief operating officer; and Rajamani himself.

It was not quite as formal as the minutes made it sound. Indeed, afterwards, when memories were compared, it was agreed that nobody had even sat down. They all stood around in Quarry’s office, apart from Quarry himself, who perched on the edge of his desk so that he could keep an eye on his computer terminal. Hoffmann took up his former position at the window and occasionally parted the slats of the blinds to check on the street below. That was the other thing everyone remembered: how distracted he seemed.

‘Okay,’ said Quarry, ‘let’s keep this quick. I’ve got a hundred billion dollars on the hoof unattended in the boardroom and I need to get back in there. Close the door, will you, LJ?’ He waited until there was no chance of their being overheard. ‘I take it we all saw what just happened. The first question is whether by making such a large bet to the down side on Vista Airways shortly before its share price collapsed we’re going to trigger an official investigation. Gana?’

‘The short answer is yes, almost certainly.’ Rajamani was a neat, precise young man, with a strong sense of his own importance. His job was to keep an eye on the fund’s risk levels and ensure they complied with the law. Quarry had poached him from the Financial Services Authority in London six months earlier to serve as a bit of window-dressing.

‘Yes?’ repeated Quarry. ‘Even though we couldn’t possibly have known what was going to happen?’

‘The whole process is automatic. The regulators’ algorithms will have detected any unusual activity surrounding the airline’s stock immediately prior to the price collapse. That will already be leading them straight to us.’

‘But we haven’t done anything illegal.’

‘No. Not unless we sabotaged the plane.’

‘We didn’t, did we?’ Quarry glanced around. ‘I mean, I’m all in favour of people using their initiative …’

‘What they will want to know, however,’ continued Rajamani, ‘is why we shorted twelve and a half million shares at that precise moment. I know this sounds an absurd question, Alex, but is there any way VIXAL could have acquired news of the crash before the rest of the market?’

Reluctantly Hoffmann let the slats of the blind click shut and turned to face his colleagues. ‘VIXAL takes a direct digital news feed from Reuters – that might give it an advantage of a second or two over a human trader – but so do plenty of other algorithmic systems.’

Van der Zyl said, ‘Besides, you couldn’t do much in that time. A position the size of ours would have taken some hours to put together.’

‘When did we start acquiring the options?’ asked Quarry.

Ju-Long said, ‘As soon as the European markets opened. Nine o’clock.’

‘Can we just stop this right now?’ said Hoffmann irritably. ‘It will take us less than five minutes to show even the most dumb-assed regulator that we shorted that stock as part of a pattern of bets to the down side. It was nothing special. It was a coincidence. Get over it.’

‘Well, speaking as a former dumb-ass regulator,’ said Rajamani, ‘I have to say I agree with you, Alex. It’s the pattern that matters, which is why actually I tried to talk to you about it earlier this morning, if you remember.’

‘Yeah, well, I’m sorry, but I was late for the presentation.’ Quarry should never have hired this guy, Hoffmann thought. Once a regulator, always a regulator: it was like a foreign accent – you could never quite hide where you came from.

Rajamani said, ‘What we really need to focus on is the level of our risk if the markets rally – Procter and Gamble, Accenture, Exelon, dozens of them: tens of millions in options since Tuesday night. These are all huge one-way bets we have taken.’

‘And then there is our exposure to the VIX,’ added van der Zyl. ‘That’s been ringing alarm bells with me for some days now. I did mention this to you, Hugo, last week, if you remember?’ He had once taught engineering at the University of Technology in Delft and retained a pedagogic manner.

Quarry said, ‘So where are we on the VIX? I’ve been so busy preparing for the presentation, I haven’t actually checked our positions lately.’

‘The last time I looked, we were up to twenty thousand contracts.’

‘Twenty thousand?’ Quarry shot a look at Hoffmann.

Ju-Long said, ‘We started accumulating VIX futures back in April, when the index stood at eighteen. If we had sold earlier in the week we would have done very well, and I assumed that’s what would happen. But rather than following the logical course and selling, we are still buying. Another four thousand contracts last night at twenty-five. That is one hell of a level of implied volatility.’

Rajamani said, ‘I’m seriously worried, frankly. Our book has gone all out of shape. We’re long gold. We’re long the dollar. We’re short every equity futures index.’

Hoffmann looked from one to another – from Rajamani to Ju-Long to van der Zyl – and suddenly it was clear to him that they had caucused beforehand. It was an ambush – an ambush by financial bureaucrats. Not one of them was qualified to be a quant. He felt his temper beginning to rise. He said, ‘So what are you suggesting we do, Gana?’

‘I think we have to start liquidating some of these positions.’

‘That’s just about the stupidest goddam thing I’ve ever heard,’ said Hoffmann. In his frustration he slapped the back of his hand hard on the blinds, rattling them against the windows. ‘Jesus, Gana, we made close to eighty million dollars last week. We just made another forty million this morning. And you want us to ignore VIXAL’s analysis and go back to discretionary trading?’

‘Not ignore it, Alex. I never said that.’

Quarry said quietly, ‘Give him a break, Alex. It was only a suggestion. It’s his job to worry about risk.’

‘No, actually, I won’t give him a break. He wants us to abandon a strategy that’s showing massive alpha, which is exactly the kind of illogical, insane reaction to success, based on fear, that VIXAL is designed to exploit! And if Gana doesn’t believe that algorithms are inherently superior to human beings when it comes to playing the market, then he’s working in the wrong shop.’

Rajamani, however, was unfazed by his company president’s tirade. He had a reputation as a terrier: at the FSA he had gone after Goldman. He said, ‘I have to remind you, Alex, that the prospectus of this company promises clients exposure to a yearly volatility of no more than twenty per cent. If I see that those statutory risk limits are in danger of being breached, I am obliged to step in.’

‘Meaning what?’

‘Meaning, if the level of our exposure isn’t dialled back, I will have to notify the investors. Meaning I really must talk to their board.’

‘But this is my company.’

‘And the investors’ money, or most of it.’

In the silence that followed, Hoffmann started massaging his temples vigorously with his knuckles. His head was aching badly again: he needed a painkiller. ‘Their board?’ he muttered. ‘I’m not even sure who’s on their frigging board.’ As far as he was concerned, it was a purely technical legal entity, registered in the Cayman Islands for tax purposes, that controlled the clients’ money and paid the hedge fund its management and incentive fees.

‘Okay,’ said Quarry, ‘I don’t think we’re anywhere near that point yet. As they used to say in the war, let’s keep calm and carry on.’ He bestowed one of his most winning smiles upon the room.

Rajamani said, ‘For legal reasons I must ask that my concerns be minuted.’

‘Fine. Write up a note of the meeting and I’ll sign it. But don’t forget you’re a new boy and this is Alex’s company – Alex’s and mine, though we’re both only here because of him. And if he trusts VIXAL then we all should trust it – Christ knows, we can hardly fault its performance. However, I agree, we also have to keep an eye on the risk level – we don’t want to be so obsessed watching the instrument panel we fly into the side of a mountain. Alex, you’d accept that? So, given that most of these equities are US-traded, what I suggest is we reconvene in this office at three thirty when the American markets open, and review the situation then.’

Rajamani said ominously, ‘In that case, I think it would be prudent to have a lawyer present.’

‘Fine. I’ll ask Max Gallant to stay behind after lunch. You okay with that, Alex?’

Hoffmann made a weary gesture of agreement.

At 12.08, according to the minutes, the meeting broke up.





‘OH, ALEX, BY the way,’ said Ju-Long, turning in the doorway as they were filing out, ‘I almost forgot – that account number of yours you asked about? It turns out it is on our system.’

‘What account is this?’ asked Quarry.

Hoffmann said, ‘Oh, nothing. Just a query I had. I’ll catch up with you in a second, LJ.’

The trio walked back to their offices, Rajamani leading the way. As Quarry watched them go, the expression of suave conciliation with which he had ushered them out changed to a sneer of contempt. ‘What a pompous little shit that fellow is,’ he said. He imitated Rajamani’s flawless, clipped English: ‘“I really must talk to their board.” “It would be prudent to have a lawyer present.”’ He mimed taking aim at him along the barrel of a rifle.

Hoffmann said, ‘It was you who hired him.’

‘Yes, all right, point taken, and it’ll be me who fires him, don’t you worry.’ He pulled an imaginary trigger a second before the trio rounded a corner and moved out of sight. ‘And if he thinks I’m paying Max Gallant two thousand francs an hour to come and cover his ass he’s in for a shock.’ Suddenly Quarry dropped his voice. ‘We are okay here, aren’t we, Alexi? I don’t have to be worried? It’s just that for a second in there I had the same feeling I used to get when I was at AmCor, selling collateralised debt.’

‘What feeling was that?’

‘That every day I’m getting richer but I’m not sure how.’

Hoffmann regarded him with surprise. In eight years he had never heard Quarry express anxiety. It was almost as unsettling as some of the other things that had happened that morning. ‘Listen, Hugo,’ he said, ‘we can put an override on VIXAL this afternoon if that’s what you want. We can let the positions wind down and return the money to the investors. I’m actually only in this game in the first place because of you, remember?’

‘But what about you, Alexi?’ asked Quarry urgently. ‘Do you want to stop? I mean we could, you know – we’ve made more than enough to live out the rest of our days in luxury. We don’t have to carry on pitching to clients.’

‘No, I don’t want to stop. We have the resources to do things here on the technical side that no one else is even attempting. But if you want to call it quits, I’ll buy you out.’

Now it was Quarry who looked taken aback, but then he suddenly grinned. ‘Like hell you will! You don’t get rid of me that easily.’ His nerve seemed to revive as quickly as it had wilted. ‘No, no, I’m in this for the duration. I suppose it was just seeing that plane – it spooked me a bit. But if you’re fine, I’m fine. Well then?’ He gestured for Hoffmann to step ahead of him. ‘Shall we return to that esteemed bunch of psychopaths and criminals we are proud to call our clients?’

‘You do it. I’ve nothing left to say to them. If they want to put more money in – fine. If not – screw ’em.’

‘But it’s you they’ve come to see …’

‘Yeah, well now they’ve seen me.’

Quarry’s mouth turned down. ‘You’ll come to the lunch at least?’

‘Hugo, I really cannot stand these people …’ But Quarry’s expression was so forlorn that Hoffmann capitulated at once. ‘Oh Christ, if it’s really that important, I’ll come to the goddam lunch.’

‘Beau-Rivage. One o’clock.’ Quarry seemed on the point of saying something else, but then looked at his watch and swore. ‘Shit, they’ve been on their own for a quarter of an hour.’ He set off towards the boardroom. ‘One o’clock,’ he called, turning round and walking backwards. He cocked his finger. ‘Good man.’ He already had his cell phone in his other hand and was entering a number.

Hoffmann pivoted on his heel and headed in the opposite direction. There was no one in the corridor. He quickly put his head round the corner of the alcove and checked the communal kitchen with its coffee machine, microwave and giant refrigerator: also empty. A few paces further on, Ju-Long’s office door was shut, his assistant away from her desk. Without waiting for a reply, Hoffmann knocked and went in.

It was as if he had disturbed a group of teenage boys examining pornography on the family computer. Ju-Long, van der Zyl and Rajamani drew back quickly from the terminal and Ju-Long clicked the mouse to change the screen.

Van der Zyl said, ‘We were just checking the currency markets, Alex.’ The Dutchman’s features were slightly too large for his face, giving him the look of an intelligent, lugubrious gargoyle.

‘And?’

‘The euro is weakening against the dollar.’

‘Which is what we anticipated, I believe.’ Hoffmann pushed the door open wider. ‘Don’t let me keep you.’

‘Alex—’ Rajamani began.

Hoffmann interrupted: ‘It was LJ I wanted to speak with – in private.’ He stared straight ahead as they filed out. When they had gone, he said, ‘So you say that account is on our system?’

‘It comes up twice.’

‘You mean it’s one of ours – we use it for business?’

‘No.’ Ju-Long’s smooth forehead creased into an unexpectedly deep frown. ‘Actually, I assumed it was for your own personal use.’

‘Why?’

‘Because you asked the back office to transfer forty-two million dollars into it.’

Hoffmann studied the other man’s face carefully for evidence that he was joking. But Ju-Long, as Quarry always said, though possessed of many admirable qualities, was entirely devoid of a sense of humour.

‘When did I request this transfer?’

‘Eleven months ago. I just sent you the original email to remind you.’

‘Okay, thanks. I’ll check it out. You said there were two transactions?’

‘Indeed. The money was entirely repaid last month, with interest.’

‘And you never queried this with me?’

‘No, Alex,’ said the Chinese quietly. ‘Why would I do that? Like you say, it is your company.’

‘Yeah, sure. That’s right. Thanks, LJ.’

‘No problem.’

Hoffmann turned at the door. ‘And you didn’t just mention this to Gana and Pieter?’

‘No.’ Ju-Long’s eyes were wide with innocence.

Hoffmann hurried back towards his own office. Forty-two million dollars? He was sure he had never demanded the transfer of such a sum. He would hardly have forgotten. It had to be fraud. He strode past Marie-Claude, sitting typing at her workstation just outside his door, and went straight to his desk. He logged on to his computer and opened his inbox. And there indeed was his instruction to transfer $42,032,127.88 to the Royal Grand Cayman Bank Limited on 17 June last year. Immediately beneath it was a notification from the hedge fund’s own bank of a repayment from the same account of $43,188,037.09, dated 3 April.

He performed the calculation in his head. What kind of fraudster repaid the capital sum he had stolen from his victim, plus exactly 2.75 per cent interest?

He went back and studied what purported to be his original email. There was no greeting or signature, merely the usual standard instruction to transfer the amount X to the account Y. LJ would have put it through the system without a second’s hesitation, confident that their intranet was secure behind the best firewall that money could buy and that the accounts would in any case be reconciled electronically in due course. If the money had been in the form of bars of gold or suitcases of cash, they might perhaps have been more careful. But this was not really money in the physical sense at all, merely strings and sequences of glowing green symbols, no more substantial than protoplasm. That was why they had the nerve to do with it what they did.

He checked what time he was supposed to have sent his email ordering the transfer: midnight exactly.

He tilted back in his chair and contemplated the smoke detector in the ceiling above his desk. He often worked late in the office, but never as late as midnight. This message, if genuine, would therefore have had to have come from his terminal at home. Was it possible that if he checked the computer in his study he would find a record of this email, along with the order to the Dutch bookseller? Could he be suffering from some kind of Jekyll-and-Hyde syndrome that meant one half of his mind was doing things the other half knew nothing about?

On impulse he opened his desk drawer, took out the CD and inserted it into the optical drive of his computer. The program took a moment to run, and then the screen was filled with an index of two hundred monochrome images of the inside of his head. He clicked through them rapidly, trying to find the one that had caught the attention of the radiologist, but it was hopeless. Viewed at speed, his brain seemed to emerge from emptiness, swell into a cloudburst of grey matter, and then contract again to nothing.

He buzzed his assistant. ‘Marie-Claude, if you look in my personal directory you’ll see an entry for a Dr Jeanne Polidori. Will you make me an appointment to see her tomorrow? Tell her it’s urgent.’

‘Yes, Dr Hoffmann. What time?’

‘Any time. Also, I want to go to the gallery where my wife’s having her exhibition. Do you know the address?’

‘Yes, Dr Hoffmann. When do you want to go?’

‘Right away. Can you fix me a car?’

‘You have a driver at your disposal at all times now, arranged by Monsieur Genoud.’

‘Oh yeah, that’s right, I forgot. Okay, tell him I’m coming down.’

He ejected the CD and put it back in the drawer along with the Darwin volume, then grabbed his raincoat. Passing through the trading floor, he glanced across at the boardroom. Where a section of the blinds was not properly closed he could see Elmira Gulzhan and her lawyer boyfriend through the slats, bent over an iPad, watched by Quarry, who had his arms folded: he looked smug. Etienne Mussard, the curved turtle shell of his back turned towards the others, was entering figures with elderly slowness on to a large pocket calculator.

On the opposite wall Bloomberg and CNBC were showing lines of red arrows, all in the descendent. The European markets had shed their earlier gains and had started falling fast. That would almost certainly depress the opening in the US, which would in turn make the hedge fund much less exposed to loss by mid-afternoon. Hoffmann felt his spirits lighten with relief. Indeed, he experienced a definite thrill of pride. Once again VIXAL was proving smarter than the humans around it, smarter even than its creator.

His good humour persisted as he rode the elevator down to the ground floor and turned the corner into the lobby, where a bulky figure in a cheap dark suit rose to greet him. Of all the affectations of the wealthy, none had ever struck Hoffmann as quite as absurd as the sight of a bodyguard sitting outside a meeting or restaurant; he had often wondered who exactly the rich were expecting to attack them, except possibly their own shareholders or members of their families. But on this particular day he was glad to find himself approached by the polite, thuggish-looking man who flashed his ID and introduced himself as Olivier Paccard, l’homme de la sécurité.

‘If you would wait just a moment, please, Dr Hoffmann,’ said Paccard. He held up his hand in a polite plea for silence and stared into the middle distance. He had a wire trailing from his ear. ‘Fine,’ he said. ‘We can go.’

He moved swiftly to the entrance, hitting the exit button with the heel of his hand precisely as a long dark Mercedes drew up at the kerb, with the same driver who had picked Hoffmann up from the hospital. Paccard strode out first, opened the rear passenger door and ushered Hoffmann inside. His palm briefly brushed the back of the physicist’s neck. Before Hoffmann even had the chance to settle himself into his seat, Paccard was sliding into the front, the car doors were all closed and locked, and they were pulling out into the noonday traffic. The whole procedure must have taken less than ten seconds.

They made a sharp left, tyres squealing, and shot down a gloomy side street, which opened at the end on to the lake and the distant view of the mountains. The sun had still not broken through the cloud. The high white column of the Jet d’Eau rose 140 metres against the grey sky, dissolving at its top into a chilly rain that plunged to detonate against the dull black surface of the lake. The flashes from the cameras of the tourists photographing one another at its base winked bright in the gloom.

The Mercedes accelerated to beat a red light and made another sharp left into the dual carriageway, only to come to a halt alongside the Jardin Anglais, held up by some unseen obstruction ahead. Paccard craned his neck to see what was happening.

This was where Hoffmann sometimes went for a jog if he had a problem to solve – from here across to the Parc des Eaux-Vives and back again, two or three times if necessary, until he had found an answer, talking to no one, looking at nothing. He had never really examined the area properly before, so that now he gazed out at the unseen familiarity with a kind of wonder: the kids’ play area with the blue plastic slides, the outdoor crêperie under the trees, the pedestrian crossing where he might have to jog on the spot for a minute waiting for the lights to change. For the second time that day he felt as if he were a visitor to his own life, and he had a sudden desire to order the driver to stop the car and let him out. But no sooner had the thought arisen than the Mercedes moved forward again. They entered the busy traffic system at the end of the Pont du Mont-Blanc and emerged from it at speed a few seconds later, weaving westwards through the slower trucks and buses towards the galleries and antique shops of the Plaine de Plainpalais.