Outliers or Out Right Liars?

A very nice piece here by Janet Tavakoli Malfeasance-Not Models-Killed Wall Street

Paul Volker, former U.S. Federal Reserve Board chairman and member of President Obama’s economic advisory team, gave a speech in Toronto on February 11 at the Grano Salon Speakers Series on the U.S. economic crisis. He made the mistake of blaming mathematical models instead of malfeasance as the key source of the financial meltdown:

They thought financial markets obeyed mathematical laws. They have found out differently now. You know, they all said these events happen once every hundred years. But we have ‘once every hundred years’ events happening every year or two, which tells me something is the matter with the analysis.

Volker was only partly right; there is something wrong with his analysis. The models would have failed to capture unexpected "hundred year events," the outliers Mr. Volker referred to in his speech, but that was not the cause of the U.S. financial meltdown. There were no outliers; there were outright liars. The models crunched misleading data fed to them by Wall Street’s financiers. The events that keep happening every year or two are the effects of massive unchecked malfeasance.  {hit the link above to read on}

Now it's true that Ms Tavakoli is a little rough on my "man-crush"  Paul Volcker and, from being in the middle of it, think that one gives Wall Street too much credit by saying "the powers that be" knew it was all one big scam.  Nevertheless, a great piece.  I am currently reading Janet's "Dear Mr Buffett.  What an Investor Learns 1,269 Miles From Wall Street"......And I like.

Comments

[Bill Bost]

I disagree with that analysis. What Greenspan, Volker and others failed to take into consideration is that the leaders of these banks were never as smart as they, or anyone, thought they were. The best poker players in the world do not put their entire bankroll down on a single hand, even if it is four aces. There is always the possibilty that something could happen, and they would would be wiped out with no stake to start over again.

The fact that so many bankers put their entire stakes into a single type of product leads me to believe that, unlike good poker players, they never understood fully at any point the rules of the game. A few good years, like a few good hands, can give bad players, and marginally intelligent executives, an unwarranted sense of superiority and confidence. A good player keeps on playing carefully, knowing that his luck can change; a stupid one bets his entire stack thinking he knows better than the others how to play, or, more egregiously, that he is entitled to win. That is what happened here. The banks bet it all, and, because they didn't understand the rules of the game, they lost it all. Good poker players welcome suckers like that; they always lose in the end.

Ken Lewis, Henry Paulson and the boys are welcome any time to join my Monday night poker game.