Thursday, September 18, 2008

Wall Street Cooks the Books

Where were the “quants” when we needed them? The “quants” were the quantitative analysts: economists and computer techies, whose job it was to warn a banking firm's traders of risk. They were there, but they were systematically undermined by bankers with deals too rich to ignore.

In an article on the technology pages of the New York Times for September 18th Saul Hansell writes:

They (the “quants”) were developing systems that would comb through all the firm’s positions, analyze everything that might go wrong and estimate how much it might lose.

As a mater of fact the computer models did a pretty good job of alerting financial institutions to risk. The bankers were now in a tough position.

Top bankers couldn’t simply ignore the computer models, because after the last round of big financial losses, regulators now require them to monitor their risk positions. Indeed, if the firm’s models say a firm’s risk has increased, the firm must either reduce its bets or set aside more capital as a cushion in case things go wrong.

According to Gregg Bermann, co-head of Risk Metrics, a risk management software company quoted in the NY Times article:

There was a willful designing of the systems to measure risks in a certain way that would not necessarily pick up all the risks. They wanted to keep their capital base as stable as possible so that the limits they imposed on their trading desks would be stable.

As Hansell says,

Lying to your risk-management computer is like lying to your Doctor. You just aren’t going to get the help you really need.

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