…..just take a very large one and be “economical with the truth” to the computers, it would seem.

One of the things that intrigued me about the recent financial meltdown was how the quant jocks and computers could have got is so wrong. After all, if you read books like The Predictors you will know that these are smart algorithms, run by smart people. Saul Hansell of NYT’s Bits writes an interesting article, explaining that it was good old GiGo – and the bosses were misleading the computers to evade the regulators:

“There was a willful designing of the systems to measure the risks in a certain way that would not necessarily pick up all the right risks,” said Gregg Berman, the co-head of the risk-management group at RiskMetrics, a software company spun out of JPMorgan. “They wanted to keep their capital base as stable as possible so that the limits they imposed on their trading desks and portfolio managers would be stable.”

Key tricks used apparently were to:

(i) Treat complex derivatives as far simpler securities when inputting them to the computers

(ii) Where risk was unknown (true of most complex derivatives), treat it as equal to or less than simpler securities – despite the lessons of Long Term Capital management & others

(iii) “Trend Smooth” over longer time periods – months or even yaers – so that systems did not see increasing volatility.

These tricks are as old as the hills, and it tells you lots about the morality of the people running the banks. Heck, if you can lie to your own computers….

Speaking of morality, these are the same people that We The Taxpayers are now bailing out so they get to keep their bonusses, mansions and pensions, even though some of us may well lose ours in the havoc they have wrought.

There’s a moral in moral hazard materiality there somewhere ….