pop quiz for the day
(R) So, you just walked into Finance 101 and the professor hands you a quiz.
Don't worry, it's not a bad dream! It's multiple choice, so you've got good odds. Much better odds than the ratings agencies seem to have of rating things.
The assertion that pricing for various financial products (stocks, commodities, derivatives, etc) is normally distributed (ie, bell curve, Gaussian, etc) is best described as
If you chose B, you're correct! (Note, if you wrote in choice c. So wrecklessly false that the regulators should be fired and the corporate executives prosecuted for threatening our national security, that answer would also be acceptable. Please be aware the NSA has been notified of your opinion, so they can forward that to Goldman Sachs, who is requesting that the FBI begin an investigation of you.)
I've been doing a little reading of book reviews to add some items to my Amazon wish list (hint, it's right here), and I have enjoyed the commentary mocking our esteemed Masters of the Universe (no, not this).
I've never excelled at the probability and statistics arena. Perhaps that's part of what makes it so juicily delicious that the guys who thought they did understand screwed up so royally. Being part of a tail, an outlier, one develops an appreciation for other outliers. The way I figure it, if you can recognize when the professor puts up the data points for the test that you're an outlier and calculate that your score was in the bottom 5% because you were over two standard deviations from the mean, that should mean you understand the material. But alas, I digress.
The point of this diatribe isn't to look back fondly upon those lovely two semesters of stats ('Quantitative Business Analysis' in the Olin lingo du jour). Rather, the point is to serve as a reminder that common sense is a bedrock principle for designing policies in the real world. The mathematics itself is rarely flawed. Unfortunately, real people have a tendency to apply math in ways where the real world doesn't match the academic assumptions. When this is done accidentally, it's sad enough.
When this is coordinated policy at some of the most powerful corporations in the country, it's infuriating. And dangerous, a threat to our welfare and even our democracy.
Perhaps the most skewered comment by an executive back in 2007 when all this was unfolding was offered by David Viniar, Goldman Sachs' Chief Financial Officer. See if you can spot the crazy.
“We were seeing things that were 25-standard deviation moves, several days in a row,” said David Viniar, Goldman’s chief financial officer.
He followed that with, oh, and the Kansas City Royals are going to win the next 5 World Series.
For the book review from Naked Capitalism on Lecturing Birds on Flying, click here. For some handy concise definitions and charts, Risk Glossary is very nice. For regulators/executives/both I'm not too fond of, see Hank 'the banks are sound' Paulson, Gary 'don't regulate derivatives' Gensler, Ed 'AIG bonus contracts are sacred' Liddy, or Lloyd 'we're fully hedged but put me in the meeting anyway' Blankfein.
And those are just the recent Goldman visionaries.
Don't even get me started on Robert 'see, Dems can represent corporate America, too' Rubin, Larry 'don't ask who paid me money when it looked like I was going to be close to the new President' Summers, Tim 'I couldn't possibly be responsible for anything, all I did was run the NY Fed' Geithner, or Ben 'at least I'm not Alan' Bernanke.
/(R) That does feel a lot better.
Now if we could just please have our trillions of tax dollars back please.