Financial crisis explained

Two great articles in the Sunday New York Times explaining the origins of the current financial crisis in clear terms.

The End of the Financial World As We Know It

Michael (Liar’s Poker) Lewis and David Eindhorn lay bare the regulatory failings at the S.E.C. and Treasury Secretary Paulson’s secretive maneuvering with the $700B TARP fund which included guaranteeing $306B to Citigroup:

“Three hundred billion dollars is still a lot of money. It’s almost 2 percent of gross domestic product, and about what we spend annually on the departments of Agriculture, Education, Energy, Homeland Security, Housing and Urban Development and Transportation combined. Had Mr. Paulson executed his initial plan, and bought Citigroup’s pile of troubled assets at market prices, there would have been a limit to our exposure, as the money would have counted against the $700 billion Mr. Paulson had been given to dispense. Instead, he in effect granted himself the power to dispense unlimited sums of money without Congressional oversight.”

Lewis and Eindhorn recommend a short list of practical steps that can be taken to prevent a re-occurrence of these series of unfortunate events – most telling is to close the revolving door between Wall St and the S.E.C. which puts future fox’s in charge of the chicken coop.

Risk Mis-Management

Joe Nocera explains the complexities of the statistical ‘Value at Risk’ or VaR model managed by the beautiful minds of PhD statistician ‘quants’ whose complex algorithms justified the trading excesses of the bubble era. By using only tame historical data in their models they were unable to anticipate the ‘black swan’ event of the 1% chance of catastrophic risk:

“One reason nobody seems to know how to deal with this kind of crisis is because nobody envisioned it.”

Both articles shed light on the dynamics of executive communications when group-think rules. Thinking outside the box before the box imploded was not encouraged or rewarded. Pity.