Math Failure

I see that two rocket scientists were fired from Merrill Lynch the other day. Apparently fixed income gambling and no rules mortgage lending turned out to be less profitable than originally calculated.
Readers of this blog understand, or will come to understand, the converse of the old economics observation. You remember. If you lay all the economists in the world end to end, they wouldn’t reach a conclusion.
The converse math observation is that if you lay all the mathematicians in the world end to end around Wall Street, they still can’t calculate the butterfly effect.
The quants, the math geniuses that gave you Long Term Capital Management and it’s subsequent implosion, got busy and created more complexity in derivatives, which they assured themselves were mathematically pristine, and any little risks could be hedged away.
Oops. They lost billions too. Dang.
Think of the problem like this. The more parts in any system, the greater the chance of a malfunction. It’s particularly nasty when the failure of any one of those parts creates stress on the remaining parts, which begin to fail. You’ll recall the spreading power failure down the East coast years ago when one grid went down? Interlocking global financial markets have the same systemic problems. These are multiplied by the ability to control huge amounts of money with very little of your own money on the table. This is what happened at Merrill Lynch, UBS and other Wall Street firms, hedge funds and other derivatives players. Homeowners played a version of the game by taking no money down loans with teaser rate that readjusted two to five years out. They lived in blissful optimism, that they would keep their jobs, make more money and that real estate “always” went up. Not only didn’t they get raises, one spouse got laid off, time passed, the rate adjusted up and home prices stagnated or declined. Even if they sell the place, they still owe money to some mysterious mortgage lender.
I promise you, the math guys will keep trying. The bonuses are too big when the next new calculation tricks seem to work for a while. Then another part malfunction, and all the money will flush away.
No worries mate. Look at it this way. If you could earn millions in salary and bonuses, and the only risk is that you get fired eventually, would you go for it?