“All I can say is, beware of geeks … bearing formulas.” – Warren Buffet
Today’s WSJ (page 1 dead tree edition) has this headline: “Behind AIG’s Fall, Risk Models Failed to Pass Real-World Test”.
That pretty much tells you what you need to know, but there’s this further gem which shows that (as one might expect) there were problems with aspects that were not modeled.
“[Yale professor] Mr. Gorton’s models harnessed mounds of historical data to focus on the likelihood of default, and his work may well prove accurate on that front. But, as AIG was aware, his models didn’t attempt to measure the risk of future collateral calls or writedowns, which have devastated AIG’s finances.”
“AIG didn’t apply effective models for valuing the swaps and for collateral risk until the second half of 2007, long after the swaps were sold, AIG documents and investor presentations indicate. The firm left itself exposed… because it had agreed to insure so much debt without protecting itself adequately through hedging.”