How Wall Street Lied to Its Computers

If the top-flight mathematicians employed by Wall St firms got their models disastrously wrong, what does it say about other complex models?

That's what has been running through my head as I watch some of the oldest and seemingly best-run firms on Wall Street implode because of what turned out to be really bad bets on mortgage securities. Before I started covering the Internet in 1997, I spent 13 years covering trading and finance. I covered my share of trading disasters from junk bonds, mortgage securities and the financial blank canvas known as derivatives. And I got to know bunch of quantitative analysts ("quants"): mathematicians, computer scientists and economists who were working on Wall Street to develop the art and science of risk management. They were developing systems that would comb through all of a firm's positions, analyze everything that might go wrong and estimate how much it might lose on a really bad day.

We've had some bad days lately, and it turns out Bear Stearns, Lehman Brothers and maybe some others bet far too much. Their quants didn't save them. I called some old timers in the risk-management world to see what went wrong. I fully expected them to tell me that the problem was that the alarms were blaring and red lights were flashing on the risk machines and greedy Wall Street bosses ignored the warnings to keep the profits flowing. Ultimately, the people who ran the firms must take responsibility, but it wasn't quite that simple.

In fact, most Wall Street computer models radically underestimated the risk of the complex mortgage securities, they said. That is partly because the level of financial distress is "the equivalent of the 100-year flood," in the words of Leslie Rahl, the president of Capital Market Risk Advisors, a consulting firm. But she and others say there is more to it: The people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough.

Top bankers couldn't simply ignore the computer models, because after the last round of big financial losses, regulators now require them to monitor their risk positions. Indeed, if the models say a firm's risk has increased, the firm must either reduce its bets or set aside more capital as a cushion in case things go wrong. In other words, the computer is supposed to monitor the temperature of the party and drain the punch bowl as things get hot. And just as drunken revelers may want to put the thermostat in the freezer, Wall Street executives had lots of incentives to make sure their risk systems didn't see much risk.

"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."

One way they did this, Mr. Berman said, was to make sure the computer models looked at several years of trading history instead of just the last few months. The most important models calculate a measure known as Value at Risk - the amount of money you might lose in the worst plausible situation. They try to figure out what that worst case is by looking at how volatile markets have been in the past. But since the markets were placid for several years (as mortgage bankers busily lent money to anyone with a pulse), the computers were slow to say that risk had increased as defaults started to rise. It was like a weather forecaster in Houston last weekend talking about the onset of Hurricane Ike by giving the average wind speed for the previous month.

But many on Wall Street did even worse, as Mr. Berman describes it. They continued to trade very complex securities concocted by their most creative bankers even though their risk management systems weren't able to understand the details of what they owned. A lot of deals were nonstandard in many ways, "so you really had to go through the entire prospectus and read every single line to pick up all the nuances," Mr. Berman said. "And that slows down the process when mortgage yields looked very attractive."

So some trading desks took the most arcane security, made of slices of mortgages, and entered it into the computer if it were a simple bond with a set interest rate and duration. This seemed only like a tiny bit of corner-cutting because the credit-rating agencies declared that some of these securities were triple-A. (20/20 hindsight: not!) But once the mortgage market started to deteriorate, the computers were not able to identify all the parts of the portfolio that might be hurt. Lying to your risk-management computer is like lying to your doctor. You just aren't going to get the help you really need.

All this is not to say that the models would have gotten things right if only they were fed the most accurate information. Ms. Rahl said that it was now clear that the computers needed to assume extra risk in owning a newfangled security that had never been seen before. "New products, by definition, carry more risk," she said. The models should penalize investments that are complex, hard to understand and infrequently traded, she said. They didn't. "One of the things that has caused great pain is complex products," [And there's not much that is more complex than climate!] Ms. Rahl said.

That made me think back to some of the great trading debacles of the last century, such as the collapse of Askin Capital Management, a hedge fund that fell apart because of complex mortgage security investments gone bad. Wasn't the moral of those stories that you shouldn't put your money (or your client's money) in something you didn't understand? Furthermore, even if you are convinced you do understand it, you're not going to be able to sell it when you need the money if no one else does. "In some ways there is nothing new," said Ms. Rahl, who helped investigate what went wrong at Askin. "The big deals are front-page news, then they go into the recesses of people's memories."

And, ultimately, the most important risk-management systems are the ones that have gray hair. "It's not just the Ph.D.'s who must run risk management," Ms. Rahl said. "It is the people who know the markets and have lifelong perspective." And at too many firms it is those people who failed to make sure the quants really did their jobs.

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Alaskan professor continues to question sources of global warming

Now that Sarah Palin has turned Alaska into a Leftist boogeyman, the "Alaskan" in the heading above is going to give any Green/Leftist a horn

A University of Alaska Fairbanks professor emeritus known for his belief that carbon dioxide is not the sole cause of climate change presented his latest research Thursday. More than 40 researchers and students gathered into a room at the International Arctic Research Center, now named after Syun-Ichi Akasofu, for the hour-long presentation. "Retirement is good because I can spend the time to correct information," Akasofu said.

For several years now, Akasofu has put forward the idea that while the world was warming for most of the 20th century, it stopped warming sometime around 2000 or 2001. He clarified Thursday that according to his latest research, the oceans have stopped warming since that time, but it appears as if temperatures are still rising if one only looks at land temperatures.

Akasofu also was skeptical of reported changes in lan d temperature, however. For example, he noted that while many scientists claim global temperatures have risen slightly less than one degree on average across the past few decades, their studies don't take urbanization into account. Tokyo, he said, appears to have warmed four degrees, but that does not take into account the fact that the number of dark manmade structures that absorb heat, raising temperatures in their vicinity.

The retired geophysics professor also questioned the accuracy of readings from weather stations where no one is there to regularly monitor the equipment. "A friend of mine found one station where the temperature gauge was just outside the air conditioner," he said.

Still, Akasofu doesn't completely deny the existence of climate change, so much as question what causes it. One culprit he suggested is the recent lack of sunspots. "Something is happening on the sun," he said. "There are no sunspots when there should be 50-100 right now, so people warn the sun has become warmer."

A similar phenomenon was observed between 1650 and 1700, which coincides with what researchers call the Little Ice Age, a period of widespread cooling that came shortly after a warming trend may have peaked sometime around 1000 AD.

However, Akasofu didn't necessarily connect that warming period to what the planet is experiencing now. "Some people say i t was a degree higher or about the same, but there were no thermometers, so how accurate were they?" he said.

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Endless Winter: 'It is difficult to know when last winter ends and this winter begins' in Europe

With skiing and snowboarding continuing at a few European ski areas all year round, it is difficult to know when last winter ends and this winter begins. But some glacier resorts that closed in the Spring or Summer re-open in September and stay open right through to next Spring 2009, so September seems the best candidate for the month of the year in which to declare the new ski season 2008-9 officially underway!

Fortunately, mother nature is playing ball too, with snow in the Alps last weekend. Although it is not yet open, www.Skiinfo.com reported that Val d'Isere received 9cm (just under four inches) of fresh snow at the weekend with more forecast later this week, building up their base ready for the season. It was a similar story across many other ski areas and www.Skiinfo.com works in partnership with the resorts to deliver the latest conditions several times daily....

The Dachstein Glacier re-opens for winter 2008-9 this Saturday, September 20th after a month's closure for annual maintenance. The first ski lift to open will be the "Austriascharte" serving slopes that are currently reporting a 50cm (20 inch) snow base with temperatures on the glacier below zero and thus helping to maintain snow quality....

Elsewhere in the Alps, some ski areas haven't really closed since last winter, are still open today and will stay open through to next winter. These include the Tux and Kitzsteinhorn glaciers in Austria. Tux is currently reporting 20cm of fresh snow and a 75cm base, but the Kitzsteinhorn glacier is not in such good shape and has had to suspend skiing temporarily whilst awaiting more fresh snow on top of the 4cm recently received.

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Record snow in New Zealand

Another 24 hours of snow falling on the southern slopes of Mt Ruapehu has seen Turoa's snow base reach a record five metres today. In mid-August, the snow measuring stake at Turoa had to be extended from its previous maximum of 3.8m to allowed continued measurement as the snow kept coming. The skifield set a record for any ski area in New Zealand when its snow base reached 4.5m.

With the snow stake measuring 4.88m on Monday, Ruapehu Alpine Lifts announced that Turoa would extend its season until November 16. The Whakapapa side of the mountain currently has a base of 3.77m, the deepest since 1995.

Mt Ruapehu marketing manager Mike Smith said the continuous snowfalls from mid-July to late August had created the record conditions. Whakapapa plans to close as scheduled at Labour Weekend but will reopen for Christmas skiing from Boxing Day until early January 2009 if sufficient snow remains, Mr Smith said.

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Chemist calls agw fears a 'blind adherence to people who don't know what they are talking about'

I have written a lot about global warming in this column challenging the argument that you and I are responsible. I do it to provide balance to the media coverage. They have failed to print both sides of this story. When questioned, many reporters say "the debate is over!" That's not their job! Back in the days when real journalism was practiced, we got both sides. The debate is never over as long as there is a strong argument from both sides of any question.

The media elite have bought into the propaganda that you and I are responsible. Yet, there are numerous experts who say the proponents are wrong. Their stories are not being told, which means pro-global warming tactics (to silence the opposition) have worked. "The argument is over," they declare. What that says to me is, "we're too lazy to investigate the other side." There are hundreds and perhaps even thousands of scientists out their that have their doubts about "man made global warming."

Here in Paradise we have a well-qualified voice speaking out against what many call the, "Global Warming Myth." His name is Paul Crapuchettes, who spent his lifetime working with General Electric and Litton Industries designing electron tubes. He also spent time overseeing the preservation of marshes and wetlands. "Opinions are opinions, not facts," he said. "We've known about greenhouse gases since the early 1800s green house gas (was discovered) in the early 1800s. The atmosphere was a greenhouse." We pay "carting costs" to haul waste that releases CO2 that, " should go to a digester, rather than the dump," he concludes.

Crapuchettes has strong qualifications. He has a Bachelor of Science degree in chemistry and as a chemist he said the calculations to develop the global the warming theory have not been properly carried out.

"They (pro-global warming enthusiasts) only look at CO2 they need to check all gasses and the change in inventory and that's not being done!" The retired chemist notes, "we don't have enough data we have to know what's going on everywhere on the planet we have 17,000 weather stations in the world nowhere near enough (to get adequate data)."

He says our press corps is the major problem because they prefer using inadequate data and information to amplify problems that do not exist. "The spotted owl was not endangered yet thousands lost their jobs because of irrational and thoughtless reporting by the mainstream media." He's also challenging the idea of using "ethanol" as a means to eliminate carbon in the environment noting such actions will drive up the cost of food, and lower the mileage we presently get on gasoline produced in our refineries.

He believes the global warming movement is a, " blind adherence to people who don't know what they are talking about. Character assassination (a trait of the pro-global warming crowd who get angry when they are challenged) is abhorrent to me." The retired chemist concludes, " somebody has established an imperial relationship between themselves and melting ice they don't know why!" He concludes those pushing the issue such as Al Gore, " don't know what they are talking about."

Crapuchetts believes pro-global warming advocates are not using proper calculations to reach their conclusions. "They only use CO2 they need (to analyze) all gasses," he said, "then check the change in inventory (of those gasses), and there's no evidence that is being done! "We don't have enough data (to set up proper models)," he continued, " (to do that) we have to know what's going on everywhere on the planet." I'm a journalist, not a scientist, and I can't say at this time global warming is either a myth or fact. But, I know when we are being fed inadequate data to make claims about climate change that simply have not been proven.

Crapuchettes has worked in both the private and public sectors. Besides developing electron tubes, he's also worked in the environmental field over seeing marshes and other environmental habitats including Suisun marsh in the North part of San Francisco Bay, studying their relationship to our environmental balance.

It's more than unfortunate that reporters in the so-called main stream media will not talk to people like Crapuchettes and many others like him who are willing to speak out on the issue. There are many scientists on the college campuses who know Crapurchettes is right but are afraid to say so.

Anyone who has spent time on a University of California campus in recent years will tell you about the "tyrannical atmosphere" developing between social and "real" scientists.

Those that speak out on some campuses do so at the risk of losing their jobs, and that is dangerous. Only the media elite, social scientists and politicians support the global warming theory. Real scientists know we have a lot more to investigate before we make any solid conclusions.

We all need to pay more attention to people with solid credentials like Paul Crapuchettes, and less attention to "pseudo-scientists," like Al Gore.

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Is Australian Prime Minister Kevin Rudd another James Hansen Disciple?

If you still have doubts about whether man made climate change is real, stop it because according to Prime Minister Kevin Rudd:

We must prepare for a low-carbon economy, to delay any longer, to stay in denial as the climate change skeptics and some members opposite would have us do, is reckless and irresponsible.

The Prime Minister made that statement in an unexpected and impassioned speech yesterday near the end of a long parliamentary debate on a government bill that clears the way for millions of tonnes of carbon dioxide to be stored under the sea. Throughout the speech Rudd emphasized the need for URGENT action:

Expert analysis points to severe global and national consequences including rising sea levels, more severe weather events, water shortages, large-scale migration, increased threats to border security, loss of infrastructure and regional conflict over increasingly scarce resources.

He finished up with the following emotional call to action (more about this later):

"For our generation, for our kids and future generations, we must act now."

The Prime Minister has continually maintained that he takes his advice from the IPCC science on this matter. But who are these expert analysts? From the Prime Minister's agenda and language it would appear that his adviser on the science is none other than James Hansen. Hansen is the father of the Global warming alarmist movement since the 1980's and just happens to be AlGore's science adviser.

A personal letter written from James Hansen written to Prime Minister Kevin Rudd on the 27th of March 2008 is most revealing. You can click through and read the letter in full at the Crikey web site, but here are some extract that show Rudd parroting what Hansen has written: In the letter Hansen urges Rudd to act - just notice how he plays to Rudd's ego and his ambition to be a major player on the world stage. Hansen lays it on with a trowel.

I recognize that for years you have been a strong supporter of aggressive forward-looking actions to mitigate dangerous climate change. Also, since your election as Prime Minister of Australia, your government has been active in pressing the international community to take appropriate actions. We are now at a point that bold leadership is needed, leadership that could change the course of human history.

Hansen then goes on to say the situation is URGENT, NEAR critical tipping points and then spells out what COULD happen:

"Global climate is near critical tipping points that could lead to .. progressive, unstoppable global sea level rise, shifting of climatic zones with extermination of many animal and plant species, reduction of freshwater supplies for hundreds of millions of people, and a more intense hydrologic cycle with stronger droughts and forest fires, but also heavier rains and floods, and stronger storms driven by latent heat, including tropical storms, tornados and thunderstorms.

Funny that's exactly what Rudd has been telling the Australian Public, almost word for word. Then Hansen goes on to chronicle the dangers of coal and recommend the development of the very thing that Rudd unexpectantly spoke so passionately about in Parliament yesterday, carbon capture. -

"Due to the dominant role of coal, solution to global warming must include phase-out of coal except for uses where the CO2 is captured and sequestered. Yet there are plans for continuing mining of coal, export of coal, and construction of new coal-fired power plants around the world, including in Australia, plants that would have a lifetime of half a century or more."

Then Hansen lays it on with a trowel again. Note the word COULD

Your leadership in halting these plans COULD seed a transition that is needed to solve the global warming problem. If Australia halted construction of coal-fired power plants that do not capture and sequester the CO2, it could be a tipping point for the world. There is still time to find that tipping point, but just barely. I hope that you will give these considerations your attention in setting your national policies. You have the potential to influence the future of the planet.

Prime Minister Rudd, we cannot avert our eyes from the basic fossil fuel facts, or the consequences for life on our planet of ignoring these fossil fuel facts. If we continue to build coal-fired power plants without carbon capture, we will lock in future climate disasters associated with passing climate tipping points. We must solve the coal problem now.

To finish, Hansen recommends 7 Australian scientist who are his disciples.... Oh don't forget the references to the little children. Hansen said:

Prospects for today's children, and especially the world's poor, hinge upon our success in stabilizing climate.

Or here from Hansen's report on his lobbying trips to the UK, Germany & Japan in July

If we continue to ignore obvious geophysical facts about the magnitude of fossil fuel reservoirs, our children and grandchildren will have little reason to forgive our obtuseness.

Kevin Rudd in Parliament yesterday:

"For our generation, for our kids and future generations, we must act now."

Or Here from his appearance on 60 minutes.

Look at your kids in the eye tonight and ask yourself this question - "If we have this much evidence available to us now "on climate change and just refuse to act, "then what are the consequences for them?"

It's comforting to know that an American NASA professor who cannot convince his own government to sign the Kyoto protocol is driving Australia to leading the world into a carbon constrained future. It appears that on the advice of a one US professor Kevin Rudd is about to launch Australia into the greatest shake up of our economy the nation has ever seen. By the time the Kevin Rudd / James Hansen agenda is in place we will be poorer as a nation, but at least we'll be cleaner.

Oh sorry I forgot because we only represent 1.3% of world CO2 emissions, cutting our Greenhouse gas emission will actually have zero impact on world emissions. But its important to be seen on the world stage as a visionary leader and savior of the planet, when you spend as much time overseas as Kevin Rudd does. Isn't it Kevin?

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