UnRisk 7

Sudoku Bail-Out

It seems that Taleb´s enemies insist on playing right into his hands and shooting themselves in the foot. If not long ago Merton made some funny remarks during a Harvard roundtable, it is Scholes turn now.

Allow me to highlight the following from his recent q&a in the New York Times: Q: Some economists believe that mathematical models like yours lulled banks into a false sense of security, and I am wondering if you have revised your ideas as a consequence. A: I haven’t changed my ideas. A bank needs models to measure risk. The problem, however, is that any one bank can measure its risk, but it also has to know what the risk taken by other banks in the system happens to be at any particular moment. Q: What good is a theory of risk management if it applies to one tree instead of the forest? A: Most of the time, your risk management works. With a systemic event such as the recent shocks following the collapse of Lehman Brothers, obviously the risk-management system of any one bank appears, after the fact, to be incomplete. We ended up where banks couldn’t liquidate their risk, and the system tended to freeze up.

I guess I don´t need to point how inappropriate/arrogant/ignorant/antisocial it is for Scholes (manufacturer and defender of flawed lethal theories, sinker of two funds) to openly admit that no matter what´s going on out there he is not changing his mind one iota and that risk management works just fine. The globe may be burning, hopelessly engulfed in a sea of VaR-Copula-NonNormal flames, but hey that´s no reason for this standard-bearer of theoretical orthodoxy to change his ideas just a bit. Let hubris keep rolling on, even after disaster has struck!

But again the point of this post is not to enlighten you on the obvious. Rather, I believe that Scholes interview enlightens us on the true defining characteristic of the theoretical finance establishment: utter cynicism, utter disregard, utter mocking, utter counterfeiting, utter conning, utter swindling, utter duping. The definite unveiling of such state of affairs is one of the most significant outcomes from this crisis. We have seen it hard at work among VaR defenders. Now we see it coming, in an even less remorseful fashion, from Nobel winners (btw, the Nobel was awarded for something that can´t work and that caused at least the biggest one-day drop in equity markets history; note to the Swedes: current events, with the final destruction of sigma and Normality, make that "Nobel" appear even more suspect and your misjudgment even more palpable) These theoreticians just don´t care if the theories work or not, if they destroy or not, if they are ridiculed or not. The lesser of them try to change the subject or cling to tired discredited one-liners so that they can go on making a living out of theorizing. The grandees like Scholes (fat bank account, academic tenure, a demonstrable ability to talk others into investing their money with him) engage in these debates just for the fun of it, for the fun of being able to publicly laugh at the world and loudly state with an open smile "I do not give a damn, and will never ever admit to any failings in my thinking; the world is burning? tough luck, and long live VaR"

For theoreticians to not admit failure in light of the latest mess is akin to Nazi officers engaging in Holocaust-denying. Self-serving, yes. Antisocial, yes. Scamming, yes. They take us for fools, yes.

Taleb mentioned Sudoku as a possible alternative occupation for the disavower-in-chief Scholes. It is tempting to argue that the Obama administration should perhaps devote some of that bail-out money to finance the construction of Sudoku houses where financial economists can devote their considerable brain power to activities other than concocting, promoting, and endorsing machinations with a demonstrable power to cause unemployment, poverty, and desperation.