Why Is the VaR Debate Being Ignored?

Last September 10th several men and women assembled in a sober Washington DC room to discuss one of the key issues (if not the key issue) behind the terrible economic and financial crisis that has caused so much misery. Among the gatherees were top politicians and top financial pros. A world-renowned bestselling author was there too. You would think that the media would have, globally, devoted endless broadcast hours and inundating amounts of ink to such an important event. After all, this crisis is the only thing that seems to have occupied people´s minds, globally, for the past two years. Surely journalists wouldn´t want to miss the opportunity to report on a roundtable of policymakers and experts that promised to tackle the true factors behind the mayhem, right?

Wrong. The historic hearing convened by the US Congress' Committee on Science and Technology on the responsibility of mathematical model Value at Risk for the meltdown has received essentially no attention from the punditocracy. A couple of informed bloggers here and there have shared the news with their e-readers, but the silence from the mainstream behemoths has been deafening. This is simply outrageous. It´s not only that the first congressional hearing ever on the real-life (negative) impact of financial models should naturally deserve some media cuddling, but VaR was, without a doubt and for the umpteenth time, a decisive malign force behind this crisis.

Bluntly stated, you can´t talk about this crisis without talking about VaR. Just like you couldn´t talk about WWII without mentioning Hitler. If you want to be properly informed and, most crucially, properly inform others about this crisis you can´t hide when it comes to debating VaR, you can´t ignore it. Just like you couldn´t ignore the guy with the funny moustache when discussing the Big War. Can you imagine a reporter covering the fraudulent accounting crisis that afflicted America a few years back and not attending the Enron hearings on Capitol Hill? Or a reporter covering the OJ Simpson case and not attending Mark Fuhrman´s testimony? Or a reporter covering WWII and not attending the Nuremberg trials?

I don´t need to tell you that this crisis involved financial fraud, murder, and annihilation of the worst kind. Shouldn´t media people want to dig in and truly get what happened? Some may say, come on be fair, journalists should not be expected to be aware of the existence of obstruse models like VaR, let alone comprehend them. Really? VaR has for the past twenty years been the risk radar of choice for Wall Street, religiously detailed under regulatory filings and annual reports. And, certainly, VaR has been for the past fifteen years the tool of choice when it came to determining the capital charges to impose on banks' trading activities. You are telling me that those covering the economic and business landscapes should not know this? Should not be aware of VaR? You must be kidding.

Many of the main forces behind the chaos are of a decidedly technical nature. CDOs, CDSs, SIVs, Gaussian Copula, VaR. Even those journalists who understand those things may want to shy away from reporting on them, fearing that their quick fix-seeking audience may hopelessly be at loss and change the channel, log out of the site, or put down the paper. To be fair, some in the media (including mainstream) have covered those themes in some detail, but generally speaking not overwhelmingly so and much less than was required. To the vast majority of folks out there all that matters when it comes to this recession are subprime loans, Greenspan´s too-easy policies, Wall Street´s remuneration structure, greed, and loosely-stated regulatory mishaps. All of the above did of course contribute to igniting the fuse, and it is only normal that they be talked about in spades. But that should be no excuse to neglect other, less straightforward perhaps, factors that played an even more clearly direct role. Covering D-Day and the Battle of the Bulge should not compensate for failure to mention Hitler.

By not covering the VaR hearing and keeping their audience in the dark as to such an impacting and eye-opening development, the mediatocracy makes sure that the truth is not unveiled, going a long way towards contributing to a repeat of the cataclysm down the road.

Why Taleb is the True Predictor of this Crisis

The punditry and the world at large have been hard at work trying to find ex-ante predictors for the malaise that has engulfed our markets, our economies, and our societies. Desperate efforts to find those who “called it” have been relentlessly launched. We all seem to want to know who among us really saw the mayhem coming. It was unavoidable that such agitated process would deliver a sizable dose of less-than-reliable prophets and less-than-robust explanations. The breathless quest for prospective explainers, the unquenchable thirst for totemic ex-ante seers has resulted in the crowning of individuals who, notwithstanding their many qualities, did not get it exactly right before the troubles initiated. Yes, many of those vaticinators did warn as to the unsustainability of the housing bubble, as to the insalubrious practices taking place in the subprime mortgage business, and (much less often) as to the toxic nature of certain new-flanged securities. But only one person among the appointed oracles truly pointed fingers prospectively at the true culprit behind the current devastation. And he did so not in 2005 or 2006, but as far back (at least) as 1997.

This is what Nassim Taleb said more than a decade ago that qualifies him, in my eyes, as the true and only visionary: “I believe that Value at Risk is the alibi bankers will give shareholders and the bailing-out taxpayer to show documented due diligence, and will express that their blow-up came from truly unforeseeable circumstances and events with low probability, not from taking large risks they did not understand…I maintain that the due diligence VaR tool encouraged untrained people to take misdirected risk with shareholders´, and ultimately the taxpayers´, money”.

In the midst of the credit nightmare, such pearls could not appear any more prescient. For VaR did ultimately cause the crisis (and the Taleb-predicted bail-out), precisely by providing reckless bankers with an iron-clad, scientifically-smelling, regulatory-sanctioned alibi to monstrously leverage their balance sheets with the most toxic and illiquid of financial wares. Since those gigantic toxic positions are what truly sank Wall Street, and since the sinkage of the latter is what truly unleashed what is known as the credit crisis, it follows that without VaR the pain would have been much more diluted.

This crisis was not really a “housing crisis”, but a “trading crisis”. Mortgage defaults on their own would have never created this kind of tremors. The melting into oblivion of complex securities based on those mortgages is what did unleash hell. VaR unseemly allowed banks to afford the complexity feast, and that´s why I declare it guilty numero uno. Only Taleb saw this coming, more than ten years ago. If only we had listened to him more attentively.