- Hardcover: 264 pages
- Publisher: Wiley; 1 edition (December 6, 2011)
- Language: English
- ISBN-10: 0470529733
- ISBN-13: 978-0470529737
- Product Dimensions: 6.3 x 1 x 9.3 inches
- Shipping Weight: 1 pounds (View shipping rates and policies)
- Average Customer Review: 2.5 out of 5 stars See all reviews (8 customer reviews)
- Amazon Best Sellers Rank: #1,610,588 in Books (See Top 100 in Books)
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The Number That Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis Hardcover – December 6, 2011
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“Pablo Triana, whose previous book was an elliptical trip around the world of risk entitled Lecturing Birds on Flying, knows whereof he speaks. Indeed, he was one of the quants entrusted with the task of gaming VaR…Triana’s argument is that it wasn’t subprime US mortgages or excessive remuneration or even financial engineering as such that brought the banking system to its knees. It was the hubris of quants who believed that market risk could be encapsulated in a single number, the naivety of regulators who, he implies, did not have the little grey cells to argue with them, and the greed of banker bosses who quickly cottoned on that this ‘objective’ measure of risk was in fact highly subjective and infinitely manipulable…I hope [the book] prompts a response from VaR’s remaining defenders.”—Financial World
From the Inside Flap
The devastating financial crisis that began in the summer of 2007 and led to staggering losses for the banking industry, a global economic recession, and an implosion in government finances was caused by two main factors: toxic assets and leverage. But why did banks and other financial institutions take on this "toxic leverage" in the first place? Because an immensely powerful, but little talked about, mathematical model told them to. Known as Value at Risk (VaR), this model inaccurately projected no risk for these clearly worthless assets, insisting that they could be accumulated worry-free. Intoxicated by the promise of short-term profits, the banks listened, and disaster followed.
Now, for the first time, The Number That Killed Us reveals the "greatest story never told" about the Great Recession, explaining the key reasons behind this and past market disasters. Providing a comprehensive overview of the development of VaR—a story fraught with mathematical wizardry, intriguing characters, and financial drama—the book reveals how all our lives have been influenced by this mysterious analytical tool.
For the past two decades, VaR has been one of the most influential forces in finance. Acting as a radar for risk that guides the decision-making processes of banks around the world, it can determine whether a banking crisis takes place or not. But with its tendency to sanction dangerous and reckless behavior, VaR can also create chaos out of nothing.
As in his previous book, Lecturing Birds on Flying, author Pablo Triana takes important financial issues off the backburner and brings them to the forefront of controversial contemporary debate. Financial instabilities are revealed, and VaR, the mathematical ruler of the past twenty years, is finally seen for what it really is—flawed and impractical.
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Top customer reviews
Would be interesting to hear of any updates and if any concrete action has been taken.
Also to note how banksn who surviced would have fared without Government supporting the weaker banks and buying out their losses(thereby covering the losses on the socalled "solid" banks!!
Of course that sign was mere fantasy on my part so, whatever the flaws of this latest effort, kudos to Triana for choosing a catchy title and keeping cosy financial regulation in the headlines. In fact one of the most sympathetic parts of the book is Triana's recounting of an oversight hearing held for the House Committee on Science and Technology on the topic of Value at Risk. Triana bemoans the empty chairs at this would be rock concert, a testament to waning public interest in even his anti-VAR super-hero Nassim Taleb. Does anyone care anymore?
What taints The Number That Killed Us however is a new kind of anti-mathematical slant, one championed by Triana's mentor Taleb and taken to extremes in Triana's previous book. Wearing 1-d anti-Platonic glasses doesn't help distinguish methodology from policy or history from causality so, for example, while VAR requirements could certainly be more stringent, ad-hoc rules can also be more lenient ... and in another world we might be talking how their arbitrariness caused a crisis. Triana makes a case for better capitalized financial institutions and that section of the book is the most readable, but Triana's real beef is not collusion or policy but a language he is largely unfamiliar with, mathematics. The link is strained and it makes for some odd suppositions (to a practitioner) like the fact that bankers are prone to worshiping the arcane, or inclined to bend on one knee in the presence of a mathematical formula. The weight of this accusation rests, it would seem, on some research by a Berkeley Ph.D. candidate as yet unpublished. I await further details with interest.
Value at Risk can mean different things. Taken literally it is a mere definition: a single number representing, or rather failing to represent, a distribution of potential losses. That distribution might arise as the output of a probabilistic model, or it might be a naive empirical estimate based on historical profit and loss fluctuations. Either way, a single threshold number (such as $130 million) is said to be the Value at Risk for a specified probability (say 5% for illustration) if there is a 95% chance, according to the model, that losses will not exceed said threshold. One can take issue with the information loss implicit in this definition, but how upper management chooses to consume summary data is beside the point. The real controversy surrounds the means by which the distribution of losses is modeled. In caricature pop-finance, of the variety peddled by Taleb, this amounts to choosing a univariate distribution from the shelf and - oops - the wrong one. I trust it is evident from the definition of Value at Risk, however, that the Normal distribution need have nothing to do with it. The Value at Risk/Bell Curve conflation is the most successful confusion of terms since 'Iraq' and '9/11'.
To his credit Triana cleans that up a little too, attempting an explanation of how Value at Risk was computed for some people using the RiskMetrics framework. Therein a multivariate Gaussian assumption can be made, and often is, so we expect it hides the weapons of mass destruction. Thing is though, a little more digging in the technical documentation provided by the very same vendor would have revealed stern warnings about the limitation and interpretation of the results, including suggestions for dealing with non-linear payoffs and non-gaussian distributions. It was evidently not the propeller heads who failed to notice fat tails, and what Triana misses is the real story of the crisis: the extremely limited bandwidth for communicating technical information to upper management, and a scornful, impatient attitude toward anything remotely theoretical.
Policy issues aside the calculation of firmwide Value at Risk was an complicated undertaking in several respects, influenced by front office/back office politics and, at least in this reviewers's experience, a contempt for mathematical tools extending to the valuation of what were, in reality, complex options. Trading desks who lost the most during the crisis were claiming to manage risk in mortgage backed securities but many eschewed any kind of probabilistic approach, preferring to use a small number of scenarios and their famous 'gut instinct'. So the numbers feeding into firmwide risk were not coming from a mathematical model at all, and even if they involved historical estimates of profit and loss fluctuations, those very same estimates were never honestly attempted. That reality, which many quants fought hard to change, makes a mockery of Triana's underlying thesis: that the language in which we communicate probabilistic information is to blame.
To Triana mathematics is complex and life (including global finance) is simple. One doesn't fit the other, therefore, and you couldn't hope for a more populist, simplistic argument outside of a Republican primary debate. "Before VAR showed up", Triana writes, "financial risk management was a simple affair." It is an opinion the author states many times, with gusto, but is it true that "the rules respected the simplicity of it all". Did those good old rules see "reality for what it was, not for what it should be"? It is a tough argument to make, not that Triana feels any obligation to do so. Save for some crass categorical distinctions the "good old rules" assign the very same capital to a risky loan as a safe one.
For the author, winding back the clock is the only solution but was there ever a golden era for risk management, or finance? There were certainly periods where the financial sector was smaller, as Triana is right to point out, but demographics of companies were different. The fact that more companies have access to finance than they once did (provided they can argue for potential future earnings) is not a bad thing. Distortion of retail lending via housing policy is another matter, granted, but that has little to do with VAR. There are many hidden costs to keeping financial regulation brain-dead simple just for the sake of it, just as there are many games created by overly simple rating procedures that eschew the quantitative tools used by banks.
The notion that finance is trivial is ultimately a contemptible position, almost as contemptible as pronouncements on the inability of other people to solve difficult problems. Life is, one dares to suggest, complex. The challenges of risk transfer, capital allocation and investment are complex. Mathematics on the other hand, is neither complex nor simple, any more than the attribute might be assigned to English. It is tool for building relatively simple calculators and metrics, and can also be used to build more sophisticated technology threatening the margins of Wall Street. How technology is used is a matter of education, culture and respect for careful, rational inquiry devoid of 1950's style, anti-intellectual overtones.
Why does he come to that conclusion? Well, according to this book VaR was concocted by quants who were either evil or delusional so that financial institutions could leverage their capital by anywhere from 100-1 to 1000-1 and all the traders could buy the same investments and make lots and lots of money before the world ended. Admittedly VaR is not a simple concept, has many versions used by different banks and brokers and does deserve some blame for contributing to the financial meltdown, but to base a book on the theory that but for VaR none of this would have happened is fantasy.
A reader can understand the irrationality of what is to follow by reading just the Introduction which is a repetitive screed against VaR. In later chapters there is some sensible explanation of issues, but these are usually terminated when the author wakes up, notices he is being reasonable and returns to the screed. In the longest chapter in this book there is an explanation of why Collateralized Debt Obligations (CDO) related to prime and subprime mortgage debt and its crucial role in bringing down a number of banks. There is even a mention that these were AAA rated when this was more than wishful thinking. But rather than analyzing the relative contribution of VaR vs the credit rating to the crisis, the author again places the fault on VaR (most commentors have blamed the credit rating.) The contrafactual scenario of whether the crises would have occurred if these were rated BBB as opposed to AAA never arises.
The author points to JP Morgan as the originator of this original sin. As VaR was hoisted on the regulators, according to the conspiracy theory, so that JP Morgan could trade lots of toxic assets on a super leveraged basis, and if VaR was the only cause of this calamity, why did JP Morgan come out of this unscathed? Mr. Triana does not raise the question. Also if everyone was supposed to buy the same things why were some institutions going the opposite way e.g. Goldman Sachs shorting the CDO market? Because it doesn't fit into the manichean world of VaR this too does not get raised.
The author does propose a solution: to get rid of VaR or any market risk measurement and to return to the net capital rules as they existed in the 1970's. But then he does not explain why the S&L crises with the failure of Drexel Burnham, the 1987 market crash and the LTCM meltdown occurred (the latter when the banks had VaR but the brokers had net capital rules).
The financial and economic pain of the past 5 years is a serious matter. Responsible people are looking for causes and remedies to ensure as much as possible that it does not happen again. This book, however, in pushing its one dimensional panacea to an extremely complex problem contributes little or nothing. Mr. Triana is obviously not a fan of H.L. Mencken otherwise he would have remembered that "For every complex problem there is an answer that is simple, clear and wrong."
The driver crashed the car, the engineering and vehicle inspector were to blame for allowing the car to be driven when it was known to be faulty.
And who gets crucified? The poor financier who enabled the Driver to buy it !
Other Where it concerns facts, the author is spot on. Where it concerns his opinions, nope.