FT.com Comment Opinion - Bystanders to this financial crime were many

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BreadcrumbFinancialCOMMENT OPINIONFT Home > Comment > OpinionBystanders to this financial crime were manyBy Nassim Nicholas Taleb and Pablo Triana JobsPublished: December 7 2008 19:18 | Last updated: December 7 2008 19:18On March 13 1964, Catherine Genovese was murdered in the Queens borough of New YorkCity. She was about to enter her apartment building at about 3am when she was stabbed andlater raped by Winston Moseley. Moseley stole $50 from Genovese’s wallet and left her to diein the hallway.Shocking as these details surely are, the lasting impact of the story may lie elsewhere. Forplenty of people reportedly witnessed the attack, yet no one did much about it. Not one of thealmost 40 neighbours who were said to have been aware of the incident left their apartmentsto go to Genovese’s rescue.Not surprisingly, the Genovese case earned the interest of social psychologists, who developedthe theory of the “bystander effect”. This claimed to show how the apathy of the masses canprevent the salvation of a victim. Psychologists concluded that, for a variety of reasons, thelarger the number of observing bystanders, the lower the chances that the crime may beaverted.We have just witnessed a similar phenomenon in the financial markets. A crime has beencommitted. Yes, we insist, a crime. There is a victim (the helpless retirees, taxpayers fundinglosses, perhaps even capitalism and free society). There were plenty of bystanders. And therewas a robbery ...

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• Langue: English

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Bystanders to this financial crime were many

By Nassim Nicholas Taleb and Pablo Triana

Published: December 7 2008 19:18 | Last updated: December 7 2008 19:18

On March 13 1964, Catherine Genovese was murdered in the Queens borough of New York

City. She was about to enter her apartment building at about 3am when she was stabbed and

later raped by Winston Moseley. Moseley stole $50 from Genovese’s wallet and left her to die

in the hallway.

Shocking as these details surely are, the lasting impact of the story may lie elsewhere. For

plenty of people reportedly witnessed the attack, yet no one did much about it. Not one of the

almost 40 neighbours who were said to have been aware of the incident left their apartments

to go to Genovese’s rescue.

Not surprisingly, the Genovese case earned the interest of social psychologists, who developed

the theory of the “bystander effect”. This claimed to show how the apathy of the masses can

prevent the salvation of a victim. Psychologists concluded that, for a variety of reasons, the

larger the number of observing bystanders, the lower the chances that the crime may be

averted.

We have just witnessed a similar phenomenon in the financial markets. A crime has been

committed. Yes, we insist, a crime. There is a victim (the helpless retirees, taxpayers funding

losses, perhaps even capitalism and free society). There were plenty of bystanders. And there

was a robbery (overcompensated bankers who got fat bonuses hiding risks; overpaid

quantitative risk managers selling patently bogus methods).

Let us start with the bystander. Almost everyone in risk management knew that quantitative

methods – like those used to measure and forecast exposures, value complex derivatives and

assign credit ratings – did not work and could provide undue comfort by hiding risks. Few

people would agree that the illusion of knowledge is a good thing. Almost everyone would

accept that the failure in 1998 of Long Term Capital Management discredited the quantitative

methods of the Nobel economists involved with it (Robert Merton and Myron Scholes) and their

school of thought called “modern finance”. LTCM was just one in hundreds of such episodes.

Yet a method heavily grounded on those same quantitative and theoretical principles, called

Value at Risk, continued to be widely used. It was this that was to blame for the crisis.

Listening to us, risk management practitioners would often agree on every point. But they

elected to take part in the system and to play bystanders. They tried to explain away their

decision to partake in the vast diffusion of responsibility: “Lehman Brothers and Morgan

Stanley use the model” or “it is on the CFA exam” or, the most potent argument, “modern

finance and portfolio theory got Nobels”. Indeed, the same Nobel economists who helped blow

up the system at least once, Professors Scholes and Merton, could be seen lecturing us on

risk management, to the ire of one of the authors of this article. Most poignantly, the police

itself may have participated in the murder. The regulators were using the same arguments.

They, too, were responsible.

So how can we displace a fraud? Not by preaching nor by rational argument (believe us, we

tried). Not by evidence. Risk methods that failed dramatically in the real world continue to be

taught to students in business schools, where professors never lose tenure for the

misapplications of those methods. As we are writing these lines, close to 100,000 MBAs are

still learning portfolio theory – it is uniformly on the programme for next semester. An airline

company would ground the aircraft and investigate after the crash – universities would put

more aircraft in the skies, crash after crash. The fraud can be displaced only by shaming

people, by boycotting the orthodox financial economics establishment and the institutions that

allowed this to happen.

Bystanders are not harmless. They cause others to be bystanders. So when you see a

quantitative “expert”, shout for help, call for his disgrace, make him accountable. Do not let him

hide behind the diffusion of responsibility. Ask for the drastic overhaul of business schools (and

stop giving funding). Ask for the Nobel prize in economics to be withdrawn from the authors of

these theories, as the Nobel’s credibility can be extremely harmful. Boycott professional

associations that give certificates in financial analysis that promoted these methods. Remove

Value-at-Risk books from the shelves – quickly. Do not be afraid for your reputation. Please

act now. Do not just walk by. Remember the scriptures: “Thou shalt not follow a multitude to

do evil.”

Nassim Nicholas Taleb is a professor of risk engineering at New York University PolyTechnic

Institute. He is the author of ‘The Black Swan: The Impact of the Highly Improbable’ (2007).

Pablo Triana is a derivatives consultant and author. His new book, ‘Lecturing Birds on Flying’,

will be released in spring 2009

Copyright

The Financial Times Limited 2008

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