Somewhere in China, David Li is keeping his head down. Before the crash, his grateful admirers in Wall Street and the City declared that he deserved the Nobel Prize for Economics for discovering the wondrously enriching theory of “Gaussian copula functions”, which turned base assets into gold. While the market for credit default swaps went from $920bn in 2001 to $62 trillion in 2007, he was a genius. Now that his name appears in headlines such as: “Was David Li the guy who ‘blew up Wall Street’?” acclaim from the Swedes seems unlikely.
Mathematicians are trashing his reputation and the reputation of the banks’ other quantitative analysts. Their critiques are, inevitably, complicated, but the quants’ basic fault is easy enough to grasp. They assumed they could place reassuringly neat numbers on the risks of default in bundles of mortgages or bonds. Their figures were fantasies that bore no relation to the real economy in which homeowners and companies had to fund their debts because the quants never understood that the uncertainties in calculating risk were so great, all attempts to measure them were dangerously misleading.
“They were pretending mathematics was magic,” explained Tim Johnson at Heriot-Watt University, one of a group of financial mathematicians in British universities who specialise in taking apart the models of bankers and dealers.
Ministers, led by Lord Drayson, have been wooing Johnson and his colleagues of late and I can’t say I am surprised. Tens of millions of people in the rich world and hundreds of millions in the poor are losing their livelihoods because bad maths allowed bankers to pretend to themselves that they were not being insanely reckless. The government thinks it knows how to stop a recurrence of the folly. It reasons that Britain is lucky enough to have a band of independent experts who can save jobs and stop the taxpayer being fleeced by pointing out the errors of the City’s calculations. The public pays the academics’ salaries and academics can return the compliment by protecting the public.
“You have a fucking duty to speak out,” as one blunt politician explained the deal to them.