Recipe for Disaster: The Formula That Killed Wall Street

This article goes along with one of our previous posts about the lovely Ms. Hot Heidi barteder. This is the more technical version of the story.

It pretty can be summed up by this warren buffet quote, which if you have been doing your reading, you would be familiar with.

"Beware of geeks bearing formulas."- Warren E. Buffet

David X.Li is that geek and the Gaussian copula function is his formula.


Now for the story.

Read it. Then come back to me. Don't keep me waiting.

Recipe for Disaster: The Formula That Killed Wall Street






Thanks
WSC- yerd me

How Credit Default Swaps work in Lamens Terms

"Heidi is the proprietor of a bar in Berlin . In order to increase sales, she decides to allow her loyal customers - most of whom are unemployed alcoholics - to drink now but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around and as a result increasing numbers of customers flood into Heidi's bar. Taking advantage of her customers' freedom from immediate payment constraints, Heidi increases her prices for wine and beer, the most-consumed beverages. Her sales volume increases massively. A young and dynamic customer service consultant at the local bank recognizes these customer debts as valuable future assets and increases Heidi's borrowing limit. He sees no reason for undue concern since he has the debts of the alcoholics as collateral.
At the bank's corporate headquarters, expert bankers transform these customer assets into DRINKBONDS, ALKBONDS and PUKEBONDS. These securities are then traded on markets worldwide. No one really understands what these abbreviations mean and how the securities are guaranteed. Nevertheless, as their prices continuously climb, the securities become top-selling items. One day, although the prices are still climbing, a risk manager (subsequently of course fired, due his negativity) of the bank decides that slowly the time has come to demand payment of the debts incurred by the drinkers at Heidi's bar. However they cannot pay back the debts. Heidi cannot fulfill her loan obligations and claims bankruptcy. DRINKBOND and ALKBOND drop in price by 95 %. PUKEBOND performs better, stabilizing in price after dropping by 80 %. The suppliers of Heidi's bar, having granted her generous payment due dates and having invested in the securities are faced with a new situation. Her wine supplier claims bankruptcy, her beer supplier is taken over by a competitor. The bank is saved by the Government following dramatic round-the-clock consultations by leaders from the governing political parties. The funds required for this purpose are obtained by a tax levied on the non-drinkers."

-WSJ




If you want a more technical version read this article.


And I pictured Heidi to look like this, obviously.

I hate being right, and now I am depressed.

So actually I lied I was wrong. I was calling for a push down to 7500..... Currently we are at 6500 on the Dow. GRRRRRRRRRREEEEEEEEEAAAAAAAAAATTTTTTTTTTTT.

Sorry, I have been slacking on the writing, I just can't muster up the energy with the market in its current state. Tear.


After reading this article I am even slightly more depressed. Here are few points I took away from the article.

"In the end, the timing of the bear's retreat will likely hinge on that great market imponderable: psychology. How investors feel has a lot to do with whether they start seeing mixed signals as proof of a glass half-full. "The [market] stress causes the analytical part of our brains to shut down, and that makes us hyperreactive to bad news," says Michael A. Ervolini, CEO of Cabot Research, a consultancy catering to institutional investors. People become convinced conditions are worse than rock-bottom bad, he says. Only after they see that they've overreacted can things improve: "We look for the market to start [saying] tomorrow will be brighter." - Business Week

I whole heartedly believe this is true, partly because it feel like it has happened to me and most of the people I associate with. I mean lets be honest watching the market go down a couple hundred points everyday really make you just want to take the ole mini van out for a spin the wrong way down 95 and hope for the best.

As much is this does hurt right now, one can only think that it has to be one of the greatest opportunities for people in the age bracket of 20-30 with money to put into the market. If you decided today to put 10k into the market (I don't condone such balls of steel) the market would only ( I say only like its just so easy) have to get back to 8125 for a 25% return on their money. Now based on that article it is going to take around 6-8 years for the Dow to get back to 14,000 level, but hell that would be a 115% return in 6 years. Not bad right? Well not unless you started investing 10k on the day it notched over 14,000.... Then you are just back to even, given you never invested a cent after that, which would just be dumb.




So people, for the time being, lets just try to gather those happy thoughts and turn the market back around. Throw on Mr. Jones by the Counting Crows and just stare at this picture, clearly it will solve all the problems you have.


Thanks
WSC