Barry Ritholtz' points to an outstanding post by Chris Arnade at Scientific American, with the irresistible title "The Real, and Simple, Equation that Killed Wall Street". Here's a sample, but read the whole thing!:
"If it weren't for those meddling kids!" That was the punch line for every Scooby Doo episode. It also is the overly simple narrative that many in the media have spun about the last financial crisis. Smart meddling kids armed with math hoodwinked us all.
One article, from the March 2009 Wired magazine, even pinpointed an equation and a mathematician. The article "Recipe for Disaster: The Formula That Killed Wall Street," accused the Gaussian Copula Function.
It was not the first piece that made this type of argument, but it was the most aggressive. Since then it has been a common theme in the media that mathematics, especially obscure advanced mathematics, is largely responsible for the catastrophe that doomed the world to the last five years of recession and slow growth.
This theme plays on the fallacy that danger always comes from complexity. It's a fabrication that obscures the real causes, that makes it easier to say, "Hey, it wasn't my fault, I was blinded by science."
The reality is much simpler and less sexy. Wall Street killed itself in a time-honored fashion: Cheap money, excessive borrowing, and greed. And yes, there is an equation one can point to and blame. This equation, however, requires nothing more than middle school algebra to understand and is taught to every new Wall Street employee. It is leveraged return.
The equation, though simple, reveals one dangerous truth that investors love to exploit. If you can find an asset that returns more than the cost to borrow money then any return is possible with enough leverage.
Political Calculations is a site that develops, applies and presents both established and cutting edge theory to the topics of investing, business and economics.
Be the first to read Political Calculation's column. Sign up today and receive Townhall.com delivered each morning to your inbox.
In Other News: Wasserman-Schultz Planned Attack on "Sexist" Obama for Considering New DNC Chair | Michael Schaus