Saniel Bonder

A Formula of Correlation that's Destroyed Much More than Wall Street and Is Way More Threatening than Terrorism and Global Warming - Part Two

Soon after, a Wired magazine article by Felix Salmon, a financial blogger at Portfolio.com, explained the esoteric equation for lay people, calling it “The Secret Formula That Destroyed Wall Street.”

One of a family of formulas known as a Gaussian copula function, this one is, I gather, an extremely elegant string of Greek letters and advanced mathematical functions. It was the proud achievement of a single backroom financial industry quant, a Chinese-born mathematical genius named David X. Li who at the time worked for JPMorganChase. Upon its publication in 2000 in a financial industry journal, Li’s formula was instantly seized upon by almost everyone — bond investors, Wall Street banks, the big ratings agencies and even regulators. The entire industry, almost to a person, viewed it as a miraculous device for the creation of nearly infinite wealth for many parties, with far less risk landing on any single party’s shoulders than previously could have been imagined.

Li’s formula proposed to assess the correlation or linkages of all kinds of real-world probabilities surrounding the default risks of immense numbers of mortgages and to reduce them to a single, mathematical constant. Back in the day, it dazzled most of the world of high finance.

In Salmon’s 2009 analysis, with post-disaster hindsight, a huge red flag of possible tiny miscalculations leading to possible immense catastrophes can be seen hanging over nearly every critical postulate of the formula. And, true enough, a few, mostly lone and not very powerful voices were crying wolf all along. But hardly anyone was listening.

One nay-sayer from the get-go was Nassim Taleb, of “Black Swan” fame, himself a hedge fund manager. “People got very excited about the Gaussian copula because of its mathematical elegance, but the thing never worked. Co-association between securities is not measurable using correlation,” he said, because past history can’t prepare you for the near-impossible potential event of everything collapsing all at once. Which is exactly what happened once the cracks in the dike of everyone’s faith in the formula began giving way. Speaking of past history, Li’s formula also was built upon the premise — now an obviously preposterous illusion but then, who knew? — that home prices would somehow mysteriously only continue rising forever.

Oops. And that was only one of a number of crucial cracks that Li built into the dam, behind which the financial industry then flooded a $50-60 trillion dollar mega-lake in the short space of way less than a decade. Most everyone involved wagered bet upon bet upon bet that that magical correlation constant he had posited at the end of his grand formula would always prove not just possible, or even probable, but certain.

Taleb dismisses it all out of hand. “Anything that relies on correlation is charlatanism.” Of course, a dilettante layman in those realms like myself cannot hope to understand the formula’s abstruse symbols. Still, with my own expertise in spiritual-emotional arenas, I can get a now obvious point in hindsight. However complex and sophisticated it was, this secret formula, like nearly everyone in the financial world from its creator on up to the later-mystified and mortified Alan Greenspan, had gravely failed to take the underpinnings of human emotion into account.

Greed and fear, panic and euphoria: the copula could correlate certain factors of risk but it failed miserably to anticipate our primal moods and just how far and how fast they can swing. And, sure enough, have swung.

Yet to say that people were simply dazzled by the lure of insanely large amounts of inconceivably easy money misses another whole universe of real human factors. From day one, hardly anyone has ever understood Li’s Gaussian copula function. However, the current witch-hunting of Wall Street and bankers assumes that if they had just paid attention, done their due diligence, and not been greedy, they could or would have understood both the formula and its limitations and never made the mistakes they did.

Maybe. But I vividly recall a hot day in New York last summer, sitting with a friend named Michael who’s been a Wall Street insider for many years. He was telling the human side of the story of the mortgage default derivatives meltdown.

As I recall, he picked up a sheaf of letter-size paper the thickness of a hefty paperback and asked us to imagine getting something like that in your hand when you’re the decision-making leader of a world-player financial institution. Except, the whole couple hundred page document is full of vastly complex mathematics. Which you don’t have the time on your hands to come even close to understanding. A trusted colleague and friend in your company tells you, “Joe, everyone is working on this basis now. Trust me: it’ll be fine. The whole industry is getting in on it. We can’t afford not to. We’ll be sticks in the mud, we’ll fall behind in the game. Imagine what that’d do to our share price.”

What would you have done?

I sure would have been sorely tempted to trust my colleague and the quants in the back office, and sign on.

As for the analytical quants themselves — and there were some — who early on smelled a gas leak that could blow everything up but never blew their whistles to their bosses, Michael painted a starkly different reality-picture.

Imagine being that kind of guy or gal, he said. Everyone everywhere is jumping on this bandwagon. Nobody in your firm’s executive suites wants to hear nay-saying. So if you go ahead and say nay, you’re putting your job at risk for what you’ve devoted your whole career to getting very good at. That in turn puts your reputation at risk, including your capacity to be hired anywhere else. And all this then puts your own mortgage at risk, your capacity to provide and care for your spouse and children, as well as to maintain the lifestyle and the connections the whole family is accustomed to.

So even the thought of speaking up as strongly as you feel you really should leaves you looking down the barrel of a very big gun that, no question about it, will be fired in your face if you seriously open your mouth. And it’s pretty well guaranteed to both blow your own head off and blow up the lives of everyone you care most about.

What would you have done?

I sure would have been sweating bullets. (Hm, that cliché just came from the same folder of overused but still-evocative firearm metaphors as the gun barrel above. Well, it’s still true enough to be said.) To make another picture, that’s like walking over to your high-rise window, opening it, and just jumping out, sacrificing your life and much more for a principle that you’re pretty sure of but can’t absolutely guarantee you’ve got right.

That conversation at my friend’s office, again, was in summer 2008. Bear Sterns had tanked a few months before. Prescient, Michael also told us that day that the really big danger lying ahead was for Lehman Brothers. And if it went under, he said, all hell would almost certainly break loose.

Which it did.

And so here we are. …

The news cycles will continue to roll on and on for many months and more likely years before the global and local economies of our world stabilize again and then achieve truly sustainable growth. FT ran a recent special magazine called “The Future of Capitalism,” headlining several Nobel-winning academic economists, masters of finance and industry, and the like. Its own chief economist Martin Wolf led the magazine off with a sober estimation of just how many things, not just economic but also political, even environmental, can still go so terribly wrong and wreak havoc on the recovery, before all seems even close to right again in the worlds of money and finance.

My take is, things are already terribly wrong, and always have been, in the one arena of human consciousness and culture where lie our greatest hopes for getting things really or at least sufficiently right in all the other arenas. Not “wrong,” actually. Better to say, terribly undeveloped. Terribly un-evolved. Terribly un-integrated. Which means, in simple, human-life terms, terribly immature.

In this column I’ve been introducing the notion of a “Spirit/Money split.” I’ve proposed that, if we are ever to realize true global political stability and long-term economic sustainability, this split must be healed at least among the wisest real leadership and vanguard of human society. So I’d like to present a different notion here, a formula that wasn’t created by quants, has already destroyed much more than Wall Street and is way more threatening than terrorism, global warming, pandemics, you name it.

Again, I say “destroyed” and “is threatening” because this correlation appears to be so true of us and yet so not taken into account by any of us. No one in such real-world leadership has understood it or implemented it, or in fact ever even heard of it, till now. But then, David Li’s formula was not exactly well understood either, right? In fall 2005, then still the toast of the financial world, he noted to The Wall Street Journal that “very few people understand the essence of the model.”

This model of correlation may be as sophisticated a proposition in the realms of spirit and emotion as Li’s Gaussian copula is, or was, in the realms of mathematics and finance. Except this one affects everyone. Every body. All the time. Everywhere. And until at least our political, financial-economic, and social leaders somehow grow into conscious responsibility for it, we will always be tending to blow ourselves up in all the kinds of ways we keep finding, military, genocidal, financial-economic boom to bust — you name it.

The “Houston-we’ve-got-a-problem” of this situation is that, to be fully, deeply understood, this particular way of viewing human nature and behavior requires serious, sustained work in the realms of what I’ve called, in earlier posts here, “Multidimensional Money™” and “The Whole-Being Currency Exchange Index™.”

In my experience and observation, that full, deep understanding actually takes years of intensive inner spiritual and outer relational work and a willingness and capacity to endure an utter transformation of one’s very perception of life as well as one’s worldview, values, motives, and behavior.

Here it is:

“Conscious responsibility for sex and space precedes conscious responsibility for money and time.”

After all that buildup, this proposition may strike you as inconsequential, if not just silly, boring, or irrelevant. Bear with me. …

Part Three of this multi-section post, coming next week, gets us nearly up to date — early June — with news of both further economic convulsions and some hopeful signs. Much more to the point, it presents and begins to explain and elaborate upon the author’s spiritual-emotional “formula of correlation” that, he proposes, has already destroyed far more than Wall Street and will continue wreaking havoc for some time to come, unless …

© Saniel Bonder 2009. All rights reserved.  

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About Saniel: Harvard educated “destiny-empowerment” expert, Saniel is author of the forthcoming audio series, "Wealth Without Guilt," the provocative "White-Hot Yoga of the Heart," and many other books and programs. He hails from Sonoma, California where his unique blend of intellectual curiosity and spiritual wisdom is honed and nurtured. Saniel co-writes and co-teaches with his wife, Linda. Together they travel and teach “materiality and spirit” workshops throughout the US and internationally. His website is http://heartgazing.com/spiritmoney.