Monday, November 3, 2008

GIGO (Garbage in, Garbage out)

According to the Wall St Journal, insurance giant AIG relied upon a computer model to assess the risk of the trillions of dollars of "credit default swaps" it did. "Credit default swaps" are Wall St code words meaning bond insurance. For a premium AIG insured mortgage backed bonds against default. When the real estate bubble popped in 2006, the insured mortgage backed securities began to default, and AIG had to pay them off. The losses on bond insurance completely overwhelmed the earnings from the rest of AIG's insurance business, and requiring a $105 billion bailout by us long suffering taxpayers.
One has to wonder how senior management at AIG was gullible enough to beleive any kind of computer model could predict the default rate of mortgage backed securities. How can a computer program know the true value of the mortgaged property, keep up with the fluxuation of the real estate market, know the equity in the property and understand the borrower's ability and willingnes to make the monthly payments on time? Short answer, it cannot, and the managers that OK'ed the deals were totaly clueless. Probably all a bunch of MBA's.

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