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March 19, 2022

Canadian-educated statistician taking heat for Wall Street meltdown

By Jason Buckland, Sympatico / MSN Finance

You knew the finger pointing was coming. The auto execs, definitely. The investment traders, sure. The labour unions, likely. This guy, though, not many could predict.

Finding himself under heavy fire of late is David X. Li, a Canadian-educated statistician being largely blamed for the collapse of the American economy.

Li has been the subject of several blame-it-on-the-greed media articles recently, including a feature in yesterday’s Toronto Star and an extended periodical in Wired magazine entitled, “The Formula That Killed Wall Street.”

The Chinese-born Li is accused of providing bankers and financial analysts with a mathematical formula – the Gaussian copula function, it goes by – to, at its essence, simulate the behaviour of lending and determine risk, theoretically removing the threat of investing.

As the Star puts it, “Li didn’t burn down the economy. He just supplied the matches.” The result of Li’s formula, reporter Cathal Kelly argues, “was an orgy of misspending that sent the U.S. banking system over a cliff.”

That’s a pretty fervent accusation against the man whose modest background suggests he’s more scapegoat than Dr. Claw-esque super villain.

After arriving in Canada in 1987, Li earned degree after degree from Quebec’s Laval University and the University of Waterloo, studying the realm of loss modelling before his ambition drew him to Wall Street. Li quickly shot up the corporate ladder and, by 2000, had become a partner at J.P. Morgan’s RiskMetrics unit.

The Gaussian copula function came to be known that year in a paper Li published in The Journal of Fixed Income. Instead of evaluating risk by trying to correlate all the variables at play, Li’s model based investment strategies against historical data of the market itself. “In essence, Li used the past to map the future,” Kelly writes.

Soon, even the most rickety investments looked solid using Li’s assessment strategy. Investments that were typically high-risk – mortgages, credit card debt – suddenly looked like locks for return.

The Wired feature sums up the consequences as such: Money soon funnelled into credit default swaps, which act as an insurance policy against defaults. By the end of 2007, the total investment of credit default swaps had ballooned to $62 trillion (USD), a 6,700 per cent increase in only six years.

Then, when the U.S. housing market bubble burst in 2008, Li’s model was rendered useless and defaults his formula hadn’t predicted piled up, wiping out trillions of dollars in investment. The whole system had imploded.

Li has since moved home to Beijing where he heads the risk management department for the China International Capital Corporation. He hasn’t commented on the economic meltdown, and we can’t really blame him for saving himself from a public lashing.

Isn’t this a bit much to pin an entire recession – with so many working parts and interconnected variables to blame – on a statistician? After all, it wasn’t Li who actually used the model, he merely presented it as an option. Not only that, but upon seeing the boom it had caused among U.S. investors, he warned the Wall Street Journal in 2005 that, “The most dangerous part (of the strategy) is when people believe everything coming out of it.”

Skewering Li seems a little like chastising Henry Ford for the world’s car crashes or, as Li’s mentor at Waterloo tells the Star, “like blaming Einstein for Hiroshima.”

David Li, meet Steve Bartman. Steve, this is David. You guys should get along nice.



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Gordon PowersGordon Powers

A long-time fund company executive, Gordon Powers now heads up the Affinity Group, a financial services consulting firm. Gordon was a personal finance columnist for the Globe & Mail for many years, has taught retirement planning...

James HaversJames Havers

James is the senior editor of MSN Money living in Toronto. He has worked for the Nikkei Shimbun (Tokyo),,, Canadian Business and other publications. Havers turned to journalism after teaching overseas.

Jason BucklandJason Buckland

The modern-day MC Hammer of money, Jason can often be seen spending cash that isn’t his with the efficiency of a Wilt Chamberlain first date. After cutting his teeth as a reporter for the Toronto Sun, he joined the MSN Money team with...