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.
Posted by: J Steed | Mar 19, 2022 9:09:01 AM
This does not surprise me one bit. Most people are simple minded and will always put the blame for any problem on someone else. I am familiar with the Steve Bartman incident. What a joke that was. Almost makes you embarrassed to be associated with the human race.
Posted by: steven smith | Mar 19, 2022 9:33:10 AM
Everyone wants to believe the impossible, it is simply a case of wishful thinking backed up by higher education. Mr. Li has an impressive education so he can't be wrong? If Joe Blow comes along and suggested a similar theory, bumbed down nobody would beleive it or invest a nickel on it. A classic example of when educated people ignore the fundamentals associated with investing, and prefer to believe in the impossible. Greed fueled this latest crisis simply put alot of educated people ignored a lot of fundamentals because they did not want to miss the boat. An example in nature similarily the second lemming wonders were the first one went and so on and so on.
Posted by: Ken | Mar 19, 2022 9:57:02 AM
It’s amazing how intelligence people can come up with various theories that show how stupid we really are. I call it greed and when you mix this with poor leadership in all aspects of life, you have what we have today. Solutions are not going to be easy; however they will take time.
Posted by: KDB | Mar 19, 2022 11:01:06 AM
Mr. Li presented his theory and Wall St. chose to use it and believe it to be true. Its not like the people on Wall St. are uneducated in finance,someone should have picked up on it. Its the deregulation that caused this mess not Mr. Li..
Posted by: Dave | Mar 19, 2022 11:47:23 AM
Very simple concept : guns don't kill people .... people kill people. The greed and stupidity of the big shots led them to adopt and follow Li's theories; if his were never on the table, they would simply have used some other 'tools' - and probably ended up in roughly the same place.
Posted by: GNG | Mar 19, 2022 12:01:53 PM
Wasn't it W. Buffet who said a few years ago "beware of geeks and formulas"! It was greed that brought this house of cards down and it's still evident in the news today with these bonuses being handed out (AIG).
Posted by: bat | Mar 19, 2022 12:31:44 PM
It wasn't just the greed of the big shots that caused this mess,ladies and gents, though we expect them to have known better. No, everyone that borrowed way beyond their means to buy a house that was in almost every case extremely overvalued, or took second mortgages to buy motor homes, boats, home furnishings or to fund expensive vacations is also to blame. We are a "Must have it now" society and we are paying the price for our wasteful extravagances. The lenders turned a blind eye, to gain profits and market share which is what these businesses are expected to do, and the investment houses in the same pursuit of profits followed suit. Then when the tide began to turn, the irrationality that had pervaded and perverted the fundamentals came home to bite us in our collective butts. We were like children, allowed to play on a long tether, always believing that a more responsible adult would rein us in when needed. Unfortunately, the big shots we trusted to behave like intelligent adults instead were our bigger playmates on an even longer tether and no one was holding the other end. Suck it up people, we made our bed, its time to lay in it!
Posted by: edo | Mar 19, 2022 1:59:29 PM
that's the problem, dr li got his degree in quebec.
Posted by: Terry | Mar 19, 2022 2:32:01 PM
What was it that Mark Twain said, "lies, dam lies and then there are statistics". To paraphrase.
Posted by: Bob | Mar 19, 2022 3:41:13 PM
For once cannot the US accept the blame instead of always blaming someone else in this case for the greed and lack of integrity that led to the mess.
Posted by: Des | Mar 19, 2022 5:46:29 PM
"APPLAUSE" Very well put *BAT*!!!
I think it is about time the USA takes some responsibility for their actions!! If the world were to be divided up into a high school clique chart ---I see the US as the "cool-jocks/cheerleaders/Mr and Miss Popularity" of the world = they think their hot shots- and everyone likes them- and wants to be them-
but really in reality- their the bullies everyone pretends to like- sure some people want to be like them , until they grow up and see the "super cool spot lighters" are actually kinda lame and high on themselves. They cause pain, and frustration to their peers ( other countries ) with their follow us, we're the leaders, we know best- attitudes- then lead into a dead end- but find a way for themselves ( which Im sure they will - and then smugly flaunt their recovery)
Hopefully they as a Country grow up , and see they aren't all that!!!
Im hoping that if they want the responsibility of leader ship , that they will grow up and act like adults, instead of focusing on matters that aren't of world interest! Example = Im sick of reading and watching everywhere I turn that Brangelina is off to their Estate in Who cares, or Britney went to the grocery store and bought low fat something or other!!!!
Fix this mess you`ve created!!!!
Posted by: JDS | Mar 19, 2022 6:53:32 PM
Great comments folks....ahhh the great American dream....isn't it what they south of the border so heavily promote...and now for ALOT of people, the dream is over and it's WAKE UP time. The U.S. government, the various financial sectors (be it Wall Street, Banking Institutions, and the works) all need to just stand in a close circle and point the blame at each other.
As the saying goes...it's all fun and games until someone gets hurt. Well, the rest of the world would like to Thank you "United States" for now hurting the rest of the world with your "Fun and Games"....because not only do the people of the U.S. love to live outside of their means, but so does the U.S. Government.....who currently carries such an enormus debt load it's mind blowing....it's like a bad disease! What would happen if the various countries that the U.S. has borrowed from decided to call in their loans...immediately.....the fall of the "new age" roman empire is what! And maybe that should happen as a good WAKE UP CALL!
Time to SMARTEN UP AMERICA!!!! I'm almost surprised anyone ran for president after the mess that needs to be cleaned up down there. Proud NOT to be an American!
Posted by: Steve | Mar 19, 2022 8:34:18 PM
That is just stupid... Sure, blame Li... why not. If you dont want to accept your own blame in this, then blame Li, he is a nice guy and can take it. Meanwhile several institutions used there old tried and true assesment of risks, and did not get involved in any bad losses. Some won, many lost, but certain institutions treat money the "old fashioned" way, because of course... money IS old fashioned. And Cash is king , right now. Still in style after all these years. We let people play fast and loose, and look where it got us. Personally I want a secure old fashioned banking system... like Canada's. Where you cant buy something unless you have earned it, first. My father scrimped and saved to retire in a nice neighborhood. To be surrounded by the "affluent poor", as he put it. All his neighbors had better houses and cars, all on credit of course. At least he didnt have to worry about any payments, or work. I hope this recent economic decline stops soon, as I really need to get my savings back on track... so little time to retirement, and some fker has offed with my mutual investments... I hope he thinks of me while suntanning on the beach, cause if i meet him in an alley, Iplan on getting everyones moneys worth, out of him.
Posted by: Nina G Spenelli | Mar 19, 2022 9:51:57 PM
Hey the American's have to lay the blame on someone, they did it to Anne Murray so blame another Canadian. Lets blame it on CANADA!!!!
Posted by: gary jolly | Mar 19, 2022 10:35:18 PM
So Li is an Idiot,
But all the financial people knew the risks to statistics based equations they never work if they did everyone would learn one and beat the market.
That is why it is called a market the only risks in every market are the same as baseball, You win or You lose. And yes Blame Canada for a discrete lesson in prudence and financial accountability. Numbers do not lie people Do.
Posted by: Bryan | Mar 19, 2022 10:38:41 PM
I am a retired accountant who lost a lot of his savings but it ceases to amaze me that they promote people with high education to such senior positions without being baptised by fire or walking the walk before they start to lead. I learned early in life that figures can be made to say anything that you want them to but there is no substitute for experience in both good times and bad times. Sometimes academics should stay in the classroom and do research. Those analysts using his formulas should have used it only as one tool and used common sense and logic. There is only so much capital in the world and it is mobile, short of war or new technology nothing creates new true wealth. If a projection says that for instance that oil will increase by a certain percentage it does not mean that it will become worth more than a diamond over time, people should use common sense and not just use the numbers if they tell them what they want to hear. The blame is on high paid people using the numbers and not questioning the results.