Thursday, August 9, 2007

Black Swans, Black Boxes and Six Sigma

You'll here all of these terms the next few days as the models of the computer quants didn't work.

Six Sigma events happen once every 294,000 occurrences. Six Sigma market? Not gonna cut it.

Black Swans. The definition of a black swan is a) unpredictable b) massive impact c) afterwards we justify this event by an explanation that makes it appear more predictable. Black Swan? Not this market.

Black Boxes. It's phony math, that Wall Street quants dress up as science, with rocket scientists and Phd's. But emotions can't be modeled, and here's a real life example that will affect trading tomorrow. So let me start with yesterday.

That's when President Bush said housing was heading to a soft landing. Does anyone in America believe that? Tonight, Countrywide Credit (CFC 28.66) wrote off $200 million on a billion worth of sub-prime loans, and said conditions have markedly worsened-"unprecedented disruptions". Last week they said they had $50 billion of available credit. Now it's $46.2 billion, and conditions have deteriorated farther . Haven't we seen this movie before?

So think like Wall St. If you can't believe the president, or the chairman of the Fed who says sub-prime is contained, or Secretary Paulson, or any bank big wig, what will they do with CFC? Are these people are lying, idiots or just being foolish with forecasts? But if you're frustrated, you can't sell them, you can only sell stocks. Is this in the quant's model? I didn't think so.

Mozilla sells millions of CFC stock every week. But SEC filings show CFC holds another $70 billion of loans in their portfolio for investment.

Now think like Wall Street again.

If they wrote off 20% of a billion in sub-primes, why not write off 20% on their $70 billion of loans held for investment? If they are holding them for investment, they are not liquid, so they need to be marked down. That's $14 billion.

Rational? No. Believable now? Yes. They'll crush it tomorrow. Is that in the quant's model?

Credit is tight, fear is everywhere, and the angst is palatable. Behind closed doors, even the cheerleaders will doubt themselves. So it's time for the Central bankers to move. And they will.

Because if they don't open their doors, the business will shut theirs.