Another $Trillion Lesson

According to Bloomberg, projected losses in the corporate CDO market may approach $1T.

CDO Cuts Show $1 Trillion Corporate-Debt Bets Toxic

Investors are taking losses of up to 90 percent in the $1.2 trillion market for collateralized debt obligations tied to corporate credit as the failures of Lehman Brothers Holdings Inc. and Icelandic banks send shockwaves through the global financial system.

The banks that structured the securities and investors both failed to do “fundamental credit analysis,” said Janet Tavakoli, president of Tavakoli Structured Finance in Chicago. “They were using correlation models, they were using spread models, but they weren’t doing analysis on the underlying corporations.”

As the article highlights, this is yet another example of a situation where people relied on overly complex mathematical models rather than on simple common sense.

The problem with trusting the smartest-guys in the room is that even they are limited by their models and their understanding of the world.

I am not saying that the people who built the models are to blame, nor are the professors who established the theories underlying them.

Rather it is a the establishment of a system of overconfidence in these models, theories and individuals which are to blame.

We must take these failures as a lesson in humility for the future and integrate these lessons into our businesses and personalities so as to avoid repeating these mistakes again.

The clouds remain dark and the shoes are falling like rain, but like all storms, this too shall pass.

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