June 29, 2007

I can’t stand the suspense.

Sir, I once saw a balance sheet of a hotel corporation where they had registered on their balance sheet among their fixed assets the cost of building the hotel rooms but since they had also issued user rights valid over a very long period of time for each of those rooms, and were selling these out as timeshares, they also registered as current assets the inventory of unsold timeshares, valued at the price they were selling them at, and all this duly audited by a recognized name. As you can understand, this have your cake and eat it too balance sheet looked extremely solid and paid bonuses to the executives, while it lasted.

This memory came to my mind when reading Richard Beales’ and Gillian Tett’s “Real risks emerge when Pandora’s investment box is opened” June 29. If what I recounted above could happen with open and transparent audited statements (albeit in a developing country) then what limits could there be to what you could hide in black-box algorithmic proprietary trading models. I pity those judges that tomorrow will have to try to understand the issues, as I pity those that though perhaps totally innocent will be sentenced to jail just because they can’t get anyone to understand their models.

Having said that it is clear that we must face the real possibility that all of our economic numbers could be fictitious since we could already have incurred in real big losses but that are mercifully covered by a lot of untested hot air. When those boxes are opened up who will appear? A beautiful girl or someone with a machine-gun… I can’t stand the suspense, though I must admit that the bliss of ignorance has also its attractions.