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The Number That Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis

ISBN: 978-0-470-52973-7
264 pages
December 2011
The Number That Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis (0470529733) cover image
A critical look at the risk measurement tool that has repeatedly hurt the financial world

The Number That Killed Us finally tells the "greatest story never told": how a mysterious financial risk measurement model has ruled the world for the past two decades and how it has repeatedly, and severely, caused market, economic, and social turmoil. This model was the key factor behind the unleashing of the cataclysmic credit crisis that erupted in 2007 and which the effects are still being felt around the world. The Number That Killed Us is the first and only book to thoroughly explain this hitherto-uncovered phenomenon, making it the key reference for truly understanding why the malaise took place.

The very number financial institutions and regulators use to measure risk (Vale at Risk/VaR) has masked it, allowing firms to leverage up their speculative bets to unimaginable levels. VaR sanctioned and allowed the monstrously geared toxic punts that sank Wall Street, and the world, during the latest crisis. We can confidently say that VaR was the culprit. In The Number That Killed Us, derivatives expert Pablo Triana takes you through the development of VaR and shows how its inevitable structural flaws allowed banks to take on even greater risks. The precise role of VaR in igniting the latest crisis is thoroughly covered, including in-depth analysis of how and why regulators, by falling in love with the tool, condemned us to chaos. Uncritically embraced worldwide for way too long, VaR is, in the face of such destruction, just starting to be examined as problematic, and in this book Triana (long an open critic of the tool's role in encouraging mayhem) uncovers exactly why it makes our financial world a more dangerous place. If we care for our safety, we should let VaR go.

  • Contains controversial analysis of the hotly debated risk metric Value at Risk (VaR) and its central role in the credit crisis
  • Denounces the role of regulators and academics in forcing the presence of the inevitably malfunctioning in financeland
  • Describes how bonus-hungry traders can use VaR as an alibi to take on the most reckless of bets
  • Reveals how the most recent financial crisis will simply repeat itself if the problems behind VaR are not unmasked
  • Pablo Triana is also the author of Lecturing Birds on Flying

The very risk measurement tool that was intended to contain risk allowed financial firms to blindly take on more. The model that was supposed to save us condemned us to misery. The Number That Killed Us reveals how this has happened and what needs to be done to correct the situation.

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Introduction When a Tie Is More Than Just a Tie ix

April 28, 2004 Steve Benardete Gets His Wish; The World Suffers xxvii

Chapter 1 The Greatest Story Never Told 1

Chapter 2 Origins 49

Chapter 3 They Tried to Save Us 71

Chapter 4 Regulatory Embracement 89

Chapter 5 Abetting the CDO Party 113

Chapter 6 VaR Goes to Washington 161

Chapter 7 The Common Sense That Should Rule the World 181

Finale The Perils of Making the Simple Too Complex 213

Guest Contributions 223

Why Was VaR Embraced?

A Q&A with Nassim Taleb 223

A Pioneer Wall Street Rocket Scientist’s View An Essay by Aaron Brown 226

Notes 245

Acknowledgments 251

About the Author 253

Index 255

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Pablo Triana is a professor at ESADE Business School, and the author of Lecturing Birds On Flying (also by Wiley) and Corporate Derivatives. He has published widely on risk management, derivatives, and banking regulation in many of the world's leading financial and business imprints. He has held various roles in the financial industry.
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“Pablo Triana, whose previous book was an elliptical trip around the world of risk entitled Lecturing Birds on Flying, knows whereof he speaks. Indeed, he was one of the quants entrusted with the task of gaming VaR…Triana’s argument is that it wasn’t subprime US mortgages or excessive remuneration or even financial engineering as such that brought the banking system to its knees. It was the hubris of quants who believed that market risk could be encapsulated in a single number, the naivety of regulators who, he implies, did not have the little grey cells to argue with them, and the greed of banker bosses who quickly cottoned on that this ‘objective’ measure of risk was in fact highly subjective and infinitely manipulable…I hope [the book] prompts a response from VaR’s remaining defenders.”—Financial World

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November 21, 2011
It's Time to Learn the Truth About the Financial Crisis

The credit crisis that erupted in 2007 has shaken the world to its knees.  Many have tried to explain the causes, but the main culprit has so far been left unaddressed. What was truly, truly, behind the wreckage?  According to Pablo Triana, derivatives expert and author of Lecturing Birds on Flying (Wiley; June 2009) - it all comes down to a number.

Otherwise known as Vale at Risk or VaR, this metric is used by financial institutions and regulators to measure market risk and determine bank capital requirements. It allows firms to leverage up their speculative, and often toxic, bets to unimaginable levels. This is a sure recipe for blowing up. According to Triana, the financial crisis will simply repeat itself if the problems behind the numbers are not unmasked.

Pablo Triana takes a critical look at VaR in his latest book, The Number that Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis (Wiley, ISBN: 978-0-470-52973-7; December 2011; Hardcover). This book finally tells the "greatest story never told" and how this mysterious financial risk measurement model has ruled the world for the past two decades continuing to cause market, economic, and social turmoil.

VaR is just starting to be examined as problematic. In The Number That Killed Us, Triana takes readers through the development of VaR and shows how its inevitable structural flaws allowed banks to take on even greater risks. The precise role of VaR in igniting the latest crisis is thoroughly covered, including in-depth analysis of how and why regulators, by falling in love with the tool, condemned us to chaos. Triana uncovers exactly why it makes our financial world a more dangerous place. If we care for our safety, we should let VaR go.

In the early 1990s, regulators and policy makers worried about the trading exposures that financial institutions were increasingly carrying.  And thus VaR was born and quickly embraced by financial institutions and regulators as the answer to managing risk.  As long as an institutions’ VaR number was in an acceptable range, it could do what it wanted.  The metric not only hid the iceberg lurking beneath the surface but allowed banks to pile on more and greater risk.  VaR, in effect, created the iceberg, by allowing banks leverage of 100-to-1 and even 1000-to-1 on portfolios loaded with the most toxic assets ever devised by humankind. Wall Street duly sank, and the reverberations of that debacle in turn helped unleashed the 2011 Euro meltdown, compounding the crash and spreading misery all around. It is likely that had VaR not been given the keys to the risk and capital kingdoms, the Occupy Wall Street phenomenon would not have taken place.

The very risk measurement tool that was intended to contain risk allowed financial firms to blindly take on more. Pablo Triana’s The Number That Killed Us reveals how VaR is a problem and what needs to be done to correct the situation.

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The Number That Killed Us: A Story of Modern Banking, Flawed Mathematics, and a Big Financial Crisis (US $39.95)

-and- The Only Three Questions That Still Count: Investing By Knowing What Others Don't, 2nd Edition (US $29.95)

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