Good post on this subject at Carriedinterest.com

Link is: http://www.carriedinterest.com/2009/01/the-valuation.html

That is funny– and the reality often results in the fact that the keys were in the pant pockets from the start — and the street light is just a beacon that distracts a person from something obvious.

Computer models depend on people to fit the data to a problem and then try to fit solutions into equations that fit into a finite loop that makes everyone happy — for a short time, then the model needs adjusted, fine tuned and as more time passes, the model becomes more and more meaningless. This is very much like a drunk looking around for the obvious and then relying on the convenient illumination of something easy to gravitate towards, versus having self control and not getting so drunk that you can’t ponder the obvious!

Gap management was the original form of bank balance sheet risk management. It’s still important in commercial banks, although securitization deflected focus to some degree. And Investment banks in particular developed a very lax attitude to the importance of the idea in whatever risk monitoring they did, (although they should have learned from the Salomon Brothers event.)

The importance of FAS 157 on liability valuation is also critical, but gets little attention.

As far as the final paragraph is concerned, it’s gold.

But it’s also the case that the best financial services CEOs, who understand risk management does not mean quantitative slavery, also tend to see FAS 157 as accounting and capital slavery. They argue that FAS 157 content should be applied rigidly to disclosure, rather than inflexibly to accounting.

The CEOs of the 3 best run financial institutions in Canada (Manulife Financial, Royal Bank, Bank of Nova Scotia) have recently and separately made quite public statements that are remarkably similar connecting these two points on risk management and FAS 157. (And none of these institutions has any major problems with sub-prime or securitization exposures).