MetLife And Sorkin: The Tyranny Of The Quant

| About: MetLife, Inc. (MET)

Summary

A third article appeared in the New York Times today, criticizing Judge Collyer’s ruling that MetLife is not a systemically important financial institution (SIFI).

The article, by Andrew Ross Sorkin, contains a pernicious argument.

Sorkin argues that Federal Judge Collyer does not have the technical skills necessary to decide this issue.

The investing public must reject any such argument.

The New York Times' negative reporting on Federal Court Judge Collyer's ruling for MetLife (NYSE:MET) continued this morning. Judge Collyer's finding that the government had not proven its case for the systematically important financial institution designation (SIFI) of MetLife was attacked by Andrew Ross Sorkin.

This Times article, " For a Generalist, Too Big to Fail May be Too Tricky to Judge" hauls out an old chestnut that has gained coinage in the banking business and in bank regulation in recent years, since the introduction of a new kind of bank employee, the "quant," onto bank payrolls.

"Quants" are people hired by financial institutions primarily for their quantitative abilities. They are useful in pricing securities, in risk management activities, and in algorithmic trading, among other things.

As these quants became part of the portfolio valuation and portfolio risk management process, the regulators of banks have increasingly adopted quantitative methods as well, hiring quants of their own. This is understandable. Regulators need to match the quantitative skills of regulated financial institutions. The logic is the same as hiring French-speaking employees to regulate French-speaking banks. There should not be, as there once was, an inability for regulated banks to fully explain themselves to bank regulators.

The public and the judiciary, on the other hand, have no such obligation. It is the public's franchise that the banks and their regulators use. The burden of communication with the investing public is falls on banks and their regulators.

Sorkin's objection to Judge Collyer's ruling is that the judge does not have sufficient quantitative training to form an opinion about the SIFI designation of MetLife.

In this argument, Sorkin has reversed the burden of proof. In Sorkin's view, it is not the obligation of the regulator to communicate with the courts and the public. It is the obligation of the courts and the public to understand the regulator.

This pernicious, and not uncommon, argument can never be allowed to stand. Responsible mathematicians and scientists have long understood its danger. Witness Albert Einstein's famous quote:

To be Albert Einstein required at least two skills: an awesome intellect, and the wisdom that anything important could be explained to an interested six-year-old. More importantly, he saw it as his responsibility to make his own work understandable to a six-year-old.

I will take this further. When a government official, or much worse - a journalist whose function is to explain the important decisions of our time to readers with 25 cents to buy a newspaper - tells us that we are in need of technocrats to decide important decisions impacting our economy for us, we are lost as a society. Believing that it is the public's job to accept the superior intellect of the quant, we are traveling down the road to intellectual serfdom.

I think of witch doctors and the Voting Rights Act when I see this nonsense.

And I remember hard lessons in my early training. I have a master's degree in math, am ABD in statistics, and a PhD in econometrics. I can be complicated if I need to be. But after graduation, I delivered a seminar on my PhD thesis to an audience containing Milton Friedman.

He walked into my office afterward and said to me: "There are two reasons for a paper to be that complicated. 1. It's wrong. 2. It doesn't matter." And turned on his heel and walked out.

Friedman himself was a skilled mathematician and undoubtedly understood every word of the paper. But his point stuck with me and since that uncomfortable moment, I use math sparingly, usually sitting alone in my office.

But the idea that a Federal Judge must be a PhD in statistics to decide whether MetLife is SIFI is far more pernicious than my little attempt to impress. It is a threat to our participatory democracy. And when the argument is raised by a journalist I don't question the judge's abilities; I question those of the journalist.

The judge, Sorkin reports, is a member of the United States Foreign Intelligence Surveillance Court. I would be very surprised if she has not also been told in this capacity that the technology of surveillance is too complex for a "generalist" to understand. Maybe that's where the judge learned what guff this "too technical" argument is.

But this aura of complexity permeates the modern financial climate. It is part of the litany of modern banking and banking regulation.

Banks inform their stockholders frequently throughout each quarterly report that they cannot explain the risks of their businesses - it's too complicated. Baloney. I do not advise owning things that cannot be explained.

Ford (NYSE:F) doesn't tell me how to manufacture a car. But they tell me the car's specs, how much it costs, and how much demand they expect for each model.

Bank regulators tell investors and voters that they can't explain how required capital is determined. It's complicated. Nonsense. If it's complicated, make it simpler. It's the voter's economy. It's the investor's stock. Make sense of the rules, or get rid of the rules.

And nobody can say why MetLife is SIFI. Perhaps it isn't.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.