Geek Squad's Models Missed Risks—and AIG Paid Price

Insurance giant's dependence on computer predictions made situation far worse
By Kevin Spak,  Newser Staff
Posted Nov 3, 2008 12:06 PM CST
AIG appears to have relied too heavily on computer models for trading in credit-default swaps, and even knew those models didn't take into account a variety of real-world risks.   (AP Photo)
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(Newser) – “All I can say is beware of geeks bearing formulas,” Warren Buffett once said. AIG didn’t heed his advice. The huge insurer bet tens of billions on credit-default swaps, guided by imperfect risk-assessment models created by a moonlighting finance professor, the Wall Street Journal reports. AIG knew Gary Gorton’s models left out many market forces, but followed them anyway.

In December, AIG’s CEO told investors he had “a very high level of comfort” with his risk, and that all transactions went through the models’ calculations. But they measured only past defaults, not current conditions. “The models are all extremely simple,” Gorton told investors. Too simple, it turned out, to account for the rising collateral calls that eventually forced AIG to take federal handouts.