Computer models have been getting a bad rap. It is often claimed that risk mangers and CFO’s at major banks made the mistake of relying to heavily on their models. But likes so many other things that are often said, this is self serving. It makes it seem as if all these smart people were just naive little boys who didn’t know any better.

The truth of the matter is that financial executives deliberately gamed their own models. As this New York Times blog post explains….

In other words, the computer is supposed to monitor the temperature of the party and drain the punch bowl as things get hot. And just as drunken revelers may want to put the thermostat in the freezer, Wall Street executives had lots of incentives to make sure their risk systems didn’t see much risk.

“There was a willful designing of the systems to measure the risks in a certain way that would not necessarily pick up all the right risks,” said Gregg Berman, the co-head of the risk-management group at RiskMetrics, a software company spun out of JPMorgan. “They wanted to keep their capital base as stable as possible so that the limits they imposed on their trading desks and portfolio managers would be stable.”

One way they did this, Mr. Berman said, was to make sure the computer models looked at several years of trading history instead of just the last few months. The most important models calculate a measure known as Value at Risk — the amount of money you might lose in the worst plausible situation. They try to figure out what that worst case is by looking at how volatile markets have been in the past.

But since the markets were placid for several years (as mortgage bankers busily lent money to anyone with a pulse), the computers were slow to say that risk had increased as defaults started to rise.

It was like a weather forecaster in Houston last weekend talking about the onset of Hurricane Ike by giving the average wind speed for the previous month.

The first comment on this blog post claims that Goldman Sachs superior performance relative to their peers stemmed from the fact that they did not mess with their models. I don’t find this hard to believe. While I think that Goldman Sachs will not escape in the long run, computer models do have advantages. The biggest one being that they take emotion out of a lot of decisions.