The other day, a friend sent me a really interesting interview with a Hedge Fund manager (HFM), discussing, among other things, the sub-prime mortgage problems, and what it implied for rigorous analytic trading. There are some very interesting observations about what constitutes expertise, and how effective even the best analysis can be. Here's a key graf:

HFM: So I think in comparison to the overall quality of mortgage origination in the last, call it, 3 or 4 years, ours was really much better. So I think they're happy we did a better job than our competitors--but they're not happy they lost money.

n 1: Is the person who ran that--is he going to get fired?

HFM: He was already fired.

But--to get back to the paradigm shifts--here was a guy who knows the market really, really well, who is a real expert in the nuts and bolts of mortgage lending, and really knew the collateral really well--but he was a true believer, and I think a lot of people were... true believers in the paradigm.

And there were other people at the firm, say, at the middle of last year, who were not mortgage experts, who were saying, you know, "I see the run-up in housing prices in some of these geographies, and I just don't really get it. I go down to Florida and see the forest of cranes, and I just really wonder, who's going to be in all those apartments... I see these commercials on TV, you know, about low-doc, no-doc mortgages--and there is no way, there is no way that this is not going to end badly... This is the perfect example of a bubble--and we should be short, we should be short sub-prime paper."

But the person who was the expert, the person who ran the sub-prime business, who traded sub-prime paper and issued the CDOs, he was a true believer in the paradigm: "In 2003, people said that the credit quality of the average sub-prime mortgage was deteriorating, and now look, those mortgages have performed fine. The sub-prime market works."

And, hey, he was the expert--you defer to the expert.

This touches on something which I've been thinking about recently: As we rely more on predictive tools and analytics, how can we avoid missing the forest for the trees? Nobody doubts the value of expertise, but what about perspective?

What if the non-expert traders in this scenario were able present a convincing data-driven case that the sub-prime mortgage was a bubble? How many tens of millions of dollars could that have saved?