The Signal and the Noise: Why So Many Predictions Fail-but Some Don't

by Nate Silver

But leverage, or investments financed by debt, can make the error in a forecast compound many times over, and introduces the potential of highly geometric and nonlinear mistakes. Moody’s 50 percent adjustment was like applying sunscreen and claiming it protected you from a nuclear meltdown—wholly inadequate to the scale of the problem. It wasn’t just a possibility that their estimates of default risk could be 50 percent too low: they might just as easily have underestimated it by 500 percent or 5,000 percent. In practice, defaults were two hundred times more likely than the ratings agencies claimed, meaning that their model was off by a mere 20,000 percent. In a broader sense, the ratings agencies’ problem was in being unable or uninterested in appreciating the distinction between risk and uncertainty.