This post first ran on January 29th on my mortgage blog. It got some traction there and a few mentions in the press so, lazy bastard that I am, I’m reproducing it here in a slightly improved form that corrects my own math error.

Take a look at this chart that someone sent to me a couple days ago. I’m making it big so you can see as much detail as possible. Have a look and then come back, okay?

Pretty scary, eh? It’s a chart showing the deterioration of major bank market caps since 2007. Prepared by someone at JP Morgan based on data from Bloomberg, this chart flashed across Wall Street and the financial world a few days ago, filling thousands of e-mail in boxes. Putting a face on the current banking crisis it really brought home to many people on Wall Street the critical position the financial industry finds itself in.

Too bad the chart is wrong.

It’s a simple error, really. The bubbles are two-dimensional so they imply that the way to see change is by comparing AREAS of the bubbles. But if you look at the numbers themselves you can see that’s not the case.

Take CitiGroup, for example. The CITI market cap dropped from $255 billion to $19 billion — a difference of 13.4X. If we’re really comparing the areas of the bubbles, that means 13.4 of those tiny CitiGroup-of-today bubbles should precisely fill the big CitiGroup-of-the-good-old-days bubble. Only they won’t. As a matter of fact it would take about 13.4 times as many little bubbles to fill the big bubble as the chart preparer thought or 179.64 little bubbles. Pi r squared, remember? This is because the intended comparison wasn’t two-dimensional but one-dimensional — the chart maker was intending we compare the DIAMETERS of the bubbles, not their areas.

So it’s a typo: no big deal, right? Yeah, but what a typo! It got past Bloomberg and JP Morgan and pretty much all of Wall Street before someone said, “Hey, this makes no sense!”

And who was that someone? Me! A nobody. Or at least someone unimportant enough not to be asking for a Federal bailout.

How could this be? It’s because Wall Street doesn’t work the way we think it does — the way we are led to believe it does. Wall Street is a marketplace, a selling ground where everything from ideas to stocks and bonds are on sale every day. And there is nobody easier to sell to than a salesman. Come up with a good chart that’s ALMOST within an order of magnitude of reality, put a disclaimer on the bottom, and let ‘er rip.

No wonder we’re in a global financial crisis.

The people we count on to understand what’s going on can’t even read a chart.