After the Crash, Scientific American:

[Xipe Totec]

Scientific American says quants need to learn more economics and history before deploying their mathematical tools:

If Hollywood makes a movie about the worst financial crisis since the Great Depression, a basement room in a government building in Washington will serve as the setting for a key scene. There investment bankers from the largest institutions pleaded successfully with Securities and Exchange Commission (SEC) officials during a short meeting in 2004 to lift a rule specifying debt limits and capital reserves needed for a rainy day. This decision, a real event described in the New York Times, freed billions to invest in complex mortgage-backed securities and derivatives that helped to bring about the financial meltdown in September.

In the script, the next scene will be the one in which number savvy specialists that Wall Street has come to know as quants consult with their superiors about implementing the regulatory change. These lapsed physicists and mathematical virtuosos were the ones who both invented these oblique securities and created software models that supposedly measured the risk a firm would incur by holding them... Without the formal requirement to maintain debt ceilings and capital reserves, the commission had freed these firms to police themselves using risk tools crafted by cadres of quants.

The software models in question estimate the level of financial risk of a portfolio for a set period at a certain confidence level. As Benoit Mandelbrot, the fractal pioneer who is a longtime critic of mainstream financial theory, wrote in Scientific American in 1999, established modeling techniques presume falsely that radically large market shifts are unlikely and that all price changes are statistically independent... Here is where reality and rocket science diverge. Try Googling “financial meltdown,” “contagion” and “2008,” a search that reveals just how wrongheaded these assumptions were. ...

http://economistsview.typepad.com/economistsview/2008/11/quants-did-it.html

[atimetocome]

1. hard to believe we have a science president coming up.

[BrklynLiberal]

2. Guess like Alan Greenspan, Mr. Mandelbrot made a miscalculation...

and everyone ELSE had to pay for it...

[AndyTiedye]

4. Mandelbrot Pointed Out the Flaw in the Models

This was not his mistake. He was mentioned for pointing out what they got wrong.

[BrklynLiberal]

8. You are right. I misread that long sentence...

[dixiegrrrrl]

3. Software?????? This was a software problem????

Sorta the reverse of the infamous year 2000 problem?

[iamahaingttta]

5. Actually, that problem was not "fixed"...

...it was only postponed until the year 2027.
Most companies and government agencies solved the Y2K thing by "windowing" date fields rather than by "expanding" date fields.
We're going to have that same problem again in less than 20 years.

[dixiegrrrrl]

7. All my money AND computer disaster coming???

Need long pins.
Need Bill Gates doll.

[Xipe Totec]

9. "I tend to round off numbers to the nearest billion dollars"

- David Stockman, Ronald Reagan's Director of the Office of Management and Budget



http://www.time.com/time/magazine/article/0,9171,925914,00.html

[librechik]

6. great piece, and the comments are a must to read--

wow--there is an entire education in economics below the entry