Alan Greenspan Speaks on Financial Innovation. Why it Failed.

Please read the testimony of ex-Federal Reserve Chairman before Congress on why the financial innovation of recent years, which he championed, failed so utterly. It is important to understand this failure of metrics, this failure of modeling. It all gets back to what I learned at the Center for Social Research at the University of Michigan: with complex models made possible by computing, garbage in, garbage out.

This is from Ed Yardeni’s daily feed to me:

Greenspan: “In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.”

Got that? It goes to what IDEO’s Tim Brown said to me last year at Davos—the products of financial innovation weren’t stress tested in the real world properly. It was bad innovation methodology.

Yeah, like so bad it’s brought us a global recession. Can we now get all those mathematical geniuses coming out of school to go into science and technology, instead of Wall Street?