Rather, the crisis was caused by huge numbers of smart, self-interested people involved with the financial services industry -- buy-side industry, sell-side industry, institutional and retail customers, regulators, everyone -- responding rationally to the distorted incentives created by too-big-to-fail (TBTF), sometimes consciously, often unconsciously. Of course modelers were part of the crowd looking the other way, but that misses the point: TBTF coaxed everyone into looking the other way. So the key to financial crisis management isn't as simple as executing the modelers, who perform invaluable and ongoing tasks. Instead it's credibly committing to end TBTF, but no one has found a way. Ironically, Dodd-Frank steps backward, institutionalizing TBTF, potentially making the financial system riskier now than ever. Need it really be so hard to end TBTF? As Nick Kiefer once wisely said (as the cognoscenti rolled their eyes), "If they're too big to fail, then break them up."
Monday, August 18, 2014
Models Didn't Cause the Crisis
Some of the comments engendered by the Black Swan post remind me of something I've wanted to say for a while: In sharp contrast to much popular perception, the financial crisis wasn't caused by models or modelers.
Rather, the crisis was caused by huge numbers of smart, self-interested people involved with the financial services industry -- buy-side industry, sell-side industry, institutional and retail customers, regulators, everyone -- responding rationally to the distorted incentives created by too-big-to-fail (TBTF), sometimes consciously, often unconsciously. Of course modelers were part of the crowd looking the other way, but that misses the point: TBTF coaxed everyone into looking the other way. So the key to financial crisis management isn't as simple as executing the modelers, who perform invaluable and ongoing tasks. Instead it's credibly committing to end TBTF, but no one has found a way. Ironically, Dodd-Frank steps backward, institutionalizing TBTF, potentially making the financial system riskier now than ever. Need it really be so hard to end TBTF? As Nick Kiefer once wisely said (as the cognoscenti rolled their eyes), "If they're too big to fail, then break them up."
[For more, see my earlier financial regulation posts: part 1, part 2 and part 3.]
Rather, the crisis was caused by huge numbers of smart, self-interested people involved with the financial services industry -- buy-side industry, sell-side industry, institutional and retail customers, regulators, everyone -- responding rationally to the distorted incentives created by too-big-to-fail (TBTF), sometimes consciously, often unconsciously. Of course modelers were part of the crowd looking the other way, but that misses the point: TBTF coaxed everyone into looking the other way. So the key to financial crisis management isn't as simple as executing the modelers, who perform invaluable and ongoing tasks. Instead it's credibly committing to end TBTF, but no one has found a way. Ironically, Dodd-Frank steps backward, institutionalizing TBTF, potentially making the financial system riskier now than ever. Need it really be so hard to end TBTF? As Nick Kiefer once wisely said (as the cognoscenti rolled their eyes), "If they're too big to fail, then break them up."
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