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risk
by leon on November 11, 2008

Earlier this year, I did a blog entry looking at how financial innovation had led to the meltdown.
As the New York Times points out, the basic problem with the models built around mathematics, computing and statistics is that they ignored the human factor. "In recent years, the securitization of the mortgage market, with loans sold off and mixed into large pools of mortgage securities, has prompted lenders to move increasingly to automated underwriting systems, relying mainly on computerized credit-scoring models instead of human judgment. So lenders had scant incentive to spend much time scrutinizing the creditworthiness of individual borrowers."
What's even more scary, the piece points out, is that economists said the risk models used by Wall Street analysts correctly predicted that a drop in real estate prices of 10 or 20 percent would imperil the market for subprime mortgage-backed securities but the analysts assigned a very low probability to that happening.
All the sophistication in the world could not beat arrogance.
Permalink: How the predication models failed
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