Vaunted mathematical models have at times done poorly in preventing financial meltdowns.
I refer to two examples, the LTCM (1998) and the subprime mortgage (2008) disasters.
Why did the math models behind them fail?
These math models were made up by top researchers, mathematicians, and celebrated “quants,” who figured they had anticipated all cyclic contingencies.
Yet, bond markets eventually fell apart despite their calculations. Afterward, those responsible found they should have looked at contingencies even further back than they had.
But I see a bottom line weakness in math models, no matter how much research is done. It happened with the LTCM breakdown. It very definitely is what I feel was a factor in the subprime crisis, which haunts America and the world to this day.
There is a common thread between the two breakdowns which has to do with the fact that we react to problems with panic. That is because our “experts” who come to the rescue are unfortunately from the financial community, attuned only to the short term. They cannot see how caution and avoiding over-zealous, impulsive action can overcome the danger. So they act in haste.
There was a human error in these instances, other than in mathematical calculations. Often that error is enforced by government in the form of strict regulation that is actually a reaction with the very panic that such regulation supposedly has been developed to suppress.
The formulae probably would have worked over the longer term. These are never successful for short-term markets that regulation certainly overlooks.(See the Earl J. Weinreb NewsHole® comments and @BusinesNewshole at Twitter.)
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