Saul Hansell at the NY Times has an interesting article about why risk assessment programs in investment banks were not sounding the alarm coming into the recent turmoil. The article contains this gem:
Ms. Rahl said that it was now clear that the computers needed to
assume extra risk in owning a newfangled security that had never been
"New products, by definition, carry more risk," she said. The models
should penalize investments that are complex, hard to understand and
infrequently traded, she said. They didn't.
I continue to see parallels between recent problems and the meltdown at Enron. In fact, in many ways events in the natural gas trading market were a dry run for events in the mortgage market. One filmmaker coined the phrase "Smartest Guys in the Room" to describe the hubris of the guys who ran Enron. To some extent the phrase was absolutely true - I knew Jeff Skilling at McKinsey and he was indeed the smartest guy in the room. But everyone can be wrong, and sometimes the smartest guys can be spectacularly wrong as they overestimate their ability to predict and control complex events. I think this is a fair description of what went on in Wall Street over the past several years.