If you have been following The ERM Current™ over the past few weeks, you will probably recall discussions about systemic risk permeating the financial markets. Well, yesterday the Wall Street Journal chronicled the making of the engine that fueled the systemic risk. Much of the credit derivative problem emanated from AIG and their use of sophisticated computer models to value the risk within each of their financial products. An academic consultant from Yale University promoted these models and was paid handsomely for it. His name is Gary Gorton and here is what he had to say just last month.
"You have this very, very complicated chain of the movement of the risk, which made it very opaque about where the risk finally resided. And it ended up residing in many places. So the whole infrastructure of the financial market became kind of infected, because nobody knew exactly where the risk was."
The primary objective of these financial products was to be "opaque" so investors would unwittingly buy into the scheme. However, when the institutions who peddled these products placed their faith in the computer models to value the risks, their fate was sealed.
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