Over a few beers one night, my friend Tim and I shared some comments about the state of the economy. Tim’s a pretty successful algorithm developer, so his point of view on finance is particularly insightful given that he thinks fundamentally different than most economists. As Tim put his drink down I remember him commenting on the bad financial engineering that contributed to the current credit crunch. “I just can’t see,” he said, “how you can be that stupid. Why would you get into the business of just trying to make securities and options on things you don’t know about?”
I think Tim’s right. While I can blindly recite some of the financial economics I’ve learned in my Money and Banking course on how securiziation (the process of making new securities out of financial opportunities) provides market growth, I too am a bit shocked that investors were so blind that they jumped on-board the money train bound for destitution and recession. Major investment bankers and financial consultants are not stupid by nature. From those that I know, I can infer a bit that a certain level of intelligence, creativity, and downright scrappy resolve is needed to compete in that market. In fact, the typical financial engineer strikes me as little more than a more social and arguably less meticulous version of your average software engineer. So why then would they so quickly jump on securitizing bad credit such as subprime loans?
The answer is hype. Worse, the answer is the worst type of hype imaginable: the type supposedly supported by math.
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