Is mathematics a force for accountability? Or is it a shield against accountability?
I recently gave a talk to the Undergraduate Math Union at the University of Toronto to explore one instance of a mathematical algorithm used in Wall Street that enabled the 2008 Financial Crisis. It was manipulated by the "auditors of the financial system" to make over-optimistic predictions about the economy, helping large investment banks sell toxic investment products all over the world. The implosion of those toxic products sparked the Financial Crisis.
Blurb for the talk
The correlation was underestimated by Credit Rating Agencies (the "auditors" of the financial system), misleading banks into buying those package deals. We will explore some weaknesses in the mathematical models of these agencies that led them to underestimate the correlation. We will also touch on conflicts of interest that drove the agencies to manipulate their analyses, in order to underestimate correlation even further. How is math used or abused by these "auditors" who wield so much power over the financial system - a power that affects even our savings and retirement funds?
No background knowledge is necessary, beyond a familiarity with plotting functions as graphs and calculating the area under them (which you might get from a Calculus course).
Where to learn more?
- Check out Felix Salmon's fantastic article "The formula that killed Wall Street", an accessible introduction that's available on WIRED.
- If you're hungry for details, check out the surprisingly (for a government publication) accessible Financial Crisis Investigation Report, commissioned by the US Congress. It goes into many more factors in the crisis than I could ever have time to cover in my talk, so you can see every dimension of rot in the system!
- For an epic story that reveals the patterns and common causes the recent financial crisis (2008 Financial Crisis, Eurozone Crisis, Greek Debt Crisis, etc.) and tells the behind-the-scenes negotiations by politicians and financial world elites, check out the book Crashed by Adam Tooze.
- Jordan Nickerson and John M. Griffin, 2017. Debt correlations in the wake of the financial crisis: What are appropriate default correlations for structured products?. Journal of Financial Economics, 125(3), pp.454-474
- Samuel Watts, 2016. The Gaussian Copula and the Financial Crisis: A Recipe for Disaster or Cooking the Books?
- Felix Salmon, 2012. The formula that killed Wall Street. Significance, 9(1), pp.16-20.
- Settlement between USA and Moody’s Investors Service: Annex I, Statement of Facts, p. 10