My mini quest to find out what the hell has happened to the world economy continues apace – now it is Wired’s turn to cast some light on the situation. Focusing on an aspect that hasn’t gotten a lot of attention – risk and complex mathematical shit – it does a really good job. A formula was created that made it easier for financial institutions to measure correlation of risk by making some assumptions.
Everyone loved the idea – basically because it allowed people to make a bunch of new financial products, sell them and make lots of money – but the idea was not understood by most people. The assumptions it makes means that the results it gives are not as reliable as people thought. It is an unsafe foundation to build a financial system on, but that’s what happened (there is nothing wrong with the formula itself, the problem is the unwise use it was put to.) When the cracks appeared in the foundation, everything above it toppled.