Here's a fascinating interview with Amar Bhide, who discusses the problem with using mathematical formulas to replace human judgement in the financial world.
One problem with the analysis is that Bhide recognizes that his observations apply to the regulatory structure as well as to large banks, but he seems to think that the regulatory structure can be changed to solve the problem, rather than allowing free markets to solve it. A regulator is always about group think and putting everyone facing in the same direction, thus it is always vulnerable to the BIG risk. Free markets are about many actors trying different things, with those choosing correctly surviving and the others falling by the wayside.
Bhide also does not discuss the role moral hazard has in creating reliance on mathematical formulas, since it is hard to see how those relying on mathematical formulas would survive and receive additional investments if they failed time after time with their mad formulas.
The mathematical paradigm survives, not because it has been tested and survived in the markets, but because the geeky personalities in the regulatory sphere love these models and will spend billions (of taxpayer money) to prop up those who use them and fail. Furthet they will structure additional "protections" for the system by regulating in favor of those who use the mathematical paradigm and away from those who use human judgement.
Pay particular attention to Bhide's warning about Basel III and how it is setting the financial system up for the next grand collapse.
(ViaTheHayekCenter)
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