Arnold Kling  

Merton on the Financial Crisis

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A great lecture. Found by Steven Hsu. Pointer from the indispensable Mark Thoma.

I enjoyed his comments on asset valuation. He wonders whether the issue is that the assets cannot be valued or that key players (bankers, regulators) don't want them to be valued.

He takes what I call the "geek" side of the suits vs. geeks debate. His view is that the assets are not necessarily undervalued. He emphasizes the nonlinearity, put option nature of the assets. Another key point is that it does not take complex derivatives to create embedded options. Many ordinary assets have embedded options, with resulting nonlinearity.

Rather than blame new instruments and complexity, he blames the disconnect between nonlinear instruments and linear thinking. This shows up in the process of rating AIG as AAA, which did not take into account the nonlinear risk of their swap portfolio.

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COMMENTS (4 to date)
Linus Stephens writes:

If you're interested in hearing more about the economy, the US Chamber of Commerce is hosting a conference call with one of the nation's top economists, Martin A. Regalia. The event is taking place on April 17, 2009 at 9 AM Arizona time. If you're interested in hearing his take on President Obama's budget, you definitely should register to listen in. To register, visit and click on the link to register.

Jim Glass writes:

"I am Merton, Destroyer of Fortunes"

A track record as serial wealth destroyer -- Long Term Capital Managment and Trinsum Group -- might give rise to a tad of skepticism about a fellow's investment insights. Or maybe that's just me, I dunno.

Darren writes:

"Beware of geeks bearing formulas."

--Warren Buffett

Ben Casnocha writes:

Merton spoke to my group in Colombia the other week and was terrible. He must be better when speaking to experts as opposed to lay people.

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