My favorite economist, Greg Mankiw led me to an alternative
explanation of the 2007-2009 financial collapse. This explanation is in
Wired magazine by Felix Salmon. Salmon says that financial quants
started using a measure of joint risk called a Gaussian copula that had
an inherent flaw when applied to real world assets. The
measure of risk was based on a comparison of two instruments, say two
bonds, based on the market performance of their two respective CDS
(Credit Default Swap) prices. The history of CDSs was too short to be useful.
I've thought this over and I don't buy it. It is true but it isn't
causative. It means many risk instruments seemed much safer than they
really were and many investors would have been hurt by a falling
housing market. But the explanation is not systemic. It is the
equivalent of every bond rating house being wrong in their
evaluation...many people get hurt but the system would contain it.
We've had a systemic global financial collapse.