Behind AIG's Fall, Risk Models Failed to Pass Real-World Test - WSJ.com:
"Gary Gorton, a 57-year-old finance professor and jazz buff, is emerging as an unlikely central figure in the near-collapse of American International Group Inc.
Mr. Gorton, who teaches at Yale School of Management, is best known for his influential academic papers, which have been cited in speeches by Federal Reserve Chairman Ben Bernanke. But he also has a lucrative part-time gig: devising computer models used by the giant insurer to gauge risk in more than $400 billion of devilishly complicated deals called credit-default swaps."AIG relied on those models to help figure out which swap deals were safe. But AIG didn't anticipate how market forces and contract terms not weighed by the models would turn the swaps, over the short term, into huge financial liabilities. AIG didn't assign Mr. Gorton to assess those threats, and knew that his models didn't consider them. Those risks have cost AIG tens of billions of dollars and pushed the federal government to rescue the company in September.
The turmoil at AIG is likely to fan skepticism about the complicated, computer-driven modeling systems that many financial giants rely on to minimize risk. As chief executive of Berkshire Hathaway Inc., which owns insurance companies, Warren Buffett has been sounding the alarm about the issue for years. Recently, he told PBS interviewer Charlie Rose: "All I can say is, beware of geeks...bearing formulas."