Financial Engineering vs. Mechanical Engineering


It's not all that often that you read comments over at Dealbreaker and think: "Wow. This is pretty profound."

Don't get me wrong. I love Dealbreaker. I used to run that place. But the comment sections tends toward the profane rather than profound.

Yet a commenter signing on as "CDO guy" explained yesterday why confusing financial engineering with other types of things called engineering is a mistake:

You can say "a metal of x tensile strength will fail when subjected to pressure of y" with some certainty. With finance, you can only say "history tells us that when interest rates do x and property values do y, people have done z." For example, prior to the recent crisis, people tended to abandon their credit cards prior to their homes. In other words, it's far from certain. Financial models are predicated upon compounding assumptions, not concrete principles of mathematics and science.

This is something regularly lost in discussions about the financial crisis. People assume that the brilliant men and women of finance must have known that things would implode, which implies that they must have been fraudulently pretending that things were just fine. But, in truth, all of their models told them that a national housing downturn was borderline impossible, something that had only happened once and would never happen again.

Financial models are projections from readings of history. That is all.

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