Will This Other Finance-Related Bubble Also Backfire?

The venerable Sloan School of Business at the venerable Massachusetts Institute of Technology recently announced the launch of a new educational program, its very own Masters in Finance. For those less than exaggeratedly interested in the graduate education landscape and who may doubt the relevance of such news, let me assure you that Sloan´s initiative is nothing short of revolutionary. It is the first time that a truly top US business school has decided to offer a fully-fledged specialized finance degree, in a pioneering move that may soon be imitated by some of MIT´s privileged peers (the likes of Harvard or Stanford). In doing so, Sloan joins a bandwagon that had steadily become globally crowdier. The past few years have witnessed an unmistakable explosion in the number of finance university programs worldwide, housed by both notorious institutions (Oxford, Cambridge, Princeton) and by a myriad of less mythical schools. Such development comes on the heels of a prior, even more pronounced, burst in the number of graduate degrees in quantitative finance-financial engineering-computational finance, subdisciplines that concern themselves with the heavy-duty mathematical, statistical, and software-design skills typically employed by the brainiac “quants” found inside investment banks and hedge funds.

In sum, it wouldn´t be far-fetched to say that the international financial education field is experiencing its own bubble, glowingly exemplified by MIT´s jump into the market. Paradoxically, of course, this bubble is reaching peaky dimensions precisely when the bubble that had afflicted the real financial world for so long is being prickled at a horrifyingly accelerating rate. Will all those newly-minted finance graduates be welcomed by such a lackluster job and earnings environment? Could the prickling of the real financial bubble hasten the prickle of the educational bubble?

I for one hope that is not the case. As a very strong defender of the rationale for specialized finance programs (I kind of forecasted MIT´s move a while back), I would hate to see such valiant efforts hampered because a bunch of irresponsible players decided to bet the house (pun very much intended) on the possibility that people with no income, no jobs, and no assets would not default on their unseemly mortgage loans. So my heartfelt support is with Sloan and all the others.

But such declaration of love does not imply that these new finance degrees are mistake-free. In particular, the contents of many of them are perilously close to being irrelevant in today´s shaky environment and, worse, may contribute to helping restore and perpetuate notions and practices that have clearly been key driving forces behind the current malaise and turmoil. To put it bluntly, many of these programs indoctrinate students into the sacredness and hallowedness of techniques and tools that have consistently shown (in this crisis as well as before) their unrepentant capacity to wreak havoc in the markets. There is no doubt that a big casualty of the credit nightmare than began in the summer of 2007 has been the validity of theoretical and quantitative methods in finance. The complex mathematical models used to value and rate complex credit derivatives structures proved spectacularly lacking. Value at Risk was revealed clothes-less by much-bigger-than-indicated losses. Advanced econometric forecasting tools did not provide any warning. The central tenets of modern financial economics (markets behave normally, rare events don´t happen, liquidity is not an issue, standard deviation is a reliable measure of risk) were savagely devastated by a tidal wave of hard-knocking reality. Quant funds suffered huge setbacks (though it is not entirely clear the extent to which such computer-aided punters care for finance theory at all).

And yet, the flavour of many of the new finance programs is indelibly theoretical and quanty. While the exact curriculum details are still unknown, there is a danger that, given its technical background, MIT may too err on the side of abstract abstruseness. At a time when the mathematical finance edifice is crumbling harshly and when the obsession with assigning precise, concrete figures to unknown parameters such as expected loss or default correlation has proven sensationally erroneous, is it the right approach to loudly promote those failed tenets from the far-reaching academic confines? Masters in Finance graduates are being touted as an elite corps of financial wizards, the chosen ones who will lead the finance industry into the future. Given the troubles that an unfettered faith in quantitative “certainties” can provoke, we would all be that much safer if those individuals joined the financial world free of any illusions as to the true value of theoretical and mathematical gimmicks.