2008 financial crisis / derivatives collapse

Brief tangent triggered by mention of Robert Merton (Nobel laureate, Black-Scholes algorithm). Tom describes derivatives as "a big Ponzi scheme" and attributes the financial collapse to derivatives abuse. Not developed.

The example: a few years later I was listening to Lester talk over at the Marriott Hotel to a bunch of people. He was still the dean, and he was lamenting that the business school up the river, with all their money, tends to hire away some of the best faculty from MIT. Everyone sort of knew he was talking about Robert Merton. Anybody know who Robert Merton was at the time? Robert Merton worked for Black and Scholes, who came up with the algorithm for derivatives — which also brought down the world economy. That's another story if you want to talk about the 2008 crash and why it occurred. Derivatives are a way mathematically to predict what you expect the value of something to be in the future, and we can talk about how they were abused by all the people on Wall Street and in London and elsewhere, and that was what caused the financial collapse. It's not that derivatives are a bad thing — but it had changed the whole world of finance. Black and Scholes were the faculty; they passed away, but Merton won the Nobel Prize when he was at Harvard for this. So it's a fairly well-respected thing.

Used as the punchline of the Lester Thurow "extinct volcanoes" anecdote — Merton / Black / Scholes derivatives Nobel and the 2008 collapse. Tom: "not because the theory was wrong, but because people were abusing it."

For example, he was lamenting the fact that this business school up the river would tend to hire away some of the top faculty from the Sloan School because they had all this money. And he said, "But fortunately they tend to hire our extinct volcanoes." That metaphor of extinct volcanoes does not require any explanation. You know exactly what he means. I know he was talking about Robert Merton, who is the father of derivatives along with Black and Scholes. Merton was the graduate student, I think. Black passed away, but a few years later, in the 1990s or maybe early 2000s, Merton won the Nobel Prize for derivatives. And of course in 2008 the whole world economy fell apart because of derivatives. Not because the theory was wrong, but because people were abusing it. Hard to believe that someone would abuse something that had to do with money, right? I could give you another economics lesson on derivatives, but it's not worth it.

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