<p>No amount of expertise or regulation can prevent economic depressions. This is simply impossible.</p>
<p>To be clear good financial regulation and prudent financial management are one of the factors that potentially can <em>reduce</em> frequency of economic depression but it certainly cannot eliminate them altogether.</p>
<p>For example, some economic depressions come from technological change and shocks to technology (Romer 2014 Advanced Macroeconomics). Financial regulation and management or quantitative finance can hardly prevent technology from advancing.</p>
<p>More broadly economic depressions can be caused by various other supply shocks. For example, the Russian invasion of Ukraine caused drop of GDP that is estimated to be around 45% according to <a href="https://www.worldbank.org/en/news/press-release/2022/04/10/russian-invasion-to-shrink-ukraine-economy-by-45-percent-this-year" rel="nofollow noreferrer">World Bank</a>. This is more than US contracted during Great Depression and it clearly does not have anything to do with finance.</p>
<p>Next important potential driver of economic depressions are shocks to aggregate demand. These can occur for various reasons, for example, loss of consumer confidence (ibid).</p>
<p>Finally, better financial regulation would probably not be able to eliminate even financial crises altogether. A good analogy is air safety. Thanks to regulation we made air travel the safest form of travel available. Yet, despite of being the safest for of travel, planes occasionally crash due to malfunction and human error. There are no 100% foolproof regulations, regulation just mitigates risk it does not set it to zero. I don’t think there are any economists or financial regulators who believe financial crises can be completely eliminated. For example, no amount of financial regulation can set risk of bank collapse to zero in system without full reserve requirement.</p>
<p>Regarding the fraud, better oversight can certainly reduce it, but again I don’t think anyone believes fraud can be eliminated completely, similarity as it is impossible to completely eliminate petty theft.</p>
<p>Next quantitative models can be used to detect and prevent fraud. However, such models are either multidisciplinary and not necessarily closely related to regular quantitative finance models. I found <a href="https://onlinelibrary.wiley.com/doi/abs/10.1002/isaf.1509" rel="nofollow noreferrer">this review of literature</a> on quantitative financial fraud prevention models and they often quote works outside finance literature. Nonetheless, again it’s doubtful that you can completely eliminate fraud this way, same way as using quantitative modeling can help but not completely eliminate regular crime.</p>
<p>Lastly to address what is in the title, you can’t necessarily avoid downturn because of predicting it. For example, if there is depression coming because of new disrupting technology, let’s say you predict someone invents clean, cheaper, more abundant perfect substitute for oil next year, when you share this information and people believe you, you will just cause the recession that would come as a result of this technology shock to happen sooner. People would start dumping stock of companies producing oil already now. Firms would reduce investment and employment there already now. Paradoxically by <em>credibly</em> predicting depression you just hastened it.</p>

CC BY-SA 4.0
2023-07-25T17:27:07.733Z
In a Netflix documentary about Bernie Madoff, it does mention that one of the very first people to be suspicious of Bernie Madoff's business practices was Harry Markopolis. Harry Markopolis was a quantitative finance genius. In said documentary, Mr. Markopolis looked at a financial chart that was on one of Bernie Madoff's business brochure for his Investment Advisory Business. Mr. Markoplis looked at the chart, and using his quant skills, he thought it was easy to notice that Madoff's business was a Ponzi scheme fraud.
crazyTech
CC BY-SA 4.0
2023-07-25T17:27:29.860Z
Mr. Markopolis said it took him a very short time for him to get suspicious about Madoff's business. There probably are a lot of  financial engineers & quants in the financial world. However, How good are they at their fields? From what I've read, financial engineers & quants have Masters/Phds in like Mathematics, Physics, etc.
crazyTech
CC BY-SA 4.0
2023-07-25T17:27:57.003Z
Essentially, the aforementioned fields are quite challenging. Therefore, I'm just thinking out loud. Why didn't other financial engineers & quants come to the same conclusion as Mr. Markopolis about Madoff? Why didn't anyone at the American SEC financial regulator come to said conclusion?  It seems to me that there are Not enough Highly Skilled financial engineers & quants in the financial world especially in the government regulatory organization.
crazyTech
CC BY-SA 4.0
2023-07-25T17:28:00.413Z
Again, I'm Not trying to be overly harsh. Studying to be a highly skilled financial engineering & quantitative finance is difficult. I once heard someone say that there are too many lawyers at the American SEC.
crazyTech
CC BY-SA 4.0
2023-07-25T17:43:43.353Z
@crazyTech well but that anecdote can take you only so far, its not like that person was only financial expert in the world. He was probably at a right place and time to notice it. Plus experts can get bamboozled by charismatic charlatans as well Madoff managed to run his ponzi scheme for so long precisely because he knew all the regulators, he literally helped to write lot of the financial regulation. He was even being investigated few times but he knew who to talk to and people were scared to accuse him because of his reputation.
1muflon1
CC BY-SA 4.0
2023-07-25T17:48:11.550Z
expertise can get you only so far because in every organization there are various social & economic incentives. For example, consider the whole covid19 lab leak kerfuffle
  [recently journalists](https://www.dailymail.co.uk/health/article-12289007/Scientist-denounced-Covid-lab-leak-theory-said-privately-highly-likely.html) got emails through the freedom of information act which show that even though publicly regulatory agencies dismissed it, privately most experts thought it is very likely but feared it will affect their research funding, similarly in finance regulatory agencies
1muflon1
CC BY-SA 4.0
2023-07-25T17:51:58.290Z
you cant just go after any important person unless you have such an incontrovertible evidence that it is impossible to dismiss it. That is just fact of life. This does not mean that everyone who foresaw it was some special genius, same way as the scientists who were the first to argue lab leak was not a conspiracy were not some special geniuses, just likely people who did not face as large conflicts of interests. Expertise in itself does not help if there is no correct incentive structure in place. Moreover, when it comes to uncovering any criminal activity, which is usually covert by its
1muflon1
CC BY-SA 4.0
2023-07-25T17:52:15.523Z
nature there is always some probability it will 'fly under the radar'. This does not mean expertise does not matter, if I would think that i would not care to get PhD etc, but no amount of expertise can completely prevent idiosyncratic shocks to economic system, and no amount of expertise can fix crime when there are incentives to commit crime, not properly prosecute it, hide it etc. Some could even argue, experts can sometimes be better at colluding with industry as they can better set up corrupt structures that only very few other people can understand and unwind
1muflon1
CC BY-SA 4.0
2023-07-25T16:05:57.823Z
2023-07-25T16:21:47.870Z
2023-07-25T16:21:47.870Z
1muflon1
<p>I was trying to understand why economic depressions and financial fraud occurs every now and then.</p>
<p>Is one of the reasons because there is lack of people with strong quantitative finance &amp; financial engineering backgrounds?</p>
<p>To elaborate, firms, institutes, companies and especially government regulators do Not have enough people</p>
<p>with the aforementioned backgrounds.</p>
<p>Furthermore, it's a little bit more complicated than blaming people for Not having a strong understanding of</p>
<p>the fields of quantitative finance &amp; financial engineering. The reason being is that the aforementioned fields</p>
<p>are extremely difficult academic fields that generally require students of said fields to have high scholarly aptitude</p>
<p>and intellectual capacities.</p>
<p>Moreover, when it comes to government financial regulators failing to find financial fraud sooner</p>
<p>( e.g. Madoff financial fraud went on for 40 to 50 years ) is because said regulators do Not have</p>
<p>enough skillful quantitative finance &amp; financial engineering experts.</p>
<p>Also, it's a lot more complicated than blaming government financial regulators because</p>
<p>skillful quantitative finance &amp; financial engineering experts will Not be attracted</p>
<p>to a relatively lower salaries offered by government jobs at government financial regulators.</p>
<p>In other words, said experts would find the salaries at private investments firms, institutes, banks, etc.,</p>
<p>much more attractive.</p>
<p>Is the aforementioned evaluation reasonably accurate?</p>

CC BY-SA 4.0
2023-07-25T07:10:40.020Z
When you copy paste stuff, could you at least fix the formatting?
AKdemy
<mathematical-economics><financial-economics>
Failure to see economic depressions and financial fraud due to Shortage of capable quantitative finance & financial engineering experts
crazyTech
# Failure to see economic depressions and financial fraud due to Shortage of capable quantitative finance & financial engineering experts

(Asked by: username_0 on 2023-07-25)

I was trying to understand why economic depressions and financial fraud occurs every now and then.

Is one of the reasons because there is lack of people with strong quantitative finance & financial engineering backgrounds?

To elaborate, firms, institutes, companies and especially government regulators do Not have enough people

with the aforementioned backgrounds.

Furthermore, it's a little bit more complicated than blaming people for Not having a strong understanding of

the fields of quantitative finance & financial engineering. The reason being is that the aforementioned fields

are extremely difficult academic fields that generally require students of said fields to have high scholarly aptitude

and intellectual capacities.

Moreover, when it comes to government financial regulators failing to find financial fraud sooner

( e.g. Madoff financial fraud went on for 40 to 50 years ) is because said regulators do Not have

enough skillful quantitative finance & financial engineering experts.

Also, it's a lot more complicated than blaming government financial regulators because

skillful quantitative finance & financial engineering experts will Not be attracted

to a relatively lower salaries offered by government jobs at government financial regulators.

In other words, said experts would find the salaries at private investments firms, institutes, banks, etc.,

much more attractive.

Is the aforementioned evaluation reasonably accurate?

**Tags:** mathematical-economics, financial-economics

> **Comments:**
> **username_1**: When you copy paste stuff, could you at least fix the formatting?  

---

## 1 answers

### Answer by username_2 on 2023-07-25. Score: 1

No amount of expertise or regulation can prevent economic depressions. This is simply impossible.

To be clear good financial regulation and prudent financial management are one of the factors that potentially can *reduce* frequency of economic depression but it certainly cannot eliminate them altogether.

For example, some economic depressions come from technological change and shocks to technology (Romer 2014 Advanced Macroeconomics). Financial regulation and management or quantitative finance can hardly prevent technology from advancing.

More broadly economic depressions can be caused by various other supply shocks. For example, the Russian invasion of Ukraine caused drop of GDP that is estimated to be around 45% according to [World Bank](https://www.worldbank.org/en/news/press-release/2022/04/10/russian-invasion-to-shrink-ukraine-economy-by-45-percent-this-year). This is more than US contracted during Great Depression and it clearly does not have anything to do with finance.

Next important potential driver of economic depressions are shocks to aggregate demand. These can occur for various reasons, for example, loss of consumer confidence (ibid).

Finally, better financial regulation would probably not be able to eliminate even financial crises altogether. A good analogy is air safety. Thanks to regulation we made air travel the safest form of travel available. Yet, despite of being the safest for of travel, planes occasionally crash due to malfunction and human error. There are no 100% foolproof regulations, regulation just mitigates risk it does not set it to zero. I don’t think there are any economists or financial regulators who believe financial crises can be completely eliminated. For example, no amount of financial regulation can set risk of bank collapse to zero in system without full reserve requirement.

Regarding the fraud, better oversight can certainly reduce it, but again I don’t think anyone believes fraud can be eliminated completely, similarity as it is impossible to completely eliminate petty theft.

Next quantitative models can be used to detect and prevent fraud. However, such models are either multidisciplinary and not necessarily closely related to regular quantitative finance models. I found [this review of literature](https://onlinelibrary.wiley.com/doi/abs/10.1002/isaf.1509) on quantitative financial fraud prevention models and they often quote works outside finance literature. Nonetheless, again it’s doubtful that you can completely eliminate fraud this way, same way as using quantitative modeling can help but not completely eliminate regular crime.

Lastly to address what is in the title, you can’t necessarily avoid downturn because of predicting it. For example, if there is depression coming because of new disrupting technology, let’s say you predict someone invents clean, cheaper, more abundant perfect substitute for oil next year, when you share this information and people believe you, you will just cause the recession that would come as a result of this technology shock to happen sooner. People would start dumping stock of companies producing oil already now. Firms would reduce investment and employment there already now. Paradoxically by *credibly* predicting depression you just hastened it.

> **Comments:**
> **username_0**: In a Netflix documentary about Bernie Madoff, it does mention that one of the very first people to be suspicious of Bernie Madoff's business practices was Harry Markopolis. Harry Markopolis was a quantitative finance genius. In said documentary, Mr. Markopolis looked at a financial chart that was on one of Bernie Madoff's business brochure for his Investment Advisory Business. Mr. Markoplis looked at the chart, and using his quant skills, he thought it was easy to notice that Madoff's business was a Ponzi scheme fraud.  
> **username_0**: Mr. Markopolis said it took him a very short time for him to get suspicious about Madoff's business. There probably are a lot of  financial engineers & quants in the financial world. However, How good are they at their fields? From what I've read, financial engineers & quants have Masters/Phds in like Mathematics, Physics, etc.  
> **username_0**: Essentially, the aforementioned fields are quite challenging. Therefore, I'm just thinking out loud. Why didn't other financial engineers & quants come to the same conclusion as Mr. Markopolis about Madoff? Why didn't anyone at the American SEC financial regulator come to said conclusion?  It seems to me that there are Not enough Highly Skilled financial engineers & quants in the financial world especially in the government regulatory organization.  
> **username_0**: Again, I'm Not trying to be overly harsh. Studying to be a highly skilled financial engineering & quantitative finance is difficult. I once heard someone say that there are too many lawyers at the American SEC.  
> **username_2**: @username_0 well but that anecdote can take you only so far, its not like that person was only financial expert in the world. He was probably at a right place and time to notice it. Plus experts can get bamboozled by charismatic charlatans as well Madoff managed to run his ponzi scheme for so long precisely because he knew all the regulators, he literally helped to write lot of the financial regulation. He was even being investigated few times but he knew who to talk to and people were scared to accuse him because of his reputation.  
> **username_2**: expertise can get you only so far because in every organization there are various social & economic incentives. For example, consider the whole covid19 lab leak kerfuffle   [recently journalists](https://www.dailymail.co.uk/health/article-12289007/Scientist-denounced-Covid-lab-leak-theory-said-privately-highly-likely.html) got emails through the freedom of information act which show that even though publicly regulatory agencies dismissed it, privately most experts thought it is very likely but feared it will affect their research funding, similarly in finance regulatory agencies  
> **username_2**: you cant just go after any important person unless you have such an incontrovertible evidence that it is impossible to dismiss it. That is just fact of life. This does not mean that everyone who foresaw it was some special genius, same way as the scientists who were the first to argue lab leak was not a conspiracy were not some special geniuses, just likely people who did not face as large conflicts of interests. Expertise in itself does not help if there is no correct incentive structure in place. Moreover, when it comes to uncovering any criminal activity, which is usually covert by its  
> **username_2**: nature there is always some probability it will 'fly under the radar'. This does not mean expertise does not matter, if I would think that i would not care to get PhD etc, but no amount of expertise can completely prevent idiosyncratic shocks to economic system, and no amount of expertise can fix crime when there are incentives to commit crime, not properly prosecute it, hide it etc. Some could even argue, experts can sometimes be better at colluding with industry as they can better set up corrupt structures that only very few other people can understand and unwind  

---

