It’s silly to blame risk-management calculations for sinking financial firms.

All of this comes back to me now as I contemplate Warren Buffett's animadversions against my people. The warnings about lethal interactions with overconfident nerds gain traction, I think, because they invoke the haunting specter of Dr. Frankenstein. Or maybe I'm thinking of a villainous scientist in one of the late Michael Crichton's novels. Wild-eyed number crunchers, the theory goes, have unleashed monsters that they are unable to control. Buffett himself has branded derivatives as "financial weapons of mass destruction." George Soros—cited with equal frequency in the emerging genre of crisis-lit—has added that he has long avoided the use of derivatives on the grounds that "we don't really understand how they work."

Well, with all due respect to the billionaire financial geniuses of the world, I just don't buy it. Modern financial models are highly imperfect, to be sure, and we the modelers are insufferably arrogant. But models don't kill banks; bankers kill banks. We geeks may grunt a lot (we want the world to know how laborious our calculations are), but the truth is that our models aren't that hard to build, and they aren't that hard to take apart. When bankers and their advisers fail to question the premises of these models, it's usually because they find those premises quite congenial. The models merely provide an excuse to exercise a faculty for which human beings have always shown a special talent, namely, wishful thinking. What's worse, they also provide the financial community with a rhetorical device for persuading government officials that banks are, by virtue of their purported technical expertise, capable of achieving that audaciously oxymoronic state of being known as "self-regulation." 

At the origin of the current crisis is not a new kind of mathematics but a fundamental change in the system of rewards and punishments that steers the financial management of the modern economy. Back in the first half of the 20^th century, Austrian economist Joseph Schumpeter worried that capitalism would collapse under the weight of its own bureaucratic mass. He fretted that the large and increasingly complex corporations of the world would stifle innovation and thus deprive capitalism of the risk-taking, entrepreneurial spirit so central to its survival. He found a receptive audience among those who designed today's options-based executive-compensation schemes and among those who oversaw the deregulation of the financial sector.

Schumpeter's followers need no longer worry about risk-averse corporate bureaucrats. Thanks to heads-I-win-tails-you-lose incentive plans, not to mention "regulation" that consists of urging banks to keep a close eye on themselves, the leaders of our large financial institutions have become some of the riskiest people in business. Indeed, their willingness to gamble with other people's money represents a new, fundamental force in modern capitalism. Schumpeter, lifting a line from Friedrich Nietzsche, talked about the gales of "creative destruction" that sweep away the unproductive elements in a capitalist economy and make way for the new.  In this reckless age, the right phrase would be "destructive destruction."

Frankenstein and Jurassic Park notwithstanding, the language in which the financial crisis needs to be discussed isn't the language of science. The damage we see around us wasn't caused by an erroneous formula or an innovative financial technology gone berserk, and it won't be solved by banning the derivatives bomb. We need to be talking in the language of ethics—not ethics in the narrow, legalistic sense involving hanky-panky in the office and fingers in the till, but ethics in the broader, original sense of the term.  This crisis is about simple things: trust, integrity, and responsibility—or lack thereof.  We should be using words like self-dealing, betrayal, and fraud.

(Photo of chalkboard from Getty Creative Images.)