Tuesday, September 1, 2009

Spreadsheets blamed for Global Financial Crisis

That's right fellow hedgehoggers, you read it here first.

According to a paper released by Grenville J. Croll, Chair of the European Spreadsheet Risks Interest Group, the cause for the current Global Financial Crisis is all to do with spreadsheets and their susceptibility for human errors.

As Croll states, "to err is human" and it should not come as any surprise that the GFC was human based, after all, it is not like we hedgehogs had anything to do with it, it was all your fault for spending money you didn't have in the first place, accumulating debt at record rates than wondering why your house is remortgaged.

Anyway his paper Spreadsheets and the Financial Collapse states that: “Spreadsheets are integral to the function and operation of the global financial system”.

Awesome news. Of course these snippet do not give me confidence of this revelation.

"The majority (>90%) of spreadsheets contain errors. Recent research has shown that about 50% of spreadsheet models used operationally in large businesses have material defects."
That's hardly reassuring.

Then there is this:

"Because spreadsheet users do not go looking for errors, they don’t find any or many. Spreadsheet users are therefore overconfident in their use of spreadsheets."

If it ain't broke don't fix it but if it is broke but no-one realises, how can you fix it? But more concerning is the fact that humans can design a system, unintentionally create errors within it they can't see or fail to realise until it's too late but then interpret it incorrectly:

"Translation of a business problem into the spreadsheet domain can “…lead to a position where decision makers may act in the belief that decisions can be made with confidence on the output from the spreadsheet despite evidence to the contrary”."

That's a whole lot of whoops right there.

But it gets worst.

"Most spreadsheet models rely upon a fairly lengthy series of explicit or more usually, implicit, assumptions. Not least of these is the Ceteris Paribus assumption of all other things being (or remaining) equal. Clearly the assumptions underlying many spreadsheet models now no longer apply."
He concludes that: "We have confidence in concluding that spreadsheets played a role, perhaps even a significant role, in the recent collapse of the financial system ... in our opinion, their primary role is centred around the fact that they were one of the principal technologies used in the Credit Derivatives marketplace."

Furthermore:

"This market grew very quickly due to the ease with which it was possible to design and promulgate opaque financial instruments based on large spreadsheets with critical flaws in their key assumptions."

Anyway you should check this report out if you are interested in the GFC.

I think the interesting thing here however is the fact that in their recommendations, they suggest:

"If it is the case that we cannot build a safe and effective global financial system using spreadsheets as a key component, then we will have no alternative but to gradually replace
them, which will be time consuming and expensive, if indeed it is possible at all.

"The decision to replace a spreadsheet or set of spreadsheets with an alternative is a straightforward commercial decision, influenced by regulatory considerations, which would look at the risks, costs and benefits of each of the alternatives."

If you want to replace spreadsheets then where would you start? I guess you could always turn to the European Spreadsheet Risks Interest Group -- I am sure they would have the answers.

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