Greenspan testifies about his flawed model and Morningstar quotes Buffet

Read the short exchange below.  It’s a quote taken from Greenspan’s testimony to Waxman followed by a brief Buffet quote that we should all heed and to commit to memory.  The most interesting sentences to us are:  “Now in his case, the model breaking contributed to (some say it caused) the most costly meltdown in history. What if there was a flaw in the model that you base your investment decisions on? Would you be shocked? What would the implications be for you and your family?”

I Found a Flaw in My Model

REP. HENRY WAXMAN (D-Calif.): And my question for you is simple: Were you wrong?

ALAN GREENSPAN: And what I’m saying to you is, yes, I found a flaw….a flaw in the model that I perceived is the critical functioning structure that defines how the world works, so to speak.

REP. HENRY WAXMAN: In other words, you found that your view of the world, your ideology, was not right, it was not working?

ALAN GREENSPAN: That is–precisely. No, that’s precisely the reason I was shocked, because I had been going for 40 years or more with very considerable evidence that it was working exceptionally well.

The part that worries me the most about what former Fed Chairman Greenspan told to Congress was the part about the “model” not working. This is one of the brightest economists ever. This is the guy that President Bush called a “rock star.” What he is saying here is that after 40 years of “considerable evidence,” the model broke. Now in his case, the model breaking contributed to (some say it caused) the most costly meltdown in history. What if there was a flaw in the model that you base your investment decisions on? Would you be shocked? What would the implications be for you and your family?

Warren Buffett reminds us: Investors should be skeptical of history-based models. Constructed by a nerdy-sounding priesthood…these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: Beware of geeks bearing formulas.

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