Financial Crisis Solution: Nobel Prize Winner Harry Markowitz Proposes Strategies

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Harry Markowitz, IFA Academic Consultant, outlines method for valuation and pricing of opaque mortgage tranches

Harry M. Markowitz - 1990 Nobel Prize Winner

Index Funds Advisors (ifa.com) today released an important and timely article written by Harry Markowitz, 1990 Nobel Laureate and IFA Academic Consultant.

"What to do about the Financial Transparency Crisis" reveals Markowitz's carefully detailed proposed resolution for valuing and applying priced-risk factors to the heretofore opaque mortgage tranches which currently carry untold risk and unidentified valuations. Markowitz's straightforward proposal outlines a simple, but profound four-step process to enable the owner of the mortgages, which currently happens to be the U.S. taxpayers, qualify and quantify the potential value of the debt securities based on default risk and property fundamentals.

"No one knows who has the bad paper," stated Markowitz. "The long-term effectiveness of the bailout plan remains unknown until firms, counter parties, regulators and their supervisors are able to accurately value the exotic financial instruments. What good is supervision if supervisors have no more idea than anyone else of the value of supposedly 700 billion dollars worth of pieces of paper?" Markowitz added.

Markowitz's vast and specific knowledge of the particular problems plaguing the U.S. financial system provide significant credence to his detailed analysis. Markowitz is best known for his important discoveries that explain the impact of risk, correlation and diversification on investment returns.

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In his 1952 findings, Markowitz sparked an ongoing movement that is collectively known as Modern Portfolio Theory--and he is widely known as the Father of Modern Portfolio Theory. Perhaps equally significant, but not as widely known, Markowitz is also the 1989 recipient of the von Neumann Theory Prize from The Institute of Management Sciences and The Operations Research Society of America.

"While the von Neumann prize had no monetary award, I consider it three times as good as my Nobel Prize since it recognizes three of my accomplishments, namely, portfolio theory; the SIMSCIPT programming language (once widely used to tell computers how to simulate manufacturing, transportation, computer systems, and war games); and, most relevant here, sparse matrix techniques," states Markowitz. "'Sparse matrix' is the way I characterized huge sets of equations whose coefficients are mostly zeros. Sparse matrix techniques are now part of any production code for solving large systems of equations and would be very useful for this exercise," he added.

Markowitz's piece takes exception to would-be detractors who may proclaim, "You, Harry Markowitz, brought math into the investment process with your 1952 article and 1959 book. It is fancy math that brought on this crisis. What makes you think now that you can solve it?" the article queries. Markowitz deftly answers such potential accusations, arguing that he was responsible for developing portfolio theory, a clear distinction from the financial engineering methodologies that led to the current downfall of today's financial markets.

"Neither my own portfolio, nor those which my clients supervise or advise nor, to my knowledge, any of the large institutional investors (e.g., pension funds) who apply portfolio theory in a generally accepted manner, have suffered excessively from the crisis of the last thirteen months," Markowitz argues. "Most have lost of course. It is part of a risk-return view of portfolio selection that if you want more return on average, and you proceed efficiently, you will have to accept greater fluctuations in the short run. So don't blame me and my people," he concluded.

About Harry Markowitz:

Dr. Harry Markowitz is a professor of portfolio theory at Rady School of Management at University of California, San Diego. He is also the recipient of the 1989 John von Neumann Theory Prize, and is the author of Portfolio Selection: Efficient Diversification of Investments, as well as numerous academic papers and journal articles.

About Index Funds Advisors (IFA):

Index Funds Advisors (IFA) is a fee-only independent financial advisor, registered with the U.S. Securities and Exchange Commission (SEC). The company was founded in 1999 by IFA president, Mark T. Hebner (click here to watch Mark Hebner's view of the current markets). Mark Hebner is also the author of Index Funds: The 12-Step Program for Active Investors. IFA provides investment advice to high-net-worth individuals, foundations, 401(k) plans and endowments. IFA is headquartered in Irvine, California, with branch offices in Westlake Village, California, Madison, Wisconsin and New York, New York, with regional representatives in San Diego and Monrovia, California and Naples, Florida.

To learn more visit ifa.com.

Contact: Mary Brunson
Phone: 949-428-0432
Fax: 949-502-0048
Email: mary @ ifa.com

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Mary Brunson
IFA
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