Open sourcing code may improve transparency on Wall Street

Researcher argues for open sourcing of risk models to improve financial codes, boost transparency

But Greenspan's assertion that lenders were technologically-enabled to judge the risk was wrong. RealtyTrac estimates that as many as 1 million people will loose their homes this year due to foreclosure. In 2007, 400,000 people lost their homes. Late last year, Greenspan increased his forecast of a recession.

The financial impact of the bad loans rose up through the financial system. Once the mortgage originator sold the loan, it was then sliced up into other investments, making any understanding of the risk progressively worse. The human elements, such as the number of so-called "liar's loans" (loans based on unverified income), weren't, apparently, part of the risk models. These problems are expected to increase investment in risk management.

Gerding said he believes the answer is to open source the financial codes, which would let the banks and rating agencies see the actual code for models that are used to set capital requirements and how the risk was assessed.

"Just as with open source software, other users would then be able to copy and modify these models for their own use," said Gerding, who noted studies supporting that open source was less prone to bugs.

Wall Street firms are already major users of open source software. But Lisa Cash, executive vice president of sales and marketing at DFA Capital Management, a company that develops financial codes, said it will be very difficult to get high quality products out in the market. "Who would actually spend the money to do it?" Cash asked.

Unlike US regulators, European counterparts audited the risk models, Cash said, which increased transparency and confidence in them. The more transparency, "the better it is for our business," she said. European regulators look at the codes, but agree not to disclose them.

But others suggest that improving transparence will not be as easy as simply opening up code. Peter Teuten, president and CTO of Keane Business Risk Management Solutions, said there were neither common standards in risk management, nor anything like a "universal stress test" for more than a basic set of risk scenarios.

Teuten questions an open source as a model because it may lead to multiple, non-centralized development. He does, however, see standards emerging from the current crisis.

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