Federal Reserve Board Chairman Alan Greenspan warned Tuesday that banks should not rely on computer models alone to manage risk.
"Although a sophisticated understanding of statistical modeling techniques is important to risk management, an intimate knowledge of the markets in which an institution trades and of the customers it serves is turning out to be far more important," Mr. Greenspan said at the Cato Institute's annual monetary policy conference.
Computer models are based on overly simplified assumptions that may skew the results, he said. Highly trained bankers, however, can read all the data to more accurately predict economic trends, he said.
Mr. Greenspan devoted the bulk of his remarks to warning that an economic crisis in a developing country could threaten the world's financial markets.
"The very efficiency of global financial markets ... also has the capability of transmitting mistakes at a far faster pace throughout the financial system in ways that were unknown a year ago," he said.
Governments can prevent global financial crises if they keep prices stable and disclose more information about the health of their banks, he said.
Low inflation encourages economic growth, he said, and disclosures keep investors from being caught by surprise-and pulling out en masse-when the real extent of a financial crisis becomes known, he said.
Mr. Greenspan urged foreign governments suffering from financial crises to avoid capital controls, transaction taxes, and similar measures. "Risk taking-so indispensable to the creation of wealth-would undoubtedly be curbed," he said.
Speaking at the same conference, Jerry L. Jordan, president of the Federal Reserve Bank of Cleveland, urged governments to rely more on market forces to regulate the financial system. "If private agents expect the authorities to rescue them from peril, they are more likely to imperil themselves," he said. "This is the essence of moral hazard."
Regulators also could encourage market discipline by releasing more timely data on foreign exchange reserves and other monetary policy indicators, he said.
Still, Mr. Jordan said the government must maintain a role in bank regulation. "Central banks must engage in prudential supervision to counteract disruptions stemming from these market distortions," he said.
