In testimony before Congress today, Alan Greenspan placed the blame for the current financial crisis squarely on the use of mathematical models to determine value and risk for mortgage-backed securities: "It was the failure to properly price such risky assets that precipitated the crisis," he said. "In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivates markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment."Whether or not Mr. Greenspan has the right to blame quants for problems some believe he started with his steady lowering of long-term interest rates, which led to a skyrocketing of the mortgage market, is a question to be tackled by a more knowledgeable person than me. But the issue he raises - essentially, why didn't the pricing and risk models Wall Street uses save them from massive losses in mortgage-related securities - is one that Ivy Schmerken and I have been pondering for more than a year. The answers are legion and include the lack of detailed data about mortgage-related derivatives, overconfidence in the rating agencies' work, excessive leveraging, and unprecedented market events including the subprime disaster.

But surely, more sophisticated pricing and risk modeling technology couldn't hurt. In a well-timed release, Numerix and R2 introduced this week a set of risk and valuation analytics for evaluating complex derivatives.

The new product, which has the catchy name NxR2, covers a spectrum of structured credit solutions that includes asset-backed securities, residential mortgage-backed securities and collateralized debt obligations. "Over the last year and a half, we've seen a huge need for transparency," says Dan Rosen, CEO of R2. "It's been very hard for investors and for everyone in the market to understand their collateral, derivative structures, and the implication of valuation methods on them."

Rosen notes that in the past a lot of firms, including pension plans and institutional investors, have relied on valuations that came from the dealers directly or from very simple models based on ratings. "A lot of firms didn't have the ability to do risk analytics or used very little valuation," he says.

Numerix and R2 are trying to provide consistent pricing and risk methodologies that cut across asset classes (Numerix provides the price modeling, R2 the risk software). The software can accommodate Gaussian copula modeling and Monte Carlo type simulations. It provides the ability to stress test and model worst-case scenarios. Would this product have helped firms deal with September 15, the Lehman crashed and burned?

"We don't predict the future. I wish we did -- it would be a lot easier to make money," Rosen says. "We were doing valuations for some clients around that time, we saw Lehman's CDS spreads jump up by July to really high levels. I remember thinking, come on, Lehman is not going to go down, but the CDS market was looking at it as a big risk, the market was already betting that Lehman would either default quickly or survive forever." Rosen notes that in such times, financial models are hard to calibrate. "The markets were not trading liquidly, they were trading on fear." However, the product provides a framework where quants could model a default scenario - how much money would a portfolio of CDOs lose if Lehman was in a couple of them?