The Rise of the (Financial) Machines 403
BartlebyScrivener writes "A New York Times Op-Ed quoting Freeman and George Dyson wonders if Wall Street geeks and 'quants' outsmarted themselves with computer algorithms to create the current financial debacle: 'Somehow the genius quants — the best and brightest geeks Wall Street firms could buy — fed $1 trillion in subprime mortgage debt into their supercomputers, added some derivatives, massaged the arrangements with computer algorithms and — poof! — created $62 trillion in imaginary wealth. It's not much of a stretch to imagine that all of that imaginary wealth is locked up somewhere inside the computers, and that we humans, led by the silverback males of the financial world, Ben Bernanke and Henry Paulson, are frantically beseeching the monolith for answers.'"
The quoted essay from George Dyson is available at Edge.
TFA perpetuates voodoo explanations (Score:5, Insightful)
Thanks, New York Times. Does your average reader have the reading comprehension of a 9 year old these days?
Here's what happened in simple English: investment banks invented various ways of packaging mortgages into securities. They then convinced ratings agencies to give these new securities AAA status even though the ratings agencies didn't understand them. This gave mortgage brokers a license to commit fraud because they could give a mortgage to anyone with or without a pulse and there was a sucker just dying to buy that new mortgage from them. With such easy money available, real estate agents were able to pump and dump properties (strong-arming housing appraisers was a favorite tactic) like there was no tomorrow and convince people that housing prices only go up in a straight line. In the final act of the play, the investment bankers, mortgage brokers and real estate agents that caused this retire in the Cayman Islands while taxpayers are left to clean up the mess while we hope our economy doesn't literally implode.
I don't see what's so complicated about any of this. It's pure and simple fraud on the most massive of scales.
Yes, let's blame the geeks (Score:1, Insightful)
It had absolutely nothing with the greedy executives telling them what numbers to put in, or the greedy people making the loans encouraging people to lie.
Its the Economists, Stupid! (Score:3, Insightful)
If civil engineers refused to back up their calculations with formulas derived from physics, they'd be liable when their structures fail. That's why they are lucky physicists -- at least the classical physicists upon which they base their calculations -- were fundamentally competent. The "quant geeks" are similarly limited -- but their problem is that their "physicists" are better than Court Astrologers -- but not by much.
The creation and transfer of funny money (Score:4, Insightful)
But they can. They did. The '90s tech bubble burst. The funny money that was created in the run up was promptly transferred into real estate. Lenders, overcome by a similar greed that overcame retirement investors, lent to people they knew they shouldn't have (or should have known). And voila. We have a horrible mess - basically, we think we have a lot more money than we actually do. The only viable solution? We need to realize the loss. It was never our money in the first place.
Re:TFA perpetuates voodoo explanations (Score:2, Insightful)
Ohhh, the rating agencies understood them just as well as anybody else.
There was a big data hole, static pool loss curves. They didn't have any for exotic loans being pushed to lower credit people, since all of the exotic loans had original uses for high-credit obligors. Thus, their loss estimation was too low, the multiple was too low, and thus, the credit enhancement was too low.
Nobody is retiring to the cayman islands, I think you need to get that fantasy out of your head. They were just as caught up in this problem as anybody else, except for the very top.
I do love how OP, and the article, confuse the subprime mortgage market with the CDS market. The CDS market would have existed regardless of subprime mortgages.
Not to mention that the amount of crossing of CDS and the use of notional amounts, without taking into consideration netting and recoveries, results in not "wealth" being credit, but more or less shuffled. The amount shuffled will be far less than the outstanding notional amount.
Re:This American Life (Score:5, Insightful)
YES! I whole-heartedly agree. I do not claim to be a financial maven, but I have been following the markets for a number of years and have some familiarity with the terms that have been bandied about as of late. But, these two shows did an INCREDIBLE job of taking arcane financial products and bringing them into focus with concrete examples. They showed how this crisis built up and is now unwinding.
As painful as this is, I do take some comfort in the crisis happening now rather than a year or two from now when even more leverage would have been injected into the system. That would make things FAR WORSE. Don't believe me? Let me repeat the links that eldavojohn [slashdot.org] provided: The first episode [thislife.org] sets the stage extremely well and explains how the mortgage crisis got going. The second episode [thislife.org] built upon the first and so clearly explains how the leveraging of these financial instruments got us into the credit crisis we are in today.
Listen to those. If you do nothing else today, LISTEN TO THEM.
Pure speculation, your honour. (Score:2, Insightful)
This might make an interesting defence for the crooks and gamblers who caused the problem through their greed and incompetence, but I'm not sure it deserves a place on what is generally a science/IT website.
Re:TFA perpetuates voodoo explanations (Score:2, Insightful)
It's an op-ed, not an editorial or a column. An op-ed is one step above a LTE, and is generally lightly edited. So it's hardly fair to blame the NYT for some specific stupidity of an op-ed or an LTE; their main concern is publishing a broad spectrum of well-written opinion.
This is ridiculous (Score:4, Insightful)
Re:If only people had listened to Ron Paul (Score:5, Insightful)
Anti-math/science witch hunt (Score:5, Insightful)
Re:TFA perpetuates voodoo explanations (Score:5, Insightful)
You forget the underlying problem: the bubble in housing prices. As long
as the house prices kept rising any idiot could take a 0% interest adjustable mortgage and make money 3 years later by reselling the house. Of course, analytical models showed the repayment rate on such mortgages to be high leading to lending more money.
Once the house prices started sliding the party was over.
Re:Yes, let's blame the geeks (Score:3, Insightful)
Of course Im a troll... If you want to ignore the truth...
Democrats, Republicans, Banks, Home Builders, Brokers, Speculators, Greed all played a part in this, and if you want to ignore this then... how does that saying go...
"Those that fail to learn from history, are doomed to repeat it."
Economy is Fundamentally Buggered (Score:5, Insightful)
The real problem is that Greenspan and Bernanke seem to have failed both basic economics and remedial math. Also, they must have been absent on the day that Keynesian monetary policy was explained.
As unpopular as it may be with some people, what you are seeing today are the fruits of Reagan-era economic policy, "Reaganomics" or as G.H.W. Bush called it "Voodoo Economics."
Basically, the Fed. has kept their lending rates artificially low for the past 20+ years. They have kept this rate well below the rate of inflation. Banks are paying and charging interest using this rate as the basis, since this rate essentially determines the "cost" of money.
Keeping this rate below the inflation rate encourages spending and borrowing rather than savings. After all, why save at 1% when inflation is 8% and you can borrow at 6%? By borrowing now, you can increase your buying power immediately, and get more for the same amount of money, instead of losing money in a savings account.
That's all fine, assuming your wages increase along with the inflation rate, but for most people, they haven't. When wages are not increasing to match the rate of inflation, then people are effectively getting a cut in pay and can afford to buy less stuff. (Obvious, right, but many people need this simple fact explained to them.)
So, as mentioned above, the low Fed. rates encourage borrowing, and even with the modest income increases most people can afford to keep on borrowing, but only for so long. Unless wages make a dramatic increase, borrowing consumers reach the point where they have borrowed all that they can afford to borrow. They reach the point where they are making minimum payments on their loans, paying bills, and for food, energy and other essentials, and there is no money left over. Upon reaching this point, even the most obtuse consumers will cut back on spending and borrowing. Those who don't will default and go bankrupt, whether they file papers to seek bankruptcy protection or not, they will for all intents and purposes be bankrupt.
This is, essentially, what has happened to the U.S. economy. The orgy of spending and borrowing has ended because the sun has come up and all the drunkards are staggering home after the party with massive hangovers.
This is also why injecting $700 billion to buy "bad" debt won't solve a thing. Even if the gov't buys the debt, the consumers will still owe that debt, and the conscientious ones will still try to pay it. As long as the consumers have to pay that debt, spending in the short term will be curtailed.
In the short term, there is no easy fix. In fact, many would think the cure to be worse than the disease. The long term cure is to return to the days of higher interest rates, less spending and more saving. Quite simply, Greenspan's little experiment on the American people has failed to produce the endless growth that he promised.
Computer models do what they are told. (Score:5, Insightful)
Look, if you live in an environment where you are under pressure to sell loans regardless of the risk, then you are likely going to wind up with computer models that tell you that it is going to work.
Computer models always carry the assumptions of the authors and those assumptions can be altered to suit climate. In the case of Wall Street, the assumption was likely the number of defaults on an M.B.S. as a function of credit score... and the thing is, that I bet that is spooking everyone is, that, credit score may not be a good predictor of repayment. I bet a lot of people had a decent credit score, right up until they mailed in the keys to their house.
Re:Slaves to Debt (Score:3, Insightful)
We'll all be paying for this for decades (unless we're among the hundreds of thousands in the UK, and probably millions worldwide, who will end up unemployed as a result of the bonus-chasing pinstriped bastards who caused all this), and the same situation will arise again when another bunch of fraudsters figures out a way to multiply money in a totally fictitious manner.
Unfortunately (Score:5, Insightful)
The author has a fundamental disregard for the actual underlying causes of the current economic crisis - the housing bubble. It cannot be that housing prices inflate over 300% (yes THREE HUNDRED PERCENT) in a mere ten years, while real inflation adjusted income remains the same. Sub-prime mortgages don't exist because there's a new generation of people out there who suddenly decided to default on their loans. They exist simply because no one can afford a house anymore.
Whoever you want to blame: "greedy" banks who made "irresponsible" loans (yeah, who ELSE were they going to loan the money to? There were no more buyers able to afford homes at those prices), the Fed for continuing to mismanage monetary policy (but the Federal Reserve has a history of doing this, dating back to its inception in the early 20th century), or creative accountants who tried as hard as they could to hide the shortcomings in these new "structured investment vehicles", the driving force behind today's (and tomorrow's!) economic woes is the pop of the biggest housing bubble in history.
The interesting thing is that the government has opted to print money to try to "save" the financial system and keep housing prices artificially inflated - as if anyone cares. The only person who cares about the price of their home is the person who wants to sell it. If you wanted to buy a house this year and sell it in 2 years for near 100% profit, well, welcome back to the real world again. This move on the part of the government will soon result in a collapse of the dollar.
But I was laughed at by some in July [slashdot.org] when the market was close to what many thought was a "market bottom" for saying the stock market was going to plunge lower. Guess what folks - we're still not at the bottom, despite being very near post-dot com bust lows. As a trader I watched the Dow drop 700 points in 5 minutes on Friday, only to bounce back positive, and then plunge again. This kind of volatility is NOT indicative of a bottom, it's indicative of a move to NEW lows. Housing prices should (if past bubbles are any guide) drop around 50%, which means they still have another 30% to go. Government interference in this correction will only serve to bankrupt an already insolvent US government, and destroy the US dollar's desirability on world markets.
The only people who are to blame are the greedy individuals who thought that the path to riches lay in buying real estate and "flipping" it a year or two later, with minor renovations - as well as a monetary system that is designed to spend today and pay tomorrow.
Wrong diagnosis but right fix. (Score:2, Insightful)
As unpopular as it may be with some people, what you are seeing today are the fruits of Reagan-era economic policy, "Reaganomics" or as G.H.W. Bush called it "Voodoo Economics."
This has nothing to do with Reagonomics. The idea behind Reagonomics was to lower the upper tax brackets from 70% down to a flatter rate so that people would be encouraged invest to invest their money and thus create a greater supply of consumer goods. This did exactly what it was supposed to do, as a whole the prices of consumer goods and commodities alike have largely been low, as investors sought the cheapest means of production. The essence of Reaganomics is that, we all have lots of stuff, and well, we do. So this aspect of Republican economics totally worked. Even Barrack Obama concedes, in his book, that in the USA, poor people have lots of stuff.
The critique of Reaganomics is, that, with its focus on investment, wage earners get screwed. You'll never see Democrats complain about having lots of stuff, and indeed, some will quitely condemn having so much stuff. Instead, you'll see them bemoan the social instability caused by Reaganomics. When you have investors able to shift their money around rapidly, you can leave social problems both when the money comes in and when it leaves. For every Silicon Valley or Shanghai or Dubai there is a Detroit. SO, the socialist retort is to not allow capital movement at all except via the will of the people, and, as a consequence, you can have a stabler society, except that, everyone has less stuff. North Korea is very stable, just like dead people are, and no one really has anything.
So now onto interest rates. Whether or not the Fed flooded people with low interest rates is not really the problem. You have low interest rates and low inflation because you need low inflation to have savings.
I do agree with you, though, that debt repayment by consumers will suppress economic growth in the short term, however, falling fuel prices will mitigate this somewhat. The problem is that everyone has borrowed too much. I've not seen too many figures indicating how much credit people are seeking, and, a ready indication of that figure would be a good tool for the fed to have and the people to see. I do believe that we shall public indebtedness decline and perhaps sharply. Just from my own perspective I've paid down about 30k worth of debt this year and I certainly have no plans to borrow soon, if ever. Like, I don't know that I'll ever take out another expensive car loan again...
But, if this happens, you see, people will need to save their money somewhere and it turns out that this savings can only go into precious few places. It can go under the mattress, which is stupid, it can go into commodities, which, I've argued might not be a bad move, or it can go into federal debt (treasuries), bank savings instruments, or securities, but all of those instruments are available to businesses as a means of obtaining cash for expansion and, you guessed it, the production of additional supply.
So, the moral of the story is, whether consumers choose to borrow and repay or save and buy, doesn't effect the overall course of Reaganomics all that much. All Reaganomics says is that investors are allowed to move their money about, just like consumers. The greatest irony of Reaganomics, we have achieved a sort of genuine sort of defacto socialism with it. There's a large percentage of the population that already does own stock of some kind, so much so, that one might well said that we as a people collectively do already own all the means to production.
Re:Ever wonder where 'money' comes from? (Score:4, Insightful)
Exactly, that's how one can easily arrive at 62 times the original amount. Truth be told it's probably worse. If you look at some basic numbers; the world production is measured to be about $50 trillion.
The secondary money market (known as derivatives) in the US, is $500 trillion. This means that the primary lending source (banks) sells the loans to someone else. Who incidentally, unlike banks, are totally unregulated. Who in turn then sells it too, and so it goes...
This is done with loans so many times over that we 10X the worlds total production. Think about that. A country's currency is really worth what the country produces. Just like any persons worth is what he has made. Countries used to say they are worth their weight in gold but that fact is only in history books. (Don't tell those who speculate because they make money on other people's work by driving it up and down.) Not gold on hand or anything like that. Which the Fed has all but lost anyway. The dollar is so overrated at this point it's not going to be pretty once the world starts looking closer.
My guess it's going to occur right around the time gold starts its climb back up. Gold has been going down for a long time. As I see it, all stocks and bonds are going to be worthless soon, and gold will be the only thing not only retaining value, but with currencies going down gold will go up.
Increase the score for mrbill1234 for the above link. Congress would do well to see it too. Too few people bother to learn what is going on, and now we pay the price for our ignorance.
If you have paid attention last week to the news a representative of the Federal Reserve actually came out and said it. For every dollar the bank has - 10 is lent out. His point was that removing 700 Billion means they lost 7 Trillion. Which is not correct because they just make more for each loan. It has nothing to do with Congress, that's just how the banking industry works.
With some simple research you can discover how the international banking world caused the -29 crash, and the two leading up to it as a business move. A move that let them come in as the saviors and start the Federal Reserve. This they said will stop it from happening again. You'll find for example that Pres. Woodrow Wilson on his death bed declared that he had sold out his country when he signed it into law. (Federal Reserve.)
Everybody figures that someone else is keeping an eye on things. As it was, our Sec of Treasury, and the Federal Reserve, went out and significantly lowered the requirements to get a home loan. Allowing people who could never afford it, to get a house loan. That's what I call creating a problem.
Re:Computer models do what they are told. (Score:3, Insightful)
Look, if you live in an environment where you are under pressure to sell loans regardless of the risk, then you are likely going to wind up with computer models that tell you that it is going to work.
The problem is not that individuals were given ARM & NINJA loans/mortgages.
The problem is not that the individuals were unaware of the exact nature of the loan terms they were receiving.
The problem is not even that the housing market collapsed and fucked over those individuals.
The problem is not that, instead of holding onto those loans, banks bundled that shit up and sold it.
The problem is that Moody's, Standard & Poor's, Fitch, and other financial rating agencies said "we rate these high-risk bundles of shit as if they are actually low-risk bundles of gold, act accordingly." And the markets did.
Credit Ratings Agencies do a lot by computer, but ultimately there is some analyst whose name goes on the report that says "this is AAA quality".
Because the markets had bad information, a grenade in the USA mortgage industry grew into a cluster bomb of global proportions.
Re:This American Life (Score:1, Insightful)
I'd go beyond that and say the basic problem is that subprime and interest-only mortgages are available at all.
Once financial institutions are required to make subprime and interest-only mortgages available and since they're going to have a higher default rate than conventionial mortgages, then it's a game of Hot Potato. How do you get rid of them before they default? Simple, bundle them with other mortgages and sell them to other financial institutions, last one to hold them when the bubble bursts is the loser.
Re:TFA perpetuates voodoo explanations (Score:4, Insightful)
Ah, liberals are at fault. (Score:3, Insightful)
I see where you're going with this. You're blaming the "Community Reinvestment Act" (CRA) that basically forces banks to lend to people they wouldn't otherwise lend to (i.e. people with bad credit) because they have to fulfill racial quotas.
I agree with you that this is part of the issue. But this whole problem is so far beyond liberal/conservative or Republican/Democrat. The problem is that we have a fairly corrupt system right now and everyone in power is culpable.
How about one of the reasons they made subprime loans was because they made money from them and they didn't have to bear the risk? You know, good old fashioned banker greed. So CRA was pushing them in that direction - but they were more than willing to go along!
Re:Yes, let's blame the geeks (Score:5, Insightful)
Quite a few of the larger banks avoided this mess too. JP Morgan, Bank of America and Wells Fargo are among the most notable. It is clearly a case that badly managed banks who ignored historically proven risk management practices to chase increased returns got burnt. NOBODY WAS FORCING THESE BANKS TO DO THIS.
Yes, it was public policy to encourage lending into inner cities. But NINAs, interest-only, HELOCs and ARMs? I DON'T THINK SO, and the fact is that these wacky loans are the biggest part of this.
let me break the news to you (Score:5, Insightful)
and let me break another news while im at it : there is a third concept : balanced economies. economies in which existentially critical services are controlled by government (like military, police, justice, healthcare) and all the remaining sectors are properly regulated so that no self interest group, criminals, fraudsters, scamsters can do stuff to break the entire system.
what im describing is europe.
judging from the success of europe in the last 20 years (in all respects, including better distribution of wealth), and the extent that u.s. sank ( to the point of sinking ENTIRE world economy with itself), i'd say that that holistic economic rant of yours have no substance anymore.
so please, stop it at least from now on, and conceive something new. reagan, republican eras are dead. and they wont return. neither the stupid 'let businesses be' 'youll kill jobs' 'market can solve' stupidity and accompanying wild west behaviour will.
Re:TFA perpetuates voodoo explanations (Score:5, Insightful)
people assume and have been told for years that real estate will *always* increase in value
And you know who told them this?
Every one of those people had a clear financial interest in the general public believing that house prices always go up. The good news is that for the next 20-50 years, there will always be somebody handy to call bullshit when this lie gets trotted out.
Of course, nobody will actually learn the deeper lesson: to be skeptical of things that "everybody" believes, especially when they are appealing to you and lucrative for somebody else.
People are actually missing the entire point (Score:5, Insightful)
First let me say, I don't think your analysis is wrong per se. At the level of the mechanics of where the crisis happened and how it played out in the minds of the people in the middle of it, it is perfectly valid.
However, this whole line of analysis is very much like analyzing a car wreck and concluding that the cause of accident was the driver's excessive application of braking and over correction. The driver was dead drunk. The underlying cause was the fact that his reflexes were so shot he couldn't react properly. It is largely irrelevant what the details are of how he lost control of the car, he was bound to do so under the circumstances.
Likewise the so called 'financial crisis'. Think of our economy/financial system as a bit like a building. Every part of the structure both adds 'load' to the building, and also supports the weight of the other component parts. As long as enough structural integrity exists to support the load at every given moment, the building stands.
Unfortunately what our whole society from top to bottom has been doing is looking at this structure and saying to themselves "you know, it is a waste of money to have that beam be 150% stronger than the load it is carrying" and then someone comes along and removes the beam and replaces it with one that's only 105% strong enough so they can use the extra materials someplace else, make more return on their investment.
Well, that could only go on for so long, and naturally people got a bit nervous and engineers pointed out that the building maybe was a bit shaky, so we invented a way to tie all the beams together more securely "well, if one fails its ok, if we spread out the load enough then no one part of the building will be overloaded".
Until finally one day the wind started to blow... Once one single part, ANY part of this massively over leveraged structure reached its failure point there was no margin left anywhere to take up the extra load anymore! Every part was already stressed to the absolute maximum limits of its capacity. And as long as things had kept going on an even keel it was inevitable that the search for profit would create even more leverage until inevitably the whole structure became so intolerant of even the slightest disturbance that it had to come crashing down.
The really disturbing part of this is that, as any engineer can tell you, when you reach this kind of situation of critical instability any small problem results in a cascade failure of the entire system. Every industry, practically every business, is leveraged out so far that even the smallest dips in cash flow result in immediate insolvency, which then propagates down the supply chain and up the 'wage chain'.
This thing is like an avalanche coming down the side of a mountain at 300 mph. The snow all around it looks all nice and quiet, but that means nothing. This thing has momentum, large momentum, and there isn't any stopping it because there's no redundancy left in the economy to act as a brake. No bailout plan or insurance scheme or nationalizing of banks or any other action anyone can take now is going to stop it until it gets to the bottom of the mountain.
The sad fact is we clearly saw, or should have seen, it coming. The system gave us every sign of being ready to fail. What was the 97 Asian financial crisis except a localized version of the same thing? It just didn't get big enough to build up the momentum to smash the whole system. Only one wing of the building fell off that time. If we had exercised any prudence whatsoever we would have taken the hint. But 'This American Life' certainly has it right in the sense that greed and hubris overrode common sense.
And look at where we are now. Hope you all have a nice supply of canned goods stashed. Best case scenario is they're about to get a lot more expensive.
Re:Yes, let's blame the geeks (Score:3, Insightful)
You say the banks were forced into making bad loans by the CRA, and faced lawsuits for not doing so.
Then you cite a case where THE CRA IS NOT EVEN INVOLVED. Did you actually READ what you cut and pasted?
I'm used to having to get proper cites to disprove people, you just made it easy.
"making a fortune in commissions" (Score:2, Insightful)
People should go to jail, and the system should be reformed so it cannot happen again. But then, the "system" is being managed and communicated by the same folks who have been involved in the scheme, or their best friends.
Re:VaR anybody? (Score:2, Insightful)
The Discworld variant...
Re:This American Life (Score:1, Insightful)
Once financial institutions are required to make subprime and interest-only mortgages available
The kicker? They weren't required to make interest only loans at all, they made those up themselves so they could soak up the interest. They weren't even required (by the CRA, a common scapegoat) to make subprime loans as long as they could find people in (or interested in moving into) the region that would qualify for prime, and you're neglecting not only the other 50% of the loans that were made by non-regulated non-bank corporations [house.gov] who weren't required to do anything at all, but did so because they wanted the money, but you're also ignoring that the mortgage brokers apparently routinely under-qualified applicants: "Fannie Mae has estimated that up to half of borrowers with subprime mortgages could have qualified for loans with better terms. [credit.com]" (more details here [nakedcapitalism.com])
In other words, all of the interest-only mortgages and quite a few of the subprime mortgages were freely offered by the brokers with no "requirement" involved but their own desire to make money.
Re:This American Life (Score:3, Insightful)
That's not necessarily the case. You can make subprime loans available without playing Hot Potato, but you need to estimate the risks properly and set the interest rates accordingly. This probably isn't true of so-called "liars loans", but not all subrime loans were of that variety.
If you didn't want these turkeys, why would the other financial institutions want them, unless you sold them at a discount reflecting their risk? Without the buyer committing a fundamental error in figuring their risk, you can't get rid of them that way.
Re:Anti-math/science witch hunt (Score:5, Insightful)
It's not really even "math" that's at fault here. It's "formal modeling" which is what all the quant and rationalist people use to set up their statistical regressions. When all else can be held equal, formal modeling can give you very powerful insights into causal mechanism and prediction.
The problem is, that in reality very little can be held equal. Formal modeling abstracts away too much of reality in order to come up with its parsimonious causal and predictive insights. In an economic equilibrium state formal modeling will do just fine. But if internal contradictions arising out of strategic behavior (endogenizing the formal models of your competitors into your own formal models in order to out-compete them) begin to mount, or if fundamental changes in economic structure change institutions that were previously used as assumptions (changes in the regulatory law, for instance), or if there's an exogenous shock to the markets then the formal models will be ill-equipped to explain much less predict.
Add to that the fundamental assumptions of rationalist formal modeling are highly suspect (i.e.: individuals and firms are rational maximizers of their economic interests; methodological individualism rather than herd behavior; rationality instead of bounded rationality in the more simplistic models; etc.), and you get a recipe for potential gross misinterpretation of socio-economic reality.
It's not the math that's the problem. 'Science' isn't really involved. It's the rationalist approach to formal modeling that is the center of the "machines on wall street" problem. It's the qualitative research that's not being done--the sociology and behavior of the actual people and organizations that their formal models are abstracting out with assumptions of rationality and individualism.
Re:Slaves to Debt (Score:5, Insightful)
Gold is useless except as decoration. It only has value because people have been conditioned to think it does. The same is true for dollars, euros, or any other currency. The gold standard is no less abstract than any other form of currency, since the value a gram of gold has is entirely arbitrary and not inherent in any way.
Re:More Leverage.... (Score:5, Insightful)
They would have been increased as long as no one got hurt.
I think there is going to be a very long lesson here. We have lost much faith in the Stock Market and our financial overlords. In order to keep this nation, and most nations, from coming politically unglued it will become necessary for the governments to assume a heavy hand over the Markets to either limit, validate, or guarantee the financial overlords.
I live in a society where it is extremely difficult to obtain a 1:1 leverage. It's possible to explain a 2:1 leverage to most people. But trying to explain how you can roll this out to 20+:1 leveraging merely results in a torches & pitchforks response. Anyone in their right mind knows this is too much.
Or rather, I should say, anyone who is not trained in the ways of financial genius will simply not comprehend this idea the first time around.
Leveraging is a must. But somewhere there has to be a real limit that upholds under the simplest scrutiny. If I can't show you a dollar in my hand, then I do not have a dollar. That's the point of reference that we are (almost) at today.
Re:VaR anybody? (Score:4, Insightful)
"Yes, it's called in-sewer-ants"
Re:Wrong diagnosis but right fix. (Score:4, Insightful)
What we have ended up with under Reaganomics is an economy that invests far too much of its money in non-productive consumer goods. Worse still, we buy most of those non-productive consumer goods from offshore factories. The net-result of this has been an economy based largely on the service sector, where an increasingly large sector of workers are employed in Mc-jobs. This is a massive misallocation of our labor force. Huge numbers of otherwise intelligent and capable workers are imprisoned in jobs that only require the intelligence of a twelve-year old. Meanwhile, our best and brightest go to work for huge financial corporations as lawyers and analysts, where their job descriptions can largely described as "gaming the system in favor of the company". Whatever happened to going to work for NASA?
The parent post makes the classic error of many right-wing analysts, of looking mainly at the financial numbers, while failing to acknowledge the reality on the ground.
Here's the reason for the mess: (Score:2, Insightful)
The US Federal income tax system.
I mean, consider this:
1. We have 35,000-plus lobbyists in Washington, DC trying to "warp" the Federal tax code to support their narrow constituencies. And we know what "warping the Federal tax code can do, as noted by the current sub-prime mortgage meltdown.
2. This results in a completely unwieldy Federal tax code, with 60,000-plus pages of regulations that is barely comprehensible even to the most seasoned tax professional.
3. We're now spending nearly US$600 billion per year trying to comply with the Federal tax code and in pre-compliance economic decisions.
4. The Federal tax code discourages people from actually saving because of the taxes on savings interest, dividend interest, and capital gains on property or equity sale.
5. Because of #4, many Americans are sending their liquid assets out of the country to avoid the clutches of the IRS. Why do you think some experts estimate we have at least US$14 TRILLION socked away at offshore financial centers (OFC's) in places like the Bahamas, Grand Cayman Islands, Panama, Switzerland, Liechtenstein, Singapore, Hong Kong, Nauru, Monaco, and so on?
It is high time we kibosh the current Federal income tax system and come up with a consumption-based income tax system that encourages people to invest and save. Perhaps the best example of this is the FairTax proposal, which intends to replace the current income tax system with a single 23% consumption tax (no deductions whatsoever), where the Federal government sends a monthly prebate check to cover the 23% consumption tax on basic necessity items up to the Federal-defined poverty level. While FairTax is not perfect, it certainly beats the current income tax system for these reassons:
1. Because of no more taxes on paychecks, interest income, dividend income, capital gains income and even on estate, it encourages people to save and invest (there's nothing wrong with that!).
2. Because of #1, the advantages of "offshoring" your liquid assets are gone. That means potentially several trillion US dollars coming back to the USA to be invested in our financial institutions, which would quickly stop the slide in the stock market and provide a new liquidity base for loans and lines of credit.
3. With no more taxes on investments, foreigners will send several trillion dollars of investments themselves into the USA, since we will become the world's largest legal tax haven. Again, this provides a huge bolster for the liquidity base in our financial system.
4. With no more taxes on payroll, corporate income, dividend income, and capital gains, it encourages American companies to keep as much goods production in the USA. Cities like Detriot and Cleveland could experience an economic boom as blue-collar jobs return to the USA under more advantageous tax conditions.
Re:Anti-math/science witch hunt (Score:4, Insightful)
Not quite. You see, numbers without science are just numerology. Numbers with Science are Mathematics.
Numerology has run rampant in financial circles since the general advent of computers. MBA's and traders, trained in the art of numbers, but not of science, led themselves astray with whatever concoction of forumlae pleased them most. Combine this with the connectivity of the internet, and the general mysticism surrounding computers in ordinary eyes, and you get an environment ripe for selling all kinds of fancy snake oil.
Quants were quacks. They still are.
Re:This American Life (Score:3, Insightful)
Uhhh...huh? Where are financial institutions required to make subprime and interest-only morgages available? They were doing these things because they thought it would make them money.
Re:Yes, let's blame the geeks (Score:3, Insightful)
Calculating the values of the debt swaps as if they had independent risks, when they did not, is a bigger part of the problem.
The reality (Score:3, Insightful)
After all, the smart ones got paid very well and got big bonuses.
Sure some of them might be out of a job now, but since "everybody was doing the same thing, it wasn't their fault" AND it made their bosses rich too, so they'll soon be rehired to do the same thing all over again. After a nice holiday in the bahamas or something
It's the stupid ones who don't get it, and don't see how all this "fancy math" is actually just adding games to the casino. But a casino where if the smart ones lose "too big", the stupid ones have to pay.
Call me cynical but that fancy math is almost like the finance equivalent of the "Chewbacca defense".
Think about it, if the "fancy math" was really to reduce risk, stuff wouldn't be blowing up so regularly e.g. 1987, 1997 (remember LTCM?) and 2008.
Do people really think the smart ones don't know what they are doing when Warren Buffet himself came out and referred to their schemes as "financial weapons of mass destruction"?
They probably were thinking: "I hope he shuts up before the sheep realize what's happening".
Privatize the pain, socialize the pain.
Now if they actually started putting a special tax/levy on finacial institutions that'll be progress. Then at least they'd have to pay for their own bailouts.
Re:Anti-math/science witch hunt (Score:3, Insightful)
I don't pretend to understand the formal model that was used to make mortgage investments. But HOW did the model not include some check on the underlying ability of the homeowner's ability to pay for the houses?
The ratio of home mortgage amount/owner's income is the PE of mortgage lending. How was it ignored?
Re:Evils of subprime (Score:4, Insightful)
You are correct. The problem wasn't sub-prime mortgages. It was how they were used.
Instituions like Bear-Stearns and Lehmans would get all these mortgages and package them into various debt instruments and derivatives. The problem is, these institutions usually used leverage to buy such products on their private little market.
It's the leverage that ended up being the problem. A subprime default rate of 10% can be absorbed with a fair amount of losses, but what happens when you're leveraged 10:1, 20:1, 30:1? Leverage limits were raised during the boom an people trading in these markets took full advantage of it in order to bost their profits.
No why would someone gamble like that? Easy answer: skyrocketing real-estate. People buying these mortgages viewed them as win-win situations. If the people could pay, great. If the couldn't, the owner of the mortgage would get the house and resell it at a profit. This was also the reason why they were letting anyone with a heartbeat get into a house since they couldn't lose.
However, defaults skyrocketed and prices of homes plummeted. That's when everyone started asking how much the debt instruments they were holding were really worth. No one really had answers since the securities were very opaque. That's hen panic set in and everyone tried to sell. No one would buy them. So they stayed on their books and as more mortgages defaulted the people owning the debt instruments backed by those mortgages took on larger and larger losses.
Add in the idiotic leverage that many were using and it's very easy to see how a few percentage points higher defaults could result in billions of dollars in losses.
This little black market that the institutions were running was leveraged up to $64 trillion, which is 3-4 times the GDP of the planet. What we are seeing is the unwinding process. No one is sure who is holding what. Banks are refusing to lend in fear of not being paid back. This is as much a financial crisis as it is a trust and confidence crisis.
It's likely to get worse before it gets better.
~X~
Re:Unfortunately (Score:3, Insightful)
Why would you blame "greedy" individuals?
Because "bubbles", be it Dot-coms, tulips, south sea trading companies or real estate, are always powered by human greed. Rationality is NEVER part of a bubble - only the expectation that prices for the good in question will continue to rise forever. This is not rational thinking at all.
Expecting people to make sub-optimal financial decisions so that they can collectively improve the situation at a macro-scale is silly.
No, I don't expect that at all. The boom-bust cycle is a feature of human economics throughout history, and it won't change. However a government that tries to artificially prop up a broken system by devaluing a currency to keep home prices artificially inflated, now THAT is silly. The government isn't responsible for the bubble (although low interest rates and lax regulation HELPED speed it along), but it's going to get taught a basic lesson in economics when the fiat US dollar returns to its intrinsic value - zero.
have a look at the graph of the FTSE over the past 15 years and tell me that doesn't look like the mother of all double tops.
Yes the double top is striking, whatever index you look look at (except the NASDAQ which was artificially higher thanks to being rich in tech and dot-coms). What worries me is how fast we got to 800 on the S&P, and how there's no support below that (for the people that believe in that sort of thing).
Re:Slaves to Debt (Score:1, Insightful)
Gold has *many* industrial uses besides that of decoration.
Re:Anti-math/science witch hunt (Score:4, Insightful)
Let me be clear, however. I don't think that quantitative methods are snake oil or numerology. They can produce some very powerful insights, even counter-intuitive explanations that really increase understanding of phenomena. Quantitative is not inherently illegitimate.
The problem with quants is that they often rely on rationalist assumptions rather than solid political science or sociology. In order to make quantitative methods produce the best results, you need to do the concept-building, research design, and empirical legwork beforehand. Then you can set up a formal model (one that does less violence to reality), and run statistical regressions on that.
There would be nothing wrong with quant if it were based on solid political science or sociology rather than assumptions and uninvestigated data points.
Re:Everyone misunderstands Voodoo Economics... (Score:1, Insightful)
The word Obamanomics is probably enough to discredit this. But as there is no evidence cited in here to back up the claims, perhaps someone can elucidate.
In particular:
What is this sentence even saying? It doesn't parse.
When were tax rates 70 - 90%? Not since JFK, as I understood it, and then only on the highest breakets. To say it doesn't matter whether you make 20k or 250k, you're better off with lower taxes (and the corresponding cut in social services it requires) is pure ideological cruft.
The tax cuts allowed the rich to accumulate wealth. Republican policies that accompanied these cuts squeezed the middle class and expanded the lower class.
Slow down and try again here. How does 100k in depreciation over 30 years offset a single year's profit of 100k?
If you think the tax code is unfairly weighted toward property, there are more direct ways to address that than lowering the capital gains rate -- which has the undesirable effect of transferring wealth away from the government, as the Bush tax cuts did, where it could be used to the benefit of the commonwealth (especially if it wasn't being wasted on ill-advised wars), to the wealthy, who don't generally need it anyway and tend to favor only a better return on investment.
Your assertions may be interesting, in so far as they're mystifying. But I don't find them insightful.
And you talk about European-style socialism like it's a bad thing. I for one would welcome an extra 6 weeks of vacation a year.
Re:Slaves to Debt (Score:5, Insightful)
The gold standard is no less abstract than any other form of currency, since the value a gram of gold has is entirely arbitrary and not inherent in any way.
It is less abstract in at least one very important way - the amount of work it takes to extract another gram from the ground and put it in a vault.
Modern currency has effectively zero marginal cost to make more of. There are pluses and minus to that fact - as in money can now represent something like the total value of the economy of the country rather than be limited to a pile of metal in a vault somewhere.
On the other hand it also makes it really, really, really tempting for the government to just print more money in response to any fiscal crisis with the obvious long term effect of devaluing all the money had been previously printed.
Sorry to tell you.. (Score:3, Insightful)
This effect is called the "money multiplier", and it's been around LONG before anyone went off the gold standard.
Without the money multiplier, the industrial revolution would not have gotten very far.
The reason we're facing massive economic collapse is not because of debt defaults per say, but because the markets are so skittish that nobody is lending, thus the money multiplier is being squished into nothing.
This is exactly what happened during the depression, though for slightly different and more severe reasons.
Back then, the banks themselves went bust. The money multiplier was gone, and the money supply evaporated. This meant businesses could not get loans to weather the economic storm, so they went belly-up.. and unemployment skyrocketed.
The blessing here is most assets are covered by the FDIC now, when they weren't in the late 20's. This should help cushion the worst case scenario.
Re:Slaves to Debt (Score:3, Insightful)
Except that if you create more money, as you said, all money becomes worth less. This loss of value by the existing money IS the marginal cost of creating more money. This means it isn't all that tempting to print more money. Which is why our government typically doesn't use that method to pay more more spending. Instead they take out debt (a problem in and of itself), which actually has the effect of _removing_ liquidity.
Re:Slaves to Debt (Score:3, Insightful)
Gold is useless except as decoration.
Tell me, sir, do you own a computer?
Comment removed (Score:2, Insightful)
Re:More Leverage.... (Score:3, Insightful)
I don't think we've lost faith in the stock markets. The public said the same thing back in 2001, and yet the market recovered to drop again another day. It happens. There are tons of people right now insisting that people have given up on the market while there's a (probably smaller group), who's patiently waiting with a pile of cash for the market to hit bottom so they can take advantage of the glorious opportunity that has been presented to them. The stock market is a long term game. Those who play it in the short term might as well stick to card counting at blackjack. The odds of coming out ahead are about the same and it takes a lot less time to get good at it.
The only way to lose in the long term would be if the economy totally crashed and never recovered. In that case, it wouldn't matter if you won or lost, so you wouldn't ever want to bet on that eventuality.
-Restil
Re:wrong-o, blame Moody's (Score:2, Insightful)
(in case anyone's still reading)
The basic concept of using statistics (I want to say "leveraging statistics", but ... oooh, that word!) to split a group of events into its less-risky and more-risky parts is sound but no application of statistics will find any one event within the group that is clear of risk. It's like the "rhythm method" for birth control -- pregnancy *is* statistically less likely on certain days than on others but no matter how fancy you're use of those statistics there's nothing you can do that will make sex as low-risk as abstinence. And Moody's (et.al. as they weren't the only rating agency that looked the other way while fat profits were rolling in) were selling the line that they could predict even one day a month when sex would be as safe as no-sex.
Frankly, when Moody's et.al. gave a tranche an AAA rating they were acting no differently than the high school jock plying his line of "hey baby, you can't get pregnant your first time!" Except that, unlike the high school jock, they were legally required to know better.
Re:This American Life (Score:2, Insightful)
It absolutely does NOT require sub-prime and interest only. In fact, it says specifically that banks should undertake the provisions of the CRA in accordance with safe lending practices.
Computer algorithm (Score:3, Insightful)
The problem at the heart of financial crises is fractional reserve banking. The empirically "stable" fraction is roughly 9.5% right now, and as "wealth" increases, that fraction decreases because real value isn't created to balance it out. The banks simply negotiate the most aggressive numbers they can get away with, and since all wealth is purely electronic, they can fabricate it out of thin air - they don't need to print it anymore!
The fact that money is so far removed from the concept of value, is the very reason the system has collapsed - you can only build so high on any given foundation.
We don't need your kind here. (Score:2, Insightful)
high time we kibosh the current Federal income tax system and come up with a consumption-based income tax system that encourages people to invest and save.
Oh, you mean a policy which favors the rich even more than it does today.
The only thing "fair" about the fair tax is it allows the "fairly" rich to hoard their money and never give back to society (despite conspicuous consumption, they don't spend very much of what they make). I suppose you could actually call it the "unfair" tax.
the Federal government sends a monthly prebate check to cover the 23% consumption tax on basic necessity items up to the Federal-defined poverty level.
So people at poverty level, who are exempt from federal taxes anyway, are also exempt here.. big deal.
Social safety net systems are funded by people who make their money on backs of the rest of the public, and who make use of military and police services in which people DIE to protect their wealth.
Some of those social safety net programs are worth considerably more than the simple taxes, to which these people are already exempt. (more on that below)
2. Because of #1, the advantages of "offshoring" your liquid assets are gone. That means potentially several trillion US dollars coming back to the USA to be invested in our financial institutions, which would quickly stop the slide in the stock market and provide a new liquidity base for loans and lines of credit.
what exactly is this snake oil?
Investment capital gains are already taxed considerably less than normal income tax at the income brackets you are talking about here.
What it WOULD do is, again, cause cash to the government to be further limited, and the resulting budget cuts won't be taken from military spending or pork.
They'll come from education programs, day care subsidies, and numerous other programs which make the daily lives of people at or below the poverty line "livable".
. With no more taxes on investments, foreigners will send several trillion dollars of investments themselves into the USA, since we will become the world's largest legal tax haven. Again, this provides a huge bolster for the liquidity base in our financial system.
Because we all know giving money to the already wealthy top echelons of business will definitely guarantee "trickle-down", rather than big fat bonuses, golden parachutes, and more funding for programs to offshore increasingly skilled professions for the sake of cheap labor.
4. With no more taxes on payroll, corporate income, dividend income, and capital gains, it encourages American companies to keep as much goods production in the USA.
Once again counting on the wealthy to give a damn about the great unwashed below their feet. Fox, please meet henhouse. hens, do you remember the gilded age?
With no more taxes on corporate income and capital gains, Donald trump could buy his kids platinum ferraris instead of the cheap, solid gold ones their friends make fun of.
Cities like Detriot and Cleveland could experience an economic boom as blue-collar jobs return to the USA under more advantageous tax conditions.
Because the massive corporate welfare system we have now just isn't enough right, surely adding more policies to put money into the pockets of the wealthy will encourage their generosity the same way such previous programs have.
Re:This American Life (Score:3, Insightful)
That's certainly a good description of what happened at the end of this asset / debt bubble. I suppose the point I was trying to make is that a crash or recession was inevitable. The economy was fueled by people continuing to borrow more and more money, at a faster rate than the growth of the economy. Eventually it had to stop and should have stopped some time ago. There was a point where banks stopped buying *cough* "good" debt, and started buying "bad" debt. To keep the debt induced euphoria going, they tried harder and harder to find more suckers to loan money to, turning a blind eye to the long term consequences.
If the banks had been more sensible, loaning only what people can really afford. We would still have had a recession and a crash eventually. Though I think I should revise my earlier statement. I think the 50 year debt bubble would have popped 5-15 years ago and I think it almost did.
Thanks to the banks, the only thing we have to look forward to is a long deflationary depression. This will continue until everyone has either paid back all their debts, gone bankrupt, or passed away (since debt can't be inherited).
Re:Anti-math/science witch hunt (Score:1, Insightful)
There are two problems associated with statistical modeling that are frequently overlooked, even by folks who really ought to know better.
(1) Accuracy of the model is frequently mistaken for appropriateness of the model. Accuracy can be calculated, but appropriateness is a skill associated with critically analyzing the circumstances around the model. In the technical community it is common to mistake accuracy of the model for appropriateness of the model. Unfortunately critical thinking skills are not taught with most statistical courses.
(2) The system being modeled must remain unchanged for a prediction to be valid. When a talented Statistician, Scientist or Engineer builds and uses a statistical model to understand a system, they are quite sensitive to understanding and controlling changes in the system described by statistical model. At the individual level, establishing and maintaining a high professional reputation provides a significant motivation to ensure models are used appropriately.
Personal integrity provides a similar strong pull on Corporate Executives. In the corporate world I am familiar with, personal integrity has everything to do with meeting financial targets and fitting in with the crowd.
Unless the executive has a strong technical background and a very strong backbone, he or she is not likely to question the details of a statistical analysis performed one or more organizational levels away. Sounding a nay-saying voice and not meeting financial goals is certain corporate suicide for executives. There are always a multitude of well-meaning individuals ready to replace the executive not meeting their targets or otherwise not fitting in.
Anyone who uses statistical modeling to predict the future with out understanding the mechanics, and the weaknesses, of statistical models, will soon be proven a fool unless they are a very fast talker. Unfortunately being a fast talker and going along with the crowd is likely the statistically best method to stay at the top of a large organization until that organization completely fails.
Ultimately the weakness of the financial market resides in the structure and expectations of human institutions, not statistical science. Richard Fenyman made a similar observation with his analysis of the Space Shuttle disaster.