Computer Models and the Global Economic Crash 361
Anti-Globalism passes along a review in Ars of some recent speculation on the role of interconnected computer models in the global economic crash. "If Ritholtz, Taleb, Mandelbrot, and the rest of the computer modeling and financial engineering naysayers are correct about the big picture, then we really are arguably in the midst a bona fide computer crash. Not an individual computer crash, of course, but a computer crash in the sense of Sun Microsystems' erstwhile marketing slogan, 'the network is the computer.' That is, we have all of these machines in different sectors of the economy, and we've networked all of them together either directly (via an actual network) or indirectly (by using the collective 'output' of machines in one sector as input for the machines in another sector), and like any other computer system the whole thing hums along nicely... up until the point when it doesn't."
Re:Right, this is all a big computer crash (Score:2, Informative)
No it isn't.
For one, the price of gasoline is not directly tied to the price of crude oil - it's also affected by refinery capacity, supply and demand of other petroleum products, and the varying supply of gasoline in particular.
For two, I've recently witnessed gas prices fall from around $4 to almost $1.50. Am I hallucinating this?
Re:Can somebody 'splain this? (Score:3, Informative)
I think you meant to say "banks created all kinds of workarounds to funny rules that politicians created"
Re:Can somebody 'splain this? (Score:3, Informative)
My parents had only a checking acount, savings account, and credit card.
In many developed countries (Europe, Japan, ...), many people have a single account which supports both checks and debit cards. Mine is also used as a brokerage account, but I'm probably not a typical client.
Turner (Score:3, Informative)
Probably the best comment on the current financial crisis comes from Mr. Adair Turner [ft.com].
It is not the computers or the communication standards. Sorry, not our poor computers, not the right target for the blame game.
The challenge of the crisis is intellectual. Look, I remember that economists always explained me that they have no clue where the US growth rates come from systemically or can explain where the financial markets make all that money. The surprise was that it didn't crash earlier.
Taleb's explanation of the Narrative Fallacy (Score:4, Informative)
Re:Can somebody 'splain this? (Score:2, Informative)
Our economy is a giant pyramid scheme. Wealth is created through lending by investing in business ventures. It's good for the borrower, who gets the capital to grow their business; it's good for the lender, who gets interest on their loan; it's good for the banks, who take a cut; and it's good for everyone, because savings that would otherwise be sitting in a vault gathering dust is instead flowing through the economy being exchanged for goods and services, etc.
But eventually, when things are going well, we run out of things to invest in. Times are good so people have a lot of cash and they would like to loan it to someone, but all the sensible ventures are already funded. So banks and other financial institutions invent riskier and riskier lending schemes, so that they can get a return on their capital. Eventually the banks, brokers, etc. start making bum loans and the money goes down the tubes. There's a chain reaction as investors pull their money (a run on banks, a selling of stocks, etc.).
Every economic downturn includes risky lending as a major contributing factor. The investors who pulled out early, and the financial institutions that take a cut without accepting any risk, are the top of the pyramid. The people who wind up holding the risky loans during the collapse are the bottom of the pyramid. Those guys thought the interest would always come rolling in.
The complexity of the system is there to try to hide this interaction. The rubes at the bottom of the pyramid wouldn't by into it, except that it is so obfuscated that no one can really tell what's going on. (Honestly, selling badly insured bundles of mixed-risk mortgages cost the taxpayers a trillion dollars? How is Joe Six-Pack supposed to guard himself against that?) And like any good pyramid scheme, the con involves great returns for people who get in early. Remember when your 401(k) was trending ever upwards? "Put some of that in real estate, it's huge!"
-- 77IM
Let's try... (Score:2, Informative)
Because the risks, terms and structures of the loans are different between the different products, and it requires different expertise to successfully make loans of one kind vs. another. Not to mention that the borrowers are different for each product. This means that the separation of the loans into distinct product types represents a division of labor among lenders.
Just to list some of the important factors:
This is not to say that the line of product offerings doesn't have any significant overlaps, but most pairs of products you can think of are differentiated along at least one of these, if not others. The commercial paper market, for example, exists because large corporations seeking large ($100k+) short-term loans can get better rates than at other kinds of credit product. Large corporations with good credit ratings also get better rates on long-term borrowing by issuing bonds than they could by going to a bank. Credit cards feature point-of-sale networks and allow for a large volume of small transactions, while personal lines of credit require you to borrow in much bigger chunks at a time in exchange for a better rate (a volume discount, so to speak). And so on.
Re:Can somebody 'splain this? (Score:4, Informative)
Because once a business gets large enough, the cash flow becomes enormously more complex, and very short term credit becomes a cost-effective way of managing cash flow.
Basically, a business wants to match cash inflows with outflows (and to simplify the model, we'll count "profits" as one of the outflows). The problem is when you know that your business is owed cash that's going to arrive in unpredictable payments over the next 30-90 days. Setting up the cash outflows so that they precisely match the inflows becomes hellishly more complex when the number of transactions gets big enough. Short term debt provides a buffer that allows a business to simplify this.
In principle, yes, a business could do the same thing by keeping cash reserves as a buffer, too. But when you take into account the time value of money, that really comes down to the same thing: by keeping cash, the business implicitly pays the opportunity cost [wikipedia.org] of keeping that cash. (And with an inflationary monetary policy, of course, the cash itself becomes less valuable over time.)
So, to sum up, the money owed to the business over the short terms is its accounts receivable [wikipedia.org]; short-term debt allows a business to convert, for a fee, a large fraction of its accounts receivable into cash, and therefore, to draw upon its accounts receivable to finance its operations. I.e., instead of having n dollars of pure, unencumbered cash at its disposal at any one time, it can have n + ((accounts_receivable * reliable_fraction_of_a_r) - interest_on_short_term_debt)); or, equivalently, to keep less unencumbered cash than it would otherwise need to.
Re:Can somebody 'splain this? (Score:2, Informative)
...thanks to the CRA...
CRA really had very little affect on this whole situation. Here [prospect.org] is a good argument against the "Blame-CRA" theory. To summarize, from the link:
...half of sub-prime loans came from those mortgage companies beyond the reach of CRA. A further 25 to 30 percent came from bank subsidiaries and affiliates, which come under CRA to varying degrees but not as fully as banks themselves... Most important, the lenders subject to CRA have engaged in less, not more, of the most dangerous lending.
I don't think that your description of the whole mortgage securities buying/selling process is entirely accurate. My understanding is that it is like a game of musical chairs. Banks bought and sold securities for ($loan_amount + $loan_future_interest). As the interest rate went up on adjustable rates, people were no longer able to pay the loans off and the loans defaulted. So a large percentage of $loan_future_interest was immediately lost by whoever was stuck holding the securities when the music stopped. And a significant percentage of $loan_amount also could not be recovered by taking possession of and selling the property because the property had lost value due to the housing bubble.
...they should be prosecuted for making (and winning) the bet that tens of thousands of people would lose their livelihoods, their houses.
I think prosecution goes a little too far. In most cases, everything was legal. Although I don't think that they deserve to be bailed out either. They made a bad decision, both borrower and lender (the people who took those unaffordable loans are as much at fault as the banks who gave them). Suffering monetarily is punishment enough. Personally, I think that the banks should lose the money (no bank bailouts) and the borrowers should lose their homes (no homeowner bailouts). Why should anyone else (the taxpayers) have to pay for the banks' or the homeowners' bad decisions? Sure, many banks would go under, but is that really such a bad thing? The only decent argument I've heard against letting these banks fail is that it will reduce the amount of available credit. But isn't credit (the idea that property can be obtained now while the money is paid later) what got us into this mess in the first place? Personally, I think the sooner our country loses its addiction to credit the better.
Re:Can somebody 'splain this? (Score:5, Informative)
The part I want 'splained is: Why does anyone think that the stock market is a serious indicator of the state of the economy?
If you're looking to the stock market as a barometer, you're in for a let down. The price of a stock depends on so much more than just the state of the economy. The only real rule is: historically high stock prices usually indicate overconfidence, and historically low stock prices usually indicate undue pessimism.
Everyone knows the market is going to be way up in a few years because it is currently highly undervalued...
You sound like the prognosticators in 1929. But it took 22 long years for the Dow to surpass its pre-depression highs. Don't commit the same sin of hubris that got us here in the first place.
Maybe if someone was required to hold a stock for a minimum period of time it would make stocks an indicator of something.
But that would remove one of the main reasons to own stocks, their liquidity. We don't need stocks to be an indicator of anything at all. All they represent is the value the market places on projected earnings.
I really think that the government could free up a huge quantity of the credit blockade by lending directly to the enduser to force the various credit companies to wake up and try to compete for their markets.
Now here's where you lost me. You think that banks are going to try and compete with the government, which can borrow money to lend at almost zero cost. Banks have to get their money from somewhere, and their risk of default is seen as so much higher than the government's, that the interest rates they can borrow at are sky high right now. Why would they try to compete with the government at all? They're almost guaranteed to lose.
If they would just refinance the so called "Toxic debt" mortgages at 3% over prime it would drop the payments down to a point where most of the "toxic" loans would be workable for the debtors and then they wouldn't be toxic. At 3% over prime it would be plenty profitable too. If they would force the mortgage companies to carry the paper on a portion of the loans (selected at random) it would guarantee that they wouldn't write fraudulent loans either...
I think you underestimate the scale of the mortgage problem. There is too much debt out there on homes that are worth nowhere near what is owed. What incentive does the homeowner have to repay a loan when they are $100,000 underwater? Even at a zero percent interest rate, it just doesn't make sense for the borrower. Those toxic loans are called "toxic" because there's really no good way to fix them.
Re:Can somebody 'splain this? (Score:3, Informative)
Everyone knows the market is going to be way up in a few years because it is currently highly undervalued but because the vast majority of investing groups are buying and selling with short term gain in mind the market is bouncing around like a superball.
True, but this situation may not be an ideal time to go long. As the old saying goes, the market can be wrong far longer than you can stay solvent.
Caveat emptor, your mileage may vary, and no platypuses were harmed in the making of this posting.
Re:Can somebody 'splain this? (Score:3, Informative)
That said, grandparent post does contain a modicum of Bullshit too. Consult with your local Ph.D. economist, not zanies on the Internet.
Postscript. Congress is complicit. That goes for both Republican Congress and Democrat Congress. And the Presidents. Extra for Obama, who is the second-biggest recipient of Fannie Mae campaign contributions ever.
Fractional Reserve Banking REQUIRES growth (Score:2, Informative)
The grantparent is largely correct, and it has nothing to do with accounting.
When banks create the money that they loan out (and it is the creation of money which is what makes a bank a bank), they do not create the money required to pay the interest on the loan. Therefore more and larger loans must continually be created to pay the interest on the previous round of debt. If more and larger loans are not taken out, there is a recession, or depression as the debt consumes the credit. The economy is basically a giant pyramid scheme. The longer the period of growth, the bigger the crash at the end of it. It is simply the bankruptcy process destroying the debt which allows another round of growth.
most cash proceeds from the sale of houses was deposited in banks -- this is false. Most was actually reinvested in other real property or elsewhere.
WTF? Do you think the paper was magically converted into bricks? Was it burned to fire the ovens?. No it was deposited into another bank account.
They are dependent on the stream of payments from existing debtors. When that stream dries up, their ability to lend dries up, since they become cash-flow negative, and eventually have no capital to lend.
And where does the money to pay the interest come from? It was never created, and when credit pays off debt, there is nothing left over. You call the grantparent uneducated but clearly either don't understand how banking works or are deliberately misrepresenting the process.
Re:Can somebody 'splain this? (Score:4, Informative)
Well I don't know about you, but I'm pretty sure them cows don't produce 3% more milk with each passing year, nor do they yield 3% more meat. You can say what you want about wealth, but there is a fixed amount of natural, life-sustaining resources in the world, and printing more money isn't going to change that.
Wrong. The cows do, in fact, produce more milk every year (not the individual cow, but the average cow). More importantly the dairy industry becomes more efficient every year, making it possible to have more cows using fewer resources..
"The greatest shortcoming of the human race is our inability to understand the exponential function." -- Albert Bartlett
Production and efficiency in a single industry can only increase for so long before the results become absurd or impossible.
The average dairy cow in the US produces ~20,000 pounds of milk annually (rounded for simplicity). If we pretend we can get 3% improvements annually, then after 100 years we'll have nineteen times the milk we started with. At the end of 200 years, each cow is producing a pound of milk every four and a quarter seconds. In 300 years, 4.5 pounds/second. You'd have to stick a pipe down its throat just to prevent dehydration.
And as far as more cows using fewer resources goes, you run up against basic physics. Calories in >= calories out. Efficiency improvement is constrained by the universe.
Re:Can somebody 'splain this? (Score:4, Informative)
They don't loan out more money than they receive as deposits.
Actually, they do. In most modern fiat currency models, banks must hold a minimum reserve relative to the amount of loans they give out, but can otherwise issue loans up to that ratio.
In fact, banks quite literally create money by making these loans, which is how the US money supply grows (and is one of the reasons why adjusting the interest rate affects inflation... if you reduce the rate at which loans are granted, you reduce the rate the money supply grows, which translates to lower inflation). It's actually a pretty fascinating, if confusing, topic. I'd recommend reading up on it!