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."
The source of the problem (Score:5, Insightful)
has nothing to do with computers. The source of the problem is the source of money. Who decides how much money there is? Who reaps the benefits of creating money which is not backed by real productivity? If you're truly looking for the root of the problem instead of symptoms, then you have to find out about the inner workings of the money system. In other news, the "Federal" "Reserve" bank has once more lowered the interest rate. The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.
Re:Can somebody 'splain this? (Score:5, Insightful)
It's easily explained by the Golden Rule:
He who has the gold makes the rules.
There. Explained.
Economics models are like goat entrails predict... (Score:3, Insightful)
pointing fingers (Score:5, Insightful)
I'd just like to point out the bleedingly obvious: That people programmed these computers. They are functioning exactly as they should be. If they weren't, we'd have heard about it by now. So the problem is not the computers, or the network, but rather the people who control them. Thank you. You may now resume your regular ranting, already in progress.
Re:Can somebody 'splain this? (Score:3, Insightful)
Re:pointing fingers (Score:2, Insightful)
Re:pointing fingers (Score:3, Insightful)
It's very tightly regulated, and the source code must be independently reviewed prior to certification. They're very ugly about that kind of thing. Computer models might be a problem, but only because they were based on bad assumptions made by the designers... That is a human failing, not a machine one.
Re:Can somebody 'splain this? (Score:5, Insightful)
I am also not a financial expert, but I can see a bunch of reasons why financial paper exists.
Maybe they're like payday loans for corporations. You have a long-term contract due, but not 'till the end of the month, and you want to keep your employees in the meantime. (I'm guessing this isn't as likely; only corporations with outstanding credit ratings can actually have any success in issuing corporate paper.)
Maybe it's a way of getting a loan without going through a bank or issuing stock. Say you want to build a new factory with payroll rather than actually pay your employees; maybe you're assuming the factory will pay off the interest on the corporate paper and then some.
The biggest thing at the end of the Wikipedia article you read is that, whatever the reason the money is needed, it's cheaper than getting it from a bank. If a corporation is big enough and has good enough credit, they can issue corporate paper, at a lower interest rate, instead of paying interest to a bank.
So, that one, at least, wasn't invented by bankers just to secure their own employment. Maybe somebody who actually knows something about this (a banker, maybe?) could enlighten me.
Understand the System Dymanics of Emergence (Score:3, Insightful)
The system grew far faster than it's underlying resources would allow for, ultimately driving it to a point of exhaustion and shock, leading directly to a cascade of failures spreading around the globe to nearly all segments of the market. It was inevitable, and I saw it coming many years ago, though I could not predict when it would transpire.
It's kinda like earthquakes. You can see the tension between the tectonic plates building up, but you can never be sure when that pressure will release itself. So it goes with the global financial marketplace.
Many parts of this market is zero-sum, yet predicated on the fallacy of "infinite-growth". You cannot have it both ways, my friends. It must fail, and that can "easily" be shown mathematically.
And so my "Greater Fools" theory of the market stands. If you hold a stake in it, your only hope is to find a "greater fool" than yourself to take it off your hands at a higher price. Since the supply of fools are finite, and the resources they hold are also finite, someone *must* be left holding the bag, due to the zero-sum dynamics of the market.
Computers being in the mix only make the shocks more severe and dramatic; but the same applies regardless.
Re:Can somebody 'splain this? (Score:5, Insightful)
I am not an economist but I have owned a couple businesses and consider myself a reasonably practical person.
I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.
Actually, probably not. I suspect (I'm a programmer by nature, so my experience with code may apply here) it's more of each institution and "network" offering redundant services until multiple institutions mature to the point where these services collide and become confusing.
For example, lots of people have a checking account, savings account, credit card, personal line of credit, HELOC, brokerage account, and more.
That wasn't true one generation ago. My parents had only a checking acount, savings account, and credit card.
I see absolutely no reason why a single account could not offer all those features.
With the advent of computers and networks, now it is possible. But 20 years ago? Not possible.
How would a bank know how much equity you had in your house? How would your credit card company know how much you had in the bank? How would your mortgage company know what your investment amount was?
Today, you actually have one company that handles all of it (and in cases where they don't, they can still trade information). So now I can have a HELOC, personal line of credit, credit card, savings account, etc, all tied together, in that credit from one reduces the amount of credit available on another, and all paid from the same account.
The only reason you "need" all that is because the banks created all these funny rules so that they could introduce more and more products and services.
In this case I actually disagree. Different people have different had different "collateral", so different kinds of credit were available to them. That explains why different products exist. Someone with a house vs someone with a strong credit rating vs someone who had lots of money all had access to different products. Now a single person has access to all of them.
This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.
Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?
As before, commercial paper was "invented" before credit cards (or business lines of credit or whatever) existed. It satisfied a market need that probably doesn't exist today.
And don't even get me started on real estate lending...
It's like freaking starbucks - you can get your banking services just as special as an upside-down triple no foam half calf non fat 160 degree two splenda mocha. But it's one thing for a coffee company to cater to every individual snowflake's desire, and quite another IMHO for something as important as our financial system to become as absurdly complex and fragile as it is.
It's this statement that brought me to this answer. Software is flexible (soft), so it can be molded quite easily to different needs according to different usages. The problem is that after four versions needs have evolved, but the original code has not, so now you have something complex and fragile that was originally quite simple and straightforward.
As for the people who are really benefitting from all this complexity - well, it's only during recession that we all collectively take a good hard look at who's making a contribution to society and who isn't.
So like software, it's only
Re:Can somebody 'splain this? (Score:5, Insightful)
Commercial paper is a very broad term and encompasses everything from promissory notes to normal consumer checks. Just about any transaction not involving cash or electronic transfer is done with commercial paper. A huge portion of financial transactions are still done with commercial paper. So in the general sense of the term, it is still very, very necessary.
Now if you want to start examining specific financial instruments, like the derivatives backed by (partially) crap mortgages, we can have a conversation. I think the idea behind those instruments was basically sound, but the things ended up being a lot more complicated than people thought. It makes sense that if you lump a bunch of mortgages together, only a small percentage of those will default, thereby distributing your risk. But in a climate where fraud was rampant and the people signing people up for mortgages had no incentive to make sure people could actually pay those mortgages back, your lump of mortgages has a much higher chance of containing too many bad mortgages to make the resulting instrument profitable.
The derivatives market had the perverse effect of creating and encouraging that climate, because the mortgage buyers would buy without enough questions because they knew there were buyers who would buy the derivatives without too many questions. The fundamental problem with the whole concept, it seems to me, is that the derivative buyers and sellers forgot to insist on and question the credentials of the individual mortgagees they were investing in. Had they done a little bit of verification there, we might not be in this place right now.
Re:pointing fingers (Score:3, Insightful)
the systems are designed to have transactional integrity. it doesn't prevent someone from making idiot trading decisions.
Re:pointing fingers (Score:5, Insightful)
Considering the fundamental basis of the whole system is based on the flawed assumption that credit can be infinitely expanded the current failure is hardly surprising. The Austrian school pointed out the fallacies that caused both the last depression and the current one almost a hundred years ago.
Computers have very little to do with it. Constructing models to fit political economics rather than to reflect reality is closer to the actual problem.
Re:pointing fingers (Score:5, Insightful)
Its not emergent behavior of computer systems. Its the exact same kind of behavior markets have displayed without computers.
Sure, things haven't been this bad recently, so some elements of it are new, at least in the short term, and the details change always. But none of the big picture stuff has much to do with computers, fundamentally. Economic markets are vastly interconnected because their substantive outputs and inputs (not just data outputs and inputs of the computer systems currently used as tools in managing them) are directly linked.
Blaming computers is about as justified as blaming witches.
Re:Can somebody 'splain this? (Score:3, Insightful)
Ohhh I have an idea.
Instead of doing Shady and immoral accounting practices why not do what honest small business do.
YOU HAVE THE CASH ON HAND TO PAY YOUR BILLS.
Accounting has turned into VooDoo and it's what causes these messes.
I dont run out and buy a shitload of gear on credit for my video and photography business. I do what sane people do.. when I can afford it I buy it. when the hard times hit, I ride it out easily while my competition scrambles to try and pay off the 60 some loans and their credit lines.
What if I need a new piece of gear for a job?? That's what the 50% down for the job is for. I need $8500 in gear for a corperate shoot? I get the $9500.00 downpayment at contract signing and buy the gear, do the shoot, collect the rest at delivery, and call it done. really simple.
Re:pointing fingers (Score:5, Insightful)
No one group of programmers programmed all these computers, there was no single set of specs for the whole network. All the components may well be "functioning exactly as they should be" (although in reality I'm sure there are a few bugs in the systems, but that's irrelevant here), but the system overall may behave in an unexpected way.
There's a bug in Internet Explorer. That must mean the entire internet is broken. No. Financial transaction systems are heavily audited, rigorously tested, and subjected to heavy regulation. They are the most hardened systems in wide use in the commercial sector. Period. That doesn't mean there aren't problems, but a problem big enough to cause a network-wide malfunction are very, very low.
What we're dealing with now are people who made bad assumptions about the economy, got cocky, and now we all are paying the price for the lack of oversight and auditing done on the decision-makers responsible. Looking for simple solutions (ie, "the computer did it") to complex problems is naive at best. This took many several thousand people, all making the same bad decisions, to bring us to where we are now. I will say it again -- this is not a technological failure, it's a failure of people. And if you ask me, we should start publishing the "bugs" -- ie, the names and faces of these people, so the rest of us know to never let them anywhere near the financial sector ever again.
But that would just be too easy.
Re:Can somebody 'splain this? (Score:3, Insightful)
Re:Can somebody 'splain this? (Score:5, Insightful)
Re:pointing fingers (Score:3, Insightful)
Not always. Many finance outfits use Excel a lot, which doesn't do statistics properly [forecastin...ciples.com]. However, modern finance has become very statistics heavy in the last ten years, so this shortcoming matters now a lot more.
Re:Can somebody 'splain this? (Score:5, Insightful)
Oh come on...
Here is a question do you have a mortgage or did you pay for your house UPFRONT?
What about a car? Pay for all of it upfront?
I am not saying over leverage yourself, but to say companies and businesses don't need credit is completely fool hardy.
Credit is needed in a system where you are able to make purchases in certain items. The problem is when people over leverage themselves.
Re:Can somebody 'splain this? (Score:2, Insightful)
I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.
Actually, many of them have a good basis in logic, but are used beyond their original purpose.
For example.... I see absolutely no reason why a single account could not offer all those features.
Part of the reason there are individual companies that separated items like brokerages and commercial banking is historical structure created in the Great Depression, known as the Glass Steagall Act [wikipedia.org]
Other responders to your post have pointed out various specific details, e.g. reason for commercial paper, but let me cover a more general point of view on why so many different products exist: Risk.
The issue, however, is that risk doesn't come in only one form. There are different types of risk:
- Default Risk (if a company goes bankrupt, you don't get back your principal)
- Inflation
- Interest rate risk (if interest rates change, then the value of underlying loans change)
- Tax Rate Risk (different tax rates due to different income or time)
- Counterparty Risk (risk of entering into a contract, but the other party failing to fulfill the contract)
- Secured nature of the debt (recovery in case of default)
- Opportunity cost (cost of not doing an alternative with the money)
- etc.
Looking at various products we can see how they are different. An IRA vs. a Roth IRA actually transfers the Tax Rate Risk onto the government (you pay a known tax rate, and the unknown benefit or penalty due to the future difference is absorbed by the government)
A TIPS (Treasury Inflation Protected Security) vs. a normal Bond issued by the government transfers inflation risk onto the government (presumably the normal bond is accounting for perceived inflation in the offering price, but the TIPS accounts for real inflation, thus allowing one to eliminate the risk of the perception of future inflation being incorrect.
We can see today that today's 4 week Treasury Bill Auction [treasurydirect.gov] resulted in zero yield (give money to the government for 4 weeks, no interest). This presumably would mean the return one could get in a non-FDIC insured bank account (over the current $250K limit) is entirely bankruptcy risk premium.
Also there are organizations that do market clearing of bonds and stocks that absorb counterparty risk. Part of the problem with credit default swaps was that the holders of those products actually bear the counterparty risk, as they are not regulated like other products. (When combined with a lack of market data on quantity and concentration of the risks around default of bonds, this led to one of the underlying issues in the problems we have right now)
Lastly, there are also "positive" values that are priced into different financial products, such as recovery in case of default. That's why secured loans of [statistically] appreciating assets (e.g. home mortgage) are lower rates than loans on depreciating assets (e.g. automobile) and those are lower than unsecured personal loans. Same reason bonds will maintain value longer than preferred stock.
As a specific example of what is good (and bad), look for a moment at interest rate swaps [wikipedia.org]. They actually serve a valuable purpose, in allowing an investor (or the loaning company) to convert a variable-rate instrument into a fixed-rate one (or vice versa). This is valuable to companies to be able to "lock-in" lower interest rates when rates fall, for example. What is risky is when someone speculates on interest rate swaps without having an underlying asset. This results in significant leverage that can be wiped out very quickly if interest rates (i
Re:Can somebody 'splain this? (Score:2, Insightful)
Re:pointing fingers (Score:4, Insightful)
The plumbing is not the problem here. It is the Quant models that _are_ the market in many cases (certainly where ever hedge funds are significant players).
Don't blame the computers (Score:3, Insightful)
You see a lot of this pointed out on Jim Cramer's show "Mad Money", http://madmoney.cnbc.com/ [cnbc.com]
Most of our problems have to do with the lack of transparency in financial systems on supposedly public traded companies. As Cramer pointed out, "How can you have these levels of fiction after Sarbone-Oxley?" Moreover, with the recent Ponzi scheme uncovered, it makes you wonder just how interested is the SEC in maintaining the integrity of the financial system? That and allowing the short sellers to destroy the banks, leaving the tax payer to bail out the investors in order to preserve the financial system.
Thank god, we have the best form of government money can buy. Unfortunately, it even works to preserve the status quo when the original players are bankrupt. Nothing new here, after all, Japan's emperor was able to maintain control long after he had been defeated.
I am sure the US empire will survive this minor setback. The Hessian empire was bankrupt for hundreds of years before it ultimately collapsed. Maybe we can drag this on until the next Ice Age or until we poison all life to extinction, so who cares about the messes in the meantime?
Re:Can somebody 'splain this? (Score:4, Insightful)
And that is exactly what happened. Both businesses and consumers were overleveraged, the realestate bubble burst and the whole cardhouse came crashing down.
Personally I don't see why you would need credit to buy a car though. If you don't have the cash don't buy a new car, get a second-hand one. Cars are a worthless investment, especially new ones. My rule of thumb is to only use credit if you are making an investment that has a very good chance of at least keeping its value.
Homes on the other hand... oh wait, never mind...
(but seriously, even in this market a house will still have considerable value after 10 years, where a car will be close to worthless)
Re:Can somebody 'splain this? (Score:5, Insightful)
This whole post is total bullshit. The notion that, somehow, attempts to counter historic discrimination against blacks and other minorities set off the economic crisis is just foolish. The regulations imposed on certain banks were very modest, and were essentially designed to prevent worthy borrowers from being denied due to where their house was located ("redlining"). Nothing in the CRA requires banks to extend loans to people who can't pay them back. Most of the banks that were hit hardest by the mortgage crises weren't even subject to the CRA, because they weren't commercial banks. Yet the whiners in the pundit class persist in arguing that armies of poor people strong-armed poor, defenseless banks into making bad sub-prime loans. Never mind the studies that have shown that CRA-regulated banks were less likely to make subprime loans, and less likely to re-sell their loans. Never mind the fact that only one in four sub-prime loans originated from a CRA-regulated bank. Yep... poor people. The secret masters of our economy.
And Jimmy Carter? He might have been a tool of a president, but blaming him for Iran is bizarre. Horrible policy making in the region going back to WWII sunk Iran. Jimmy was just lucky enough to be there when the music stopped.
Re:Can somebody 'splain this? (Score:5, Insightful)
Also there are a few uncertain assumptions in your little 'analysis' -- one, that the seller chooses to reinvest his sale profits with the bank. You claim that 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.
Plus, you ignore the opportunity cost of the funds the bank is due and the risk of default (hence the interest rate on the loan).
I know the banking industry has its problems, but claiming it's a ponzi scheme is just uneducated. The banking system is NOT dependent on influx of new investors to pay their creditors (leaving a gaping cash hole when new investors stop appearing). 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.
The problem is that the banks are unwilling to lend when the expected return on their capital outlay is negative. Due to the fluxed up state of the economy, banks in general have decided that lending is unwise, since the risk of default is so high. The big problem is that banks did not properly assign risk to certain loans, so that they undercharged on the interest rate. The reason this slightly relates to a Ponzi scheme, is that as long as another bank was willing to underwrite a risky loan, then bank could get rid of its risk when the property in question was sold. It was a game of hot potato -- whoever was left holding the risky loan when everyone stopped lending lost. And the big problem was that it continued for too long -- eventually the amount of risky loans was so large that almost *everyone* was left holding a sack of hot potatoes. If credit rules had been tightened, rather than loosened, then a few banks would have gotten burnt early, and the problem would not have spiraled.
Re:Can somebody 'splain this? (Score:3, Insightful)
Your exactly right, except that homes really don't go up in value at all, and never have. People just think they go up in value because they go up in price. What they really are is a hedge against inflation.
Re:Can somebody 'splain this? (Score:3, Insightful)
Inflation has not been a cumulative 400% in the last 10 years
And deflation in general won't be 75% as home prices come down over the next three years. That's why it's called a bubble.
The value that your home has is that it keeps the rain off of you, and keeps you from being arrested for sleeping in the park. It also makes a handy place to store the stuff with sentimental value you accumulate over time, like offspring.
There will be some interesting side effects from this boom and crash. Right now home prices are crashing at the same time interest rates hit unsustainable historic lows. Generally that's a good time to buy a home if you don't have one -- but get a fixed rate with a payment you can afford. If you don't, the inevitable inflationary spiral that follows will break you. With a fixed rate, inflation actually works for you by raising your income and reducing the real value of your debt. In the 80's I heard SO many stories about older people who had a nice home that cost $20,000 on a 30 year fixed 6% rate loan at the same time my parent's variable rate swelled to over 18% that the idea stuck. As soon as the market starts showing signs of life the rates will start going up again so don't miss your shot. The opportunity time is coming around again as it does for every generation -- it's almost time to fire your landlord. When it's time many will make the deal of a lifetime. Everybody else gets to spend the next 20 years kicking themselves for missing it, while they do it the hard way.
In short, GP was exactly right. In a perfect market the average home costs exactly as much as the average buyer can afford to pay. The games they've been playing with finance drove the prices up and make getting loans easy for a while and it will be followed by a time when the prices are driven down and loans are difficult to get because the market is not perfect: People always try to game the system and all systems can be gamed and so buyability swings wildly from completely impossible to ridiculously easy and most folks have to take care to get in when the time is right. The minor cycle seems to be roughly 20 years and the major cycle 80.
If inflation gets totally ridiculous, everybody with a fixed rate home loan gets to pay off the loan very easily, though other stuff starts to get harder to get. That's why it's smart to own some gold and silver too - not certificates or shares in mining companies that can be shams or go bust; real soft metal coins and bars. You don't need too much of it because the crisis can't last longer than a few years before things straighten out. Only once you've taken care of these things should you start to think about putting your extra money to work at interest.
Re:Can somebody 'splain this? (Score:5, Insightful)
Banks have to get their money from somewhere
No, they don't. [wikipedia.org]
Fractional reserve is the root of our problems today. The system is designed to lend out more money than actually exists, thus the economy is overloaded by design, and inflation is guaranteed.
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.
Re:Can somebody 'splain this? (Score:3, Insightful)
"I prefer honesty and doing things right."
Well, you are not going to get rich with that attitude. From what I've seen if you are not back-stabbing, vindictive, willing to fire people to keep the stock prices high, pay yourself more then you are worth, consider people leaches and just a number, and use tax dollars as a personal corporate safety net, then you are not a true corporate leader.