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The Rise of the (Financial) Machines
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.
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.
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.
I'm a big tall mofo.
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 provided: The first episode sets the stage extremely well and explains how the mortgage crisis got going. The second episode 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.
The subprime money was backed by property. Adding shiny metals into the equation does not fix the problem.
This isn't the reason for what's happened. But a lot of people hate math.
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.
Just be sure to wear the gold uniform when you beam down -- you know what happens when you wear the red one.
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.
This is my sig.
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 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.
Seven puppies were harmed during the making of this post.
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.
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.
when you use words like "socialist retort", "socialism", you make all your readers think that you are a brainwashed holistic economics zealot that thinks there is only unbounded and uncurtailed wild west capitalism and its counterpart strict socialism in the world, and lose them.
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.
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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.
"Malo periculosam, libertatem quam quietam servitutem." -- Jefferson
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.
Forget magic. Any technology distinguishable from divine power is insufficiently advanced.
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.
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.
When information is power, privacy is freedom.