Greenspan Tells Congress Bad Data Hurt Wall Street

CWmike writes "Former Reserve Bank chairman Alan Greenspan has long praised technology as a tool to limit risks in financial markets. In 2005, he said better risk scoring by high-performance computing made it possible for lenders to extend credit to subprime borrowers. But today Greenspan told Congress that the data fed into financial systems was often a case of garbage in, garbage out. Christopher Cox, chairman of the Securities and Exchange Commission, told the committee that bad code led the credit rating agencies to give AAA ratings to mortgage-backed securities that didn't deserve them. Explaining in his testimony what failed, Cox noted a 2004 decision to rely on the computer models for assessing risks — a decision that essentially outsourced regulatory duties to Wall Street firms themselves."

Comments

Outsourcing Their Decisions

[Herkum01]

If these people did not know what was going on, they are not professionals, they are just a schmuck who is being paid too much. To say that the computer models did not anticipate their stupidity is just denial.

Re:Outsourcing Their Decisions

[mabhatter654]

bingo! Greenspan did exactly what all the Republicans and Libertarians wanted... lowered the interest rate the Fed charged for money and kept their fingers out of market regulation. Wall Street spent and gambled like drunken sailors.. they deserve to have been shut down, their employees laid off without paychecks like all the manufacturing workers they sold out, but they're so big and tie up so much money it will put the honest people out of business too.

Re:Outsourcing Their Decisions

[The Man]

Libertarians don't want the Fed to exist at all. The market can set interest rates just fine on its own. In fact, that's what it's been doing for the past several weeks. Had that been allowed to continue, you would have gotten your wish: most companies on Wall Street would have failed, because no one can afford to pay a paltry 4% any longer. They're too highly leveraged and every asset on the market yields too little. That's the legacy of two decades worth of artificially low interest rates, courtesy of the central banking cartel. Had the market been allowed to set its own interest rates along the way, we would never have gotten here. For that matter, without the Fed and its paper money we'd still have circulating gold and silver, and the "dollar" would simply be another name for 1/20.67 ounce of gold. You could buy a house with a small purse full of coins, and the money in your savings account would never lose value. That's the libertarian way. Any claim to the contrary is a damned lie.

You can blame the Republicans if you want (I do!) but don't forget to blame the Democrats as well. FNM and FDE are well-known homes for aged Democrats and their lobbyist friends seeking sinecures, and they like anyone else benefited from the easy profits to be had when money was free to all comers. And while we're there, don't forget the political imperative to push home ownership rates as high as possible and then much higher still: that was a Democrat-led, Republican-approved move. Again, artificially low interest rates made that possible.

Blame all the politicians in office, blame the career bureaucrats, and blame the greedy bankers. But never forget, either, that every transaction has two sides. So blame the borrowers, too, and the shareholders who collected their dividends - several times what bank deposits paid, by the way - without asking questions about the assets that provided them. And blame yourself, if you're anything like the typical American: indebted up to his eyeballs, with a comfy McMansion in the 'burbs, a brace of SUVs in the garage, and a plasma TV in every room. You can't afford that crap, but you bought it anyway - maybe you believed you could pay back all that debt, maybe you believed the boom would never end, maybe you just wanted to keep up with the Joneses or feel special. But you had to know you couldn't afford it, yet you borrowed and spent anyway. Now I hope you die in the fire you set while trying to collect an insurance payout. It's people like you - and all the others I just mentioned - who make this world a shitty place to live. So please, FOADIAF already. And in the meantime, take some goddamned responsibility for yourself.

Re:Outsourcing Their Decisions

[rtb61]

Don't confuse the libertarian. They always seem to think all those regulations that controlled the excesses of capitalism mysteriously appeared on their own by accident. All those laws that were removed in the deregulation gold rush, were put in place as the direct result of failures resulting from unbridled capitalism, each failure and corrupt exploitation resulted in new laws to prevent their recurrence, of course those laws, as yet, could not ultimately prevent their removal.

The out of control lending was all about creating the illusion of profits and hence inflate the bonuses of grossly overpaid executives. It was all about a total disregard of the consequences, of people cashing in on other peoples savings, of management making millions while costing everyone else billions. It did not happen accidentally, it was inevitable and planned and executed by people who had no regard for the damage they caused, their sole interest was in how much in bonuses they could squeeze out before it all collapsed.

As the saying goes

[EEPROMS]

If all else fails, blame your tools.

Two different issues -

[Artifakt]

The data being flawed is very different than the code being flawed. In fact, what Greenspan is talking about has almost no connection to what Cox is talking about, and there's no real reason to put them both in the same article. Starting with bad data will abundantly suffice to explain the meltdown before any problems with the algorithms used have to be assumed.
Most of the bias that did the real damage is political. For example, the most recent figures on the economy show that in the months before the mortgage crash began, 68% of all spending was driven by individual consumers buying retail. If the last tax rebate had been aimed at 68% of the total going back to individual consumers, or the '700 billion bailout' had put 68% of the 200+ Billion actually committed so far into reducing the impact to non-institutional borrowers, those would be appropriately neutral positions - but in the current climate, those would both be classified as terribly liberal.
        But that figure wasn't trumpeted about until after the bailout was passed. The same goes for the corrected inflation rates, which are still not accurate but are a bit better, and which again weren't corrected in releases to the general public until after the bailout was final.

The Great Pretenders

[Mactrac]

Those bankster knew exactly what will eventually happen. But their modus operandi is to privatize profits and socialize losses. It's as simple as that. So why would they bother?

Greenspan's hubris

[Mr. Underbridge]

Bottom line, this had nothing to do with bad data. It was Greenspan's blindness to the consequences of easy monetary policy would have that caused much of the problems today.

Absolutely. Wait, rollercoaster interest rates are a bad idea? Really? And it took a genius to figure this out?

It's so easy to understand. Low credit and the push for home ownership at any cost led to insane price increases and speculation that it wasn't hard to see had to come to a crash stop. I had this figured out as of 2004 when I talked to a realtor who told me I needed to buy NOW with nothing down and use the guaranteed 2%/month price increase to refinance in a year. I can recognize a bubble when I see it.

That's why it pisses me off when Greenspan points the fingers elsewhere. He's the one who set the rates. He's the one who jacked them up, then down, waiting too long and overcorrecting to account for it. And he refuses to take the blame.

The funny thing is, this isn't the first time things have gotten sideways thanks to overspeculation. During the (mercifully) brief meltdown in 1998 due to the currency markets, he basically told the banks to do what they do, the government will help out if things go bad. The overcorrection to that mini-crisis and the post-9/11 slowdown sowed the seeds for what we have now. Gee, thanks Alan.

So now he blames bad data. Really, Alan, you're surprised that people selling certain securities said things about them that was overly rosy? Give me a break. At some point, you have to have some damned sense, and actually look at the securities without the computer models. When things defy common sense to that degree, something's wrong.

The funny thing is, it seems every crisis comes about because risk diversification models fail. Happened in 1929, happened in 1998, happened now. Investing houses have this theory that a lot of big risks can be less risky in totality, because the risks aren't correlated. Problem is, when the shit hits the fan, a lot of things become correlated that didn't use to be. Partly it's because everything's sitting on top of the same increasingly global economy. Part of it is that funds that are overly leveraged have to sell whatever they have to meet margin calls. The people who create the models study the risk correlation and assume things based on it that simply aren't valid in the real world. The book "When Genius Failed" has a good case study on this, where an investment house run by brilliant guys including Nobel Prize winners crashed and burned because they didn't understand that common sense trumps mathematical models.

To disclose, I actually see great value in statistical predictive models - indeed, that's what I do for a living. I design and implement mathematical models. But because of that, I also know what mathematical models can't do. Too much hubris by too many people, and we all suffer.

Re:Greenspan's hubris

[copponex]

It's so easy to understand. Low credit and the push for home ownership at any cost led to insane price increases and speculation that it wasn't hard to see had to come to a crash stop.

That seems to be an oversimplification. The most reasonable thing I've seen is that we deregulated the credit derivatives market, and told the crooks to "regulate themselves." When the government advocates more people to have homes, and ties that to a banks ability to expand, that's not necessarily a bad thing, unless the originating lender can hand off hot potatoes, rake in cash, and not face consequences. If full disclosure was part of that market by law, then we simply wouldn't be where we are today. Originating lenders would be unable to sell bad loans, and when they started suffering the consequences, the game would have ended early and not been nearly as bad.

Exacerbating the situation is the removal of important firewalls between investment houses, banks, and insurance companies that happened at the same time. Companies that had been only banks or only insurance providers are now in deep trouble, though their original departments weren't involved. So, I agree with you about "diversification models." One of the downsides of free markets is the inevitability of boom and bust cycles, which is why every successful economy has a powerful governing authority to regulate a relatively open market. It helps calm the highs and the lows, which restricts growth but also prevents everyone from losing their shirt at the same time.

Accountability is what's missing from capitalism. In my opinion, everyone who was aware of the risks they were handing off to others should be stripped of every penny they made off of those transactions, and if found breaking any laws, should be serving as much time as petty thieves who steal thousands instead of millions. Similarly, any company that intentionally and illegally pollutes should have to pay clean up costs and matching punitive damages that fund land trusts.

The difference in treatment of those two types of criminals is indicative of another problem at the foundations of modern western capitalism: privatized profit and socialized risk.

Re:Alan Greenspan

[Anonymous Coward]

The problem with some old people is that they don't realize how much they don't know.

The problem with most people is that they don't realize how much they don't know.

Computers cannot replace common sense

[MobyDisk]

From what I understand, they were giving loans to people who had no collateral and no income. If your computer model says that loan is a safe loan, then you have a bug.

Re:Keep Changing Assumptions Until the Right Answe

[registrar]

There are plenty of human-factor reasons why these kinds of models fail: management wants certain results, modellers want to feel they are contributing valuable results, people with big-brother pretensions placing too much faith in fancy computing, geeks lapping up the attention, etc..

But the bottom line is that people were not properly using information about uncertainty: if crap data is all you have, you have to tell the model how crap it is. If you don't do that, then your model is misleading and dishonest. Forecasting the future is tricky business, and you just have to know when it's too hard.

The bottom line is that modellers who don't turn around and say "sorry, boss, the model can't tell you that" and insist on it are largely responsible. Unfortunately, as a rule, it is the person who makes the boldest predictions who gets the most attention, and attention becomes credibility.

Collectively modellers are the /only/ people capable of understanding the output of models. Modellers must have enough influence in an organisation that /their/ interpretation of a model prevails--they don't have to dictate decisions, but the CEO needs to know the modellers' interpreattion of the model, not some intermediate's. If not, then I think negligence or fraud charges should be on the table for someone--maybe the modeller who is oversells their result, maybe someone else.

Yes, I'm a modeller. To the extent that our opinions guide decisions (what is a model if not a collection of opinions?) we need a professional code of ethics, just like engineers, lawyers, doctors, etc..

Re:Greenspan's a muppet.

[Chuck Chunder]

Flip-flopping is the last thing you want from a man that has his position.

Yeah, the last thing you want is someone who changes their mind in the light of new information.

I think the world got dumber the day the term "flip-flopper" began being used in public discourse.

Re:Too big to fail ...

[cayenne8]

"There will always be SOMETHING that can exploited. Close the loopholes ... but also jail and fine the people who orchestrated this. And every other exploit."

Trouble is....if they did all this and were playing within the rules laid forth by the SEC...there is no crime committed. There is nothing to be arrested for...

Bullshit. total televised shitting

[unity100]

Computers and programs do what they are built to do, exactly like they are programmed by programmers. and programmers code what they are TOLD to program.

this senile old bastard is trying to drop the blame ball on someone else than himself. he was the person who ushered the 'let everyone run around lawless' era in finance. he was praising it and saying that 'free market' was this and that. now he comes up saying he is 'shocked' to see the market not regulating ITSELF.

i have news for you, bastard, what you call market is comprised of PEOPLE, and its a social activity. just like life doesnt 'regulate' itself so that you still need laws and justice system, the social activity you call 'market' also is comprised of people and full of opportunists, schemers, bastards, exploiters, criminals and crooks. if you just let everything be, IT BREAKS. and IT DID.

any person with only a few decade of life experience under his/her belt would be able to realize this.

but you and your fellows in the church of holistic economists were SO zealots in your belief that, you were unable to realize this simple fact of social existence despite your 5-6 decades on the face of this world.

shame on you old man. shame on you for preparing the grounds for breakdown of ENTIRE global economy with your zealotry and foolishness, and your attempt to blame others for it.

blame the data !! after all, noone can do anything against it right ?! its not live, its nobody, and even if you hate its guts, you wont be able to remove it from business, so problem solved.

Re:Of course the code was bad.

[recharged95]

F* these guys. Using tech as a scapegoat.

Blaming computers and code? In this case, don't blame the game, blame the players. If they are truly the smartest guys in the rules, they would have known the practices (not tech) put in place were just plain wrong, or at least high risk involved. They saw tech as something to apply their new theories, without acknowledging the risk. Just because I bent the nail doesn't mean it was the hammer's fault!

If they are not the smartest guys in the room, then the emperor is without his clothes and these guys, along with all of Wall Street, do not deserve the rich payouts they're going to get in the next year, seriously...they are going to ask for more cash to put in their pockets.

Re:I blame ACORN!

[homer_s]

The invisible hand of the market would not let us down like that.

It didn't. It punished everyone who made bad decisions - the people who loaned money, the people who borrowed money to buy a home they could never afford and the people who invested in companies that loaned the money.

Of course, it is not the free-market that is giving 700-billion to the people who made reckless loans. Maybe you can figure who that is...

Re:Greenspan's a muppet.

[marco.antonio.costa]

He's not inept, he's actually a pretty bright fella. The thing is: nobody can see _all_ the consequences of, say, arbitrarily changing the interest rates.

The reason the Fed fails is the same reason the U.R.S.S. failed; Central planning _does not work_, socialism _does not work_, price fixing ( including the price of money, i.e. interest rates ) _does not work_.

To paraphrase Mises, if a God would descend from the heavens and take the economy's leash to guide us, then socialism would work under such an omniscient leadership, but since that's not likely to happen anytime soon, the free market is the only rational mechanism we have to direct economic activity.

[Citation needed]

[Estanislao Mart�nez]

The ratings were based on the idea that house prices only ever go up, and that they could always foreclose and get their money back.

Citation needed.

I don't think models were anywhere near that simple. The closest you could get to that is if you fed home appreciation data from a time period where house prices mostly went up, and had no examples of periods when they went significantly down. That's a plausible failure mode for many of these models (and it happens all the time with financial models, ugh, and the financiers don't seem to learn), but the models would have made different predictions with different data sets.

There's another assumption that people made that led to the problems with the ratings: the assumption that housing and mortgages from different parts of the country would have uncorrelated performance, so that packaging them all together would diversify risk away. The short catchy phrase for that was "all real estate is local": the assumption was that house prices can go down in some parts of the country at any given time, but that it was unlikely that they would go down in all of the country all at once. You can see how that one turned out, of course.

That one, again, turns out to be a recurring problem with financial modeling:

1. The supar-smart quant financiers make models that assume that some assets' returns are uncorrelated, using historical data from a relatively short time period.
2. The supar-smart quants then build "safe," diversified portfolios out of the assets in question, using those models.
3. When the shit hits the fan, the "safe," diversified portfolios' assets plunge in lockstep (yay for mixed metaphors!), and the portfolios crash.

The financial model failures we're seeing now are remarkably similar to the crisis that led to the failure of LTCM 10 years ago. The industry doesn't seem to learn, which is a big problem.

More generally, there's a bigger problem here (and I'm paraphrasing Buffett in the following): it's not that the mathematical models of risk aren't valuable, it's that, by putting very precise-looking numbers to aggregates of thousands of highly uncertain estimates of future risks, they make it look like risk has been tamed. If you have a model that tells you that the current risk of your portfolio is, say, 15.72%, and you mechanically decide how to allocate your capital using a formula that doesn't build in a generous margin of safety against mistakes in that number, you're going to get burned by problems like this.

Re:Of course the code was bad.

[Jah-Wren Ryel]

If we hadn't had things like CRA and community activist groups painting banks that didn't paint lots of bad loans into 'underserved' areas as racists, then we might not have had quite so many bad loans.

This wasn't the only cause, but definitely a big factor.

No, it was a relatively small factor. 50-80% of subprime loans were made by companies to which CRA didn't apply. In fact, CRA only applied to 1 of the top 25 subprime lenders. Furthermore, less than a third of CRA loans are in the category of subprime - most of them have fixed interest rates better than subprime and consequently default rates are below average too.

Re:I blame ACORN!

[evilviper]

It punished everyone who made bad decisions

Bull. The majority of those executives who made the horrible decisions were riding high on ridiculously, fraudulently inflated stock prices, and got their huge bonuses and golden parachutes, leaving before the crash.

Re:Libertarians say Federal Reserve is Theft.

[Free the Cowards]

What commodity should money be backed by, then?

The answer all the libertarians seem to give is "gold". But this is nonsensical. Gold is not particularly valuable. It has some worth in certain industrial processes and such, but mostly its value comes because people are collectively nuts. In this way, the value of gold is not much different from the value of the un-backed $20 bills in my wallet.

Re:Libertarians say Federal Reserve is Theft.

[EastCoastSurfer]

They believe that ALL money should consist of, or be 100% backed by, a valuable commodity. The value of the money would fluctuate ONLY according to the value of the commodity (and, in the case of "backed" tokens, by the perception of the reliability of the commodity warehousing operation).

The problem is that there is not enough of any commodity to support the actual amount of productivity in the US, much less the world. I agree the Fed reserve printing money at will is a crock, but money doesn't have to be backed by anything as long as everyone agrees that it can be used as an exchange of goods and services.

And yes, printing money right now is a horrible mistake. 1 trillion there another trillion here. I hope everyone is ready for the upcoming hyper inflation and 15%+ interest rates!

Re:Libertarians say Federal Reserve is Theft.

[Free the Cowards]

Value is related to scarcity and utility. People are always forgetting about that second part.

For example, if I sculpt my shit into a likeness of Jimmy Carter and call it "art", we have something that is extremely scarce. It is quite literally a one-of-a-kind item. Total value? Essentially zero. It may be worth something as fertilizer, but it's probably not worth transporting it to where it could be useful.

On the other hand, air is quite valuable. (If you don't believe that because you don't pay for it, just try doing without it for a while.) It is also about as far from scarce as you can get.

Gold has very little utility. Before the modern age it had basically zero utility. This is, quite simply, because people are irrational and assigned a value to it which is beyond its inherent worth. Exactly what the gold-standard crowd says people do to $20 bills.

Re:Alan Greenspan

[plasmacutter]

"Fox guarding the hen house"... Like Anarchy? Or Government regulation? Both are remarkable for their efficiency infringing people's freedoms and rights.

The point of government regulation is to play corporations, who are equally rapacious to people's freedoms and rights, against the government.

Corporations don't benefit from government getting too big and taking over their markets. Government recognizes that risky and anti-consumer behavior by corporations may destroy the economy or incite revolution.

A balance of power between the two using smart regulations (as opposed to the often presented "more" or "none") is the way to go.

Who is the fox, and what is the henhouse?

[DesScorp]

Whomever thinks self-regulation will ever work for the benefit of the public needs their head examined.

Does the phrase "Fox guarding the hen house" ring a bell to anyone?

Tell me, being that the root of this whole mess are subprime loans, were you this concerned when some Congressmen tried to enact new regulations on Fannie and Freddie, and others blocked it, citing such economic justifications as "racism" and "fairness"? Because it's in the Constitution that everyone gets a house, you know.

Re:Who is the fox, and what is the henhouse?

[aproposofwhat]

It's not so much the subprime loans themselves that are at the root of this, but the reselling of the debt without properly accounting for risk.

That's the whole point of TFA - that the repackaged debt was given AAA ratings despite being obviously toxic.

Of course the decision to force institutions to make these loans was stupid, but it's the subsequent repackaging and reselling of the debt, disguising its lack of real value, that was the cause of this crisis, and the methods used to create that false valuation that are the subject of Greenspan's criticism.

Re:Not to mention Freddie Mac and Fannie Mae

[theaveng]

There's an alternate conclusion: Corporations don't want a free "laissez-faire" market, because they want to be able to use government to block competitors. For example, Comcast uses government to grant it a guaranteed monopoly in various counties across the continent. Comcast certainly does *not* want a free market. Neither does Microsoft, or GE, or numerous other companies.

Oh one other thing:

It's a mistake to think corporations don't like Democrats. The TV corporations donated 74% of their funds to support Democrats, and just 26% to Republicans. Why? Well your guess is as good as mine, but I suspect it's because the TV media knows Democrats love to regulate, and the TV media is hoping the democrats will *protect* TV's business against internet competitors (like video-streaming Ipods).

Corporations don't want a free market. They want a socialized, closed market that protects their current standing. They want competition to be blocked.