Computer Models and the Global Economic Crash

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."

Comments

Taleb's explanation of the Narrative Fallacy

[icke]

http://en.wikipedia.org/wiki/Nassim_Taleb "Narrative fallacy: creating a story post-hoc so that an event will seem to have an identifiable cause."

Re:Can somebody 'splain this?

[Estanislao Mart�nez]

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.

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 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; 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?

[johnsonav]

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.