I've watched the economy for 30 years. Now I'm truly scared | Hacker News Reader

I've watched the economy for 30 years. Now I'm truly scared

guardian.co.uk

51 pointsnreece36 comments

In order to make this post a hacker-relevant discussion (I enjoyed the article, by the way) how about this quote:

"Everybody tries to 'game' the system on their route to vast personal fortunes - whether short-selling, packaging up dud mortgages as prime mortgages or telling lies about their financial viability - and the result is that the system is getting wise. The best course today in any financial transaction is to presume zero integrity. Credit is drying up and with it the very lifeblood of the economy."

When I read this, the first thing I thought of were the inevitable enhancements to the credit rating systems at personal and corporate levels which will arise in the next few years as a result of all of this.

If we're going to continue to abandon trust and integrity for their own sake and only include them as features of self-serving transactions, then it seems natural that we will have to push our current credit-rating systems much further to the (temporal and relational) edges than where they currently are.

I've been doing some thinking along the lines of using statistical mechanics and information theory to produce a self-consistent measure of risk (unlike the current rating systems). Does anyone know if there's been any work in the area?

What would it mean, in this context, for a measure of risk to be "self-consistent"?

At the first pass, it would mean that possibilities would add up correctly.

Here's one example: give every investment, stocks, bonds, cash, commodities, etc. a distribution of possible returns. Then, every holding company also has a distribution of possible returns, obtained by adding up and scaling the distributions of the stock respectively held. So long as the market changes at a rate substantially faster than the holdings change, this is a self-consistent model of stocks in that the total amount of expected stock value remains the same. One can then examine the distribution of possible returns of a given investment and assess one's own position of risk.

The problem with this is how limited it is. It does not, for example, account for hedge fund pricing well at all, since in hedge funds the holdings change nearly as fast as the market does. It doesn't account well for the wiles of any particular, fast trading investor. It does, however, lend itself to a fairly simple model for static futures, forwards, options, and swaps.

Why is this line of reasoning interesting? The credit systems we used to have couldn't handle the complexity of the derivatives that were being created. By one method or another, bad investments, especially mortgages, were being added up, and in the process the market found it difficult to track how risky the summed investments were. Credit rating agencies don't even make publicly known what their credit ratings represent! An investor is compelled to then blindly believe them, which, in this case, spectacularly failed.

How does this concept differ from the stochastic calculus based implementations of VaR?

I don't know. Maybe it doesn't differ from it at all. I'm not a domain expert by any means...

Thanks for the tip.

I've been thinking of applying agent based simulations as a new way to measure risk. That's a bit different than what you're thinking of but I think it would be self-consistent, or at least the way I understood it.

Agent based simulations would probably be a very excellent approach. Unfortunately, the system is highly nonlinear and quite chaotic, so you'd have to do some work into engineering dissipation into the system to keep it from fluctuating wildly.

Charles Stross's vision of a post-Singularity Net dominated by spam-bots, con-bots, and very convincing AI's with bridges in Alaska for sale seems more and more plausible.

I am tired of hearing "we need more decency and trust, it was just the greed of a few people that got us into this mess". I'd prefer transparency to trust, because then we could actually see if somebody is behaving badly, and decide to distrust that somebody.

Apart from that, it was everybody's greed that is to blame, not just a few bad bosses. If you put your savings into an investment you don't understand, because you have been promised high interests, you and your greed are to blame.

Also, there is the possibility that things simply went wrong. Shit happens. Why does there always have to be a scapegoat?

What the state should do is prevent fraud, that would probably be sufficient.

Unfortunately, it isn't clear that even the people selling these mortgage-backed securities knew how risky they were.

One more reason not to blame "bad morals" for the crisis. I guess most "securities" had a long chain of other investments behind them, and one or more chain elements where risky. Of course the guy selling the thing ten steps down has no idea anymore how risky it is. But that is where transparency could help a bit, maybe?

One of the things that crept up in reddit as it went downhill was a propensity for "doom! gloom!" headlines. There's certainly a lot to worry about with the current crisis, but let's be careful.

Bankers don't create wealth they gather it from other people. There are a lot of people going nuts because their ability to do this is breaking down.

So, investment banks might fail, but as long as people don't pull money out of their checking or savings account I don't think the system is losing money. What I expect is happening is a lot of "fake" wealth is being destroyed but I don't think it's a good idea to buy up fake wealth with cash the government is borrowing. Because, as soon as we borrow money people will take money out of the system to buy our bonds which necessitates our buying assets to compensate.

Bankers don't create wealth

This is a common fallacy. Bankers manage risk in lending, reducing overall risk. This is valuable, i.e. it creates wealth.

If any given Bankers were not performing risk-reduction service for society, they would be outcompeted in the market by their competitors. Therefore, to say that bankers do not create wealth, would be to imply that bankers are in conspiracy to distort the lending market.

But is that what happened here? Financial institutions lent money to borrowers who could not afford the loan they were given. The financial institutions packaged up those extremely risky loans to pass the buck on to another institution.

It seems that the institutions did not manage risk. In a very generic view, bankers may have value. But as far as this financial crisis goes, they failed miserably.

There's always the implicit disclaimer. Bankers who manage risk poorly destroy wealth, just as manufacturers who manufacture defective products destroy wealth.

That's not the complete story. Financial institutions were "encouraged" by the US govt to make those loans.

The other organizations expected to make money buying these loan packages knowing what was in them, so it's hard to see why bankers are to blame.

I agree that the US government is not blameless, but I disagree that bankers should not be blamed for their role. If a banker's value is "managing risk in lending, reducing overall risk," then the banks still failed to supply this value add.

It may also be a fair statement that the institutions did not know the value of what they were buying because of the way they were packaged. I thought that was one of the obstacles facing the bailout--how to value some/most/all of the troubled financial instruments involved. This lack of clarity seems to add to the risk.

A banker's job is packaging risk, which they did.

> It may also be a fair statement that the institutions did not know the value of what they were buying because of the way they were packaged.

Are you suggesting that banks lied or that the buyers assumed that the risk was acceptable? If the latter, why shouldn't they take the loss? After all, they were willing to take the gain.

The bailout is occurring under different assumptions - we're insisting on looking under the hood more.

> A banker's job is packaging risk, which they did.

It seems as if they hid the risk, and may even have increased it, along these lines: http://unqualified-reservations.blogspot.com/2008/01/straigh...

There's nothing at that link to suggest anything about what bankers in this universe did or didn't do.

Note that some of the slicing and dicing was intended to turn a pile of mortgages into two financial instruments, one with less risk than the original pile and the other with more risk. The two instruments would then sell for different prices.

And, are the buyers actually the financial illiterates that the "buyers didn't know" argument requires? I wouldn't call Merrill Lynch naive about money.

Financial institutions lent money to borrowers who could not afford the loan they were given.

I don't think they were doing their jobs well. The same goes for insurers.

One reason the insurance industry is so poorly run is that tax incentives are given to businesses to offer generic health-insurance to their employees. Discrimination according to individual cases is needed, and that is not what has been happening. And when they do individually discriminate (both lenders and insurers), they (being conservative, incompetent, scientifically-illiterate, etc.) ignore well-established important factors such as IQ and the various personality factors -- factors that are known to be determinative of social outcome, and more predictive than past-performance (credit-ratings, etc.).

If they are unable to do their jobs any better than that, then the market should be allowed to have its way with them, just as it did the dozens of second-rate silicon-valley VC firms -- and their, in-turn, poorly-discriminating limited-partners -- that created the internet bubble. Why? Because it makes way for the more-competent.

[Edit: Anamax just pointed out that there was government "encoruagement" in these lending decisions, and that other institutions then took on these poor-risk loans. I think the general principals apply: 1. where the government distorts the market, it causes problems; 2. wherever there is freedom in market decisions, whomever finds himself holding the bag has no-one but himself to blame.]

In theory yes, they manage risk which promotes economic growth etc. However, they are not the ones that put up the cash to start the lending cycle. So, if GM withdraws 1billion in assets their bank would have problems.

The result of this is there is no incentive to avoid failing big if you where going to fail anyway. Bank's can insure a trillion in assets and their only risk is the bank's assets. Each banker is only risking their job it's not their money (unless they have personally invested in the bank). Over time the banking system acts like a game of chicken where they each banker might as well take ever increasing risks, because they make more money in the short term by taking more risks and the downside is limited.

well without bankers we would be carrying coins around in chests. They provide more liquidity then we would otherwise have. Creating wealth can stem from that liquidity, but they also seem to have a role as a type of investor (managing risk) but I am not sure if that is a more recent thing or was always part of banking ?

While I agree with much of what he says (despite working in derivatives), and while I realise the message is what should be addressed, and not the messenger, I think it's worth noting that Will Hutton's wife profited very nicely from the debt explosion here in the UK, as part owner of a company called First Premise, a buy-to-let landlord, and that this may be why his increasingly shrill rants never place any blame on the greedy "man on the street" who was only too happy to sign up for a fraudulent loan and thereby contribute to this mess.

For the last ten or more years of my life (in Australia and the UK), I've been living in a strange world where every single social conversation eventually converges on property prices, property investment, buy to let, negative gearing, renovations, decking, auctions... I'm willing to suffer some hard times if it means all of that will disappear and we can go back to being normal humans again.

At least until the next bubble. :-(

>I've been living in a strange world where every single social conversation eventually converges on property prices

Its really tiring isn't it. well it is good that is over, its just the other crap I don't want. But if we can get back to doing stuff rather then speculating, then great.

[Hank Paulson's plan] made no demands that any financial executives sacrifice pay or bonuses despite having driven their firms and wider economy to the point of bankruptcy. He does not want the government to provide new bank capital to help recapitalise a bust banking system. Instead, he wants the government to buy their toxic debt and so leave the banks unreformed. On top he wanted complete discretion to act as he chose without any oversight.

And this is the man who originaly designed the bailout plan ? This guy obviously doesn't want to save the US & world economy, he wants to save Wall Street first and go on like nothing happened. Why him ?!

Since we're not going after the politicans who "encouraged" the no-money-down loans and took campaign contributions from Fannie and Freddie, it's unclear why you're upset that the financial execs aren't taking a hit.

If you're renting because you couldn't afford to buy or you bought what you could afford, should you pay to keep people in houses that they can't afford?

They should be out of their houses. They are lucky to have lived in such houses in the first place. Also, those that acted improperly should be brought to justice. New rules should be in place to stop this from happening again. The greed and vice that led to this won't go away with the bail out. Power is all too abused.

The housing market is a distraction guys. The problems are with derivatives.

good! good! everyone under forty should be cheering this on. if you finally want to be able to afford a house, you need people who currently own houses to go through some degree of hell. the "bailout" is about making sure those who had money yesterday have it tomorrow. i say let the power change hands. LET IT SHATTER. i will buy the pieces on sale.

I take it you aren't a homeowner, then?

yes, a home OWNER, as in i hold no mortgage. i have zero debt. i have cash to buy distressed assets. i just wish people would stop trying to "save" things.

I am in similar boat. But what worries me is if this means much more then that... what if you suddenly don't have cash, or its worth nothing. What does it matter if you own lots of houses and no one can rent them. Well, its unlikely it would ever be as bad as that ;) but heck, hard not to worry about unlikely events.

I'm so bored of listening to this! just let them go bankrupt! Is this capitalism or what???? Nationalize insurance industry, finance industry, automotive industry. Let the Market clean up the excesses as it has been doing for hundreds of years! This time is NO DIFFERENT.

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