Posts filed under “Derivatives”

Uh-Oh: Is Shiller Defending the Failures of Economists?

Was it the hammers or the carpenters?

That is the question alluded to this morning by Yale Professor Robert Shiller in the NYT. Shiller is one of my favorite academics working in the field of finance. He tries to (diplomatically) argue we can prevent future crises if only we had better econometric tools. I would counter that future crises could be avoided if only we had less economists who were fools.

Lets look at what the Professor wrote:

“There were relatively few persuasive warnings during the 1920s that the Great Depression was on its way, and few argued convincingly during the last decade that the most recent economic crisis was near. So it’s easy to conclude that because we didn’t see these events coming, nothing could have been done to prevent them.

In fact, some people view the recent crisis as just another “black swan event,” one of those outliers, as popularized by Nassim Taleb, that come out of the blue. And it’s clear that a lot of smart people simply didn’t see the housing bubble, the instability of our financial sector or the shock that came in 2007 and 2008.”

Uncharacteristically, Professor Shiller is deeply wrong about this. There were numerous “persuasive warnings” and “convincing arguments” prior to the most recent disasters. They were mostly ignored for a variety of cognitive reasons. It was not that they were not understood, it is that most people selectively refused to believe what was against their own interests. When the potential damages of what might occur is too ugly to contemplate, the silly humans find ways to ignore the truth; we seem to prefer comfortable fictions to painful reality.

And while many “smart people” may not have seen the crisis coming, many did. (Perhaps we need to rethink who we call “smart people” in the future).

It is noteworthy that one such smart person, Professor Shiller himself, had convincingly warned about the dot com bubble in 1999 and the housing collapse in 2005. And he did so using readily available data. So if some smart people did see the crisis coming, and made appropriate warnings, perhaps it is not the tools that are at fault?

Back to the Professor:

“But the theory of outlier events doesn’t actually say that they cannot eventually be predicted. Many of them can be, if the right questions are asked and we use new and better data. Hurricanes, for example, were once black-swan events. Now we can forecast their likely formation and path pretty well, enough to significantly reduce the loss of life.

Such predictions are a crucial challenge in economics, too, and they are why data collection need not be a dull or a routine field. If done correctly, it can be very revealing.”

While having better tools to measure the economy is a good thing, it would not have changed a single thing when it came to the crisis. What matters more than those tools and the data collection format are the institutions charged with overseeing the process, and who is actually interpreting that data.

Back in 2009, we discussed these 10 factors Why Economists Missed the Crises:

1. Inherent upward bias is built into ALL Wall Street research (including economics)
2. Ideological rigidity prevented creative thinking;
3. Non-critical acceptance of official data
4. Institutional rejection of negative analyses;
5. Classic Economic analysis seems ignores human irrationality;
6. Political Bias;
7. Compensation skewed views towards excessive optimism;
8. “Timing” is very different from Analysis;
9. Derivatives, leverage, liquidity a difficulty for traditional economics;
10. Herding instinct is powerful;

Hence, it is not the tools but the fools who were at fault. Even if we had better data — a social good we all should enthusiastically support — it would not have mattered.

Few economists have had more insight into various aspects of behavioral finance than Professor Shiller. His work has been hugely influential in getting more people to see how human cognitive failures lead to significant errors. But it also explains why the data was not what was not the problem.

The fault, dear Professor, is not in our stars, but in ourselves.


Why Economists Missed the Crises (January 5th, 2009)

Needed: A Clearer Crystal Ball
NYT, May 1, 2011

Category: Bailouts, Derivatives, Psychology, Really, really bad calls

ProPublica won the Pulitzer Prize for National Reporting for its series, “The Wall Street Money Machine.” Its lead reporters, Jake Bernstein and Jesse Eisinger, take a moment to explain the series, how it all started and their reaction after reeling in ProPublica’s second Pulitzer. Theirs was  the first Pultizer  awarded to a body of work…Read More

Category: Bailouts, Derivatives, Legal

ISDA Proposal: Standardized OTC Derivatives

This is rather interesting: “The International Swaps and Derivatives Association (ISDA) has proposed a new reference data registry for standardized over-the-counter derivative contracts which would leverage the FpML standard to provide a basic description of the contracts and identification codes through their lifecycle. The New York-based trade association for the $700 trillion market defined standardized…Read More

Category: Derivatives, Regulation

United States Senate PERMANENT SUBCOMMITTEE ON INVESTIGATIONS Committee on Homeland Security and Governmental Affairs Carl Levin, Chairman Tom Coburn, Ranking Minority Member Senate Report GS

Category: Bailouts, Derivatives, Think Tank

Are Oil Prices Driven by Speculators?

> Fascinating chart above via David Wilson of Bloomberg. It very much suggests that while Speculators may not have been the prime mover on the 2008 Oil peak, the specs seem to be a very large portion of the current push. By comparing the net number of contracts owned by non-commercial oil traders (Source: Commodity…Read More

Category: Derivatives, Energy, Trading

Drawing the Correct Lessons from Lehman Bros

“It wasn’t a mistake to let Lehman fail, it was a mistake to let it live so long.” -Ann Rutledge, a principal with New York-based R&R Consulting and the co-author of two books on structured finance. > I am continually astounded by the many missed opportunities you Humans have to learn valuable life lessons. Perplexingly,…Read More

Category: Bailouts, Corporate Management, Derivatives, Legal, Regulation

Industry Code: IBGYBG

The phrase I was looking for in the last post was “I’ll be gone. You’ll be gone.”

Iain Bryson was the first who suggested it, and I then tracked it down to a few sources, the first of which was Jonathan A. Knee’s “Accidental Investment Banker.

Its also mentioned in this 2009 video:


click for video

Transcript after the jump

Read More

Category: Bailouts, Derivatives, Really, really bad calls, Wages & Income

Gasparino: Spitzer Caused the Financial Crisis

I like Charlie Gasparino. I really do. He used to be a sharp elbowed, hard nosed WSJ reporter that dug for stories. Blood on the Street: The Sensational Inside Story of How Wall Street Analysts Duped a Generation of Investors remains a great read. But like many pundits on the right, he simply has a…Read More

Category: Bailouts, Derivatives

GOP: More Madoffs, Please

Percent Change SEC Staff Workload: 1991 – 2000 Chart sourced via GAO analysis of SEC data > If you can’t stop the legislation, you can defund it. That is what our Chart of the Day shows, the net impact of defunding regulation. As we previously discussed 1 year ago (SEC: Defective by Design?), there has…Read More

Category: Derivatives, Really, really bad calls, Regulation

GM Credit-Default Swaps on Non-Existent Debt

A mere technicality, my good man! WSJ: “Banks and hedge funds are trading credit-default swaps, which make payments to holders of General Motors bonds in the event of a default. But GM canceled $40 billion of debt in bankruptcy and has pledged to cut its remaining $4.6 billion bank loan to the bone this year….Read More

Category: Derivatives