Greenspan Tells Congress Bad Data Hurt Wall Street 496
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."
700B mistake (Score:1, Interesting)
It's about data quality (Score:5, Interesting)
I keep on harping about this. Who assures data quality? With web 2.0, cloud computing, distributed applications etc. who assures that those actual data are correct?
The article addresses that there were only 20 years of data, but doesn't address this fundamental issue. In the past 20 years we have had wars, terrorist attacks and recessions. Plenty of jolts. Once a data stream becomes polluted, in my experience, determining what is valid and what isn't is *hard*.
Though all-in-all I think Greenspan is in the hot seat and just looking for a scape goat.
Keep Changing Assumptions Until the Right Answer (Score:5, Interesting)
In my experience in these matters, it wasn't the code, it was the fact that management kept disagreeing with the results and changing the assumptions until the answer became something they wanted to hear.
GIGO (Score:5, Interesting)
I got that via a connection to Standford theoretical physicist who'd found loadsa money that way (I used to be a CERN experimentalist).
They were all fascinated with the Black-Scholes pde; but no-one - I mean NO-ONE - had any clue what the model was about.
They just hired geeks to make up a number.
One of the in-house coders (and they are good coders, and paid) had to stick a random-number generator onto the back of a calculator for a set of exotics.
He presented the available information. It wasn't 'accurate' enough. So - quit, or stick in spurions. He did the latter.
It is NOT rubbish data in. It's a complete inability to understand what to do with the data.
Too big to fail ... (Score:5, Interesting)
... but not to big to have their CxO's doing some jail time for supporting that.
If nothing happens then those same people are just going to find ANOTHER dodge to exploit. Just like the Savings and Loan debacle.
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.
Re:Alan Greenspan (Score:3, Interesting)
Re:Greenspan's hubris (Score:5, Interesting)
One of the downsides of free markets is the inevitability of boom and bust cycles
That is NOT a downside of free markets. That is a downside of having a central bank issuing fiat currency at essentially arbitrary interest rates that do not necessarily reflect current savings and consumer preferences.
F.A. Hayek won an Economics 'Nobel' on that work [nobelprize.org], by the way.
People fail and succeed all the time in a free market, that's good and healthy for the economy, but when everyone fails at once, you can be sure there's a central bank and an Alan Greenspan fucking everything from up on his planner's high tower.
What's wrong with your argument is that you're focusing on the symptoms and ignoring the cause. Companies DO have accountability, Lehman Brothers went bankrupt, AIG is broke on Federal life support, everybody who indulged in that binge is now dead or dying. Except the government isn't allowing the failures to fail, and in doing so they're rewarding idiocy and punishing competence. I say it is government that needs accountability.
Re:Of course! (Score:3, Interesting)
Yes, if only we'd had a computer to tell us that creating money out of thin air has negative economic consequences.
Ridiculous! Everyone knows that when you trade [stocks|houses|tulip bulbs] back and forth until their "value" is 5 to 10 times what you started with, that's all real money.
Seriously, why is it that people can't see the fact that there's 50 people and only 10 chairs, and when the music stops, 40 of them are gonna be standing? Do they think they'll be one of the lucky 10? Or are they just dumb? And more importantly, why do they get bailed out, when sensible folks like me who waited until now to buy property, and saved money for a sizable down payment, we get squat? Isn't it obvious that making stupid decision sought to be painful?
Bad Data Hurt Wall Street??? (Score:3, Interesting)
Re:Greenspan's hubris (Score:4, Interesting)
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."
I don't necessarily disagree with your analysis above, but quite honestly it IS simple. The reason for this clusterf**k doesn't require a PhD in finance to figure out, that's what kills me. Basic supply-and-demand analysis suggests there will be a problem. The issues you raise are absolutely important, but to me they just determined how big the problem would be, not whether there would be one.
I would look at it this way - the deregulated derivatives and swaps (and other not-so-transparent assets) made it easier to hide the problem for longer, but credit that was just too easy to get was the fuel for the fire.
I'm looking it from a pure supply-and-demand standpoint - historically, whenever credit is too easy to get and stays that way for too long, Bad Shit happens. Funds get greedy, overleverage, and make insane bets. Then, when the bad assets start getting sold off, their leverage screws them because they have to sell good assets to pay off depreciating leveraged debt. If too many people are too leveraged, you get a chain reaction where selling depreciates even good assets, which cascades and leads to a market crash because you don't have any buyers. It would be one thing if this were the first time that cycle has happened, but it happens frequently. 1929, a smaller one I believe after WWII, 1987, 1998, 2002, and now. The degree varies, but all owed a lot to overspeculation, which depends in large part on credit that's too easy to get.
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.
That's not a bad start, but Wall Street will always find an angle. Your approach, while necessary, is sort of like how we beefed up airline screening after 9/11, even though the next attack will be different. Preventing the last problem isn't bad, but it won't solve the next problem. Same on Wall Street - the next financial crisis will have a different cause, be it foreign currency speculation, bond speculation, housing speculation, venture capital overspeculation, whatever. Note we've had minor to major crashes due to all *five* of those just in the last 20 years, a couple of them multiple times. What's next? I don't know, neither does anybody, and that's the point. Bottom line, you can't legislate away all the holes because you can't out-think the cleverest schemers on Wall Street - but you can eliminate the easy credit that lets the morons do it.
As an example - so why housing this time? Mortgage securitization was the flavor of the month for the "can't fail" risk diversification crowd. As I've said, it's just one in a chain. The pet theory of risk diversification suggested that, based on woefully limited data, that mortgages across different socioeconomic backgrounds and different regions won't all go south simultaneously. That worked until easy credit and a clever scheme let mortgage brokers and investment banks game the system. Here's the game: while everybody knew banks were giving houses to people who couldn't afford them, and that it was happening everywhere, the mortgages were built so they didn't implode immediately. How? The balloon ARM. Everybody with a functioning brain knew these balloon ARMs that were sold to get people in houses were ticking time bombs. But the fuse on that bomb was a couple years long, by which point the people who packaged those securities had sold them. Just like the dot-bomb economy, when the vulture capitalist clowns backed IPOs that anyone knew were retarded, but they made their money up front. Some other sucker would find out later these companies had no business model.
One of the of the downsides of free markets
Bad data, no. Bad modeling assumptions, yes. (Score:5, Interesting)
Most of the risk models are based on the Black-Scholes theory of options pricing. The assumptions of the model are basically small, normally-distributed perturbations. The "unseen hand" is guiding things.
What it can't model is boom-and-bust situations. The mathematics of boom-and-bust ran CRT-type TV sets for years. The horizontal sweep in a TV set is a sawtooth oscillator that builds up linearly and then collapses and starts over again. The math is non-linear, and has been studied.
But the "unseen hand" doesn't do booms and busts. It efficiently self-corrects. Real markets sometimes boom and bust. What got in the way of proper modeling was probably a combination of ideology and the common tendency to leave out of models the things that are not easily tractable.
Re:Libertarians say Federal Reserve is Theft. (Score:4, Interesting)
He did not say a limited commodity, he said a valuable commodity. If the only thing you need is for the supply to be limited then he should have said that. But he said "valuable", which gold really isn't, so I want to know what the proper backing is.
Re:Greenspan's hubris (Score:4, Interesting)
Well I'll just stop asking leading questions and cut to the chase.
My understanding of economic history is that there have always been economic cycles. Cycles are inherent to any system with complex feedback loops. You seem to be blaming cycles on fiat currency, paper money, or fractional reserve banking, which just makes no sense in that context.
Re:Too big to fail ... (Score:5, Interesting)
That doesn't seem to have been much of a problem in the recent past, I say leave them in a hole for 5yrs and I reckon they would be ready to plead guilty to a retrospective law [wikipedia.org].
Re:700B mistake (Score:5, Interesting)
Re:Greenspan's hubris (Score:3, Interesting)
Well, you're right. Economic activity is dynamic, and is subject to the real world. I'd expect to see a big boom in the agricultural sector if crops start failing all over the world. But that is not a speculative boom created by an expansion of credit, but it's a redirection of resources to an area where a demand has shown to be increased by a rise in prices.
The point I'm trying to make is that the boom and bust cycle, like we're seeing now in which dozens of companies fail at the same time, is caused by central bank meddling with interest rates and causing speculative bubbles and malinvestment that eventually needs liquidating. It makes sense in _that_ context.
Re:Libertarians say Federal Reserve is Theft. (Score:2, Interesting)
You can say that new money gets its value by diluting the rest of the money. But the reason it is necessary to expand the money supply in the first place is because the underlying value represented by the money (the GDP) is growing. The Fed does not expand or contract the money supply to take value away from your dollars. It does so to keep the value of your dollars as constant as possible without deflating. The Federal Reserve system is ingenious in the way that it tends towards maintaining this equilibrium automatically... That is, new money is generally only created as asset-backed loans. That is, a big chunk of new value is added to the GDP as a new home or a new factory, and new money is created to balance with it in the form of the loan that the homeowner or the corporation takes out to pay for it.
All money IS backed by a valuable commodity -- the GDP of the issuing country. That's what money exists for. It does not exist to represent a single commodity within the GDP and the whole GDP simultaneously. When you try to make money do that, all it does is artificially inflate the value of the commodity to the value of the GDP, and put a cap on the ability of the GDP, to grow in value, and ultimately set the country up for a deflation spiral. That's the best case. The worst case is if a whole lot of countries are all doing that, and, stupidly, all using the same underlying commodity, and at the same time trading with each other. Then you have the insanity that was the global economy of the 1930s, with market-driven flows of gold into and out of countries out of control of everyone, and decimating the economy of every single country on the gold-standard.
I realize there is a rampant cultish belief out there that money that is not a promissory note for shiny metal is not really money. But if that belief is identified with Libertarianism, I have to be more careful not to associate myself with that term.
Re:Greenspan's hubris (Score:3, Interesting)
I don't buy it at all. You don't need central banks to get boom and bust cycles. All you need is a system which contains feedback and lag. Booms and busts simply fall out of the differential equations which describe such systems. There were probably boom and bust cycles in ancient greece involving wine and pottery and statues, long before anyone ever invented central banks.
They may make it worse, I don't know. But they certainly aren't the sole cause.
Not a mistake (Score:5, Interesting)
Printing money allows the US Gov to tax the rest of the world at will.
Commodities like oil, wheat, cooking oil, orange juice, milk, DRAM, CPUs are all traded in US dollars.
This means most of the countries in the world need to collectively hold trillions of US dollars to buy this stuff. I suspect there's more USD held by non-US entities than US entities.
If China or Japan do not have enough US dollars to buy oil, they sell stuff for them (it doesn't even have to be to the USA- other countries will buy them in USD). If China/Japan has more US dollars than they know what to do with, they often lend it to the USA and others (who promise to pay back in USD).
So what happens if the USA prints more money? The US Gov has more US dollars, the US citizens become poorer (boohoo), but more importantly, it means the rest of the world holding trillions of USD become poorer.
If you were Zimbabwe, and printed money, your citizens start having to use wheelbarrows to buy bread while the rest of the world just laughs at you or pities you.
Whereas if you were the US Gov and printed money the rest of the world is living in your "Zimbabwe" and using your currency. The US Gov hands some of the printed money to the US citizens (cronies) so that they will continue to help prop it up.
Thus overall it does not hurt the USA as much as printing money hurts a country like Zimbabwe. As long as the US Gov (Mugabe) hands over a cut to the citizens (cronies), the USA as a whole does OK.
Now the thing is Iran is selling oil in Euros. This undermines things a bit for the USA.
It's no fun printing money and having the rest of the world just laugh at you, instead of getting poorer.
BTW Iraq switched to selling oil in Euros before they got invaded. Naturally after they got invaded they switched to selling oil in US dollars.
Not saying that's _the_ reason why they were invaded. As they said, there were many reasons for invading Iraq.
Now the US citizens (cronies) have to be vigilant and see if their "Mugabe" is "cutting" them out from their share of the printed money. So they should regularly remind "Mugabe" that he needs them to stay in power (but is that still true?).
It would be bad for them after all, if it turns out that "Mugabe" has new cronies and has cut them out completely.
Re:Libertarians say Federal Reserve is Theft. (Score:3, Interesting)
My point is merely that gold is no different from the rest of these. It's all just "how much people pay for them". There's nothing magical about gold, even though people talk constantly about its "intrinsic value". It has no such thing. Gold is worth exactly what people are willing to pay for it.
Yea you're totally right. I could argue that in the end that's what 'intrinsic value' boils down to. What can you get for it, or how much money.
Let's do the reverse. If paper money is so worthless, why don't you give me enough $100 bills to fill a suitcase and I will give you an ounce of gold in return. I'm sure that the gold will be more than enough to pay for the cotton and ink.
Ohh, I'd be crazy, unless you would take 7 hundreds and a twenty for that ounce. :)
The dollar is not worthless. Yet. But it's purchasing power has gone nowhere but down since the Fed and later the severing of the gold link. Gold serves as a safe store of value because the government cannot steal the value of your gold by magically making more.
If we had God as chairman of the world's central bank, I really wouldn't mind the fiat currency, but in the unlikeliness of that scenario, I'll defend commodity money and free banking as a better system. :P
Re:Outsourcing Their Decisions (Score:5, Interesting)
This whole mess is a failure of socialist banking policy NOT capitalism or free market ideas.
Horse poo. It's nothing to do with socialism. There are much more regulated (let's drop the "socialist" distraction) economies out there, and they just aren't doing as badly in this little mess as is the USA.
It was a property market bubble, and bubbles are a result of unreasonable investor optimism and confidence. There were a few extra contributors to this little problem, but let's not pretend that libertarianism is the answer when there are NO libertarian societies out there in the real world doing better.
Don't get the idea I don't like Americans or the USA. I do---I like you because you're all gooey, ambitious and optimistic, even if that makes you prone to economic bubbles. I hope you get through this problem just ducky. But you do have too much belief in money, and I hope this beats it out of you.
Re:Of course the code was bad. (Score:3, Interesting)
Re:What the hell are you talking about? (Score:5, Interesting)
In an unregulated market fractional reserve lending should be prosecuted as fraud. It is fractional reserve lending that is the root cause of the collapse in the money supply.
No, re-read my post. It was pure greed and financial malfeasance which led to the "collapse" of the credit markets. (it's not a collapse either because the federal reserve still lends to financial institutions. Government interference prevents the economy from utterly collapsing in situations like this)
This is entirely due to government regulation.
"Regulation" is, fundamentally, government compelling a sector of private commerce to behave a specific way. The presence of the Fed does not compel a bank to engage in fractional reserve lending, in this case it merely allows it.
The banking industry has been structured upon fractional reserve lending since it arose. They don't make profits by simply holding the deposited assets. They loan out a fraction of what their patrons deposit to earn profits through interest. An (arguably beneficial) side effect of this is the "money multiplier" effect that makes the world go round. (It is arguable that the industrial revolution and our modern, technological age would not have arisen in the absence of this economic force.)
Fiat money precludes the possibility of a free market and even with an ostensibly gold backed currency is in reality a fiat currency if the government allows fractional reserve lending.
Given that you agree that fractional reserve lending and the money multiplier effect mean that even gold based currency is equivalent to fiat money, then, given the history of banking, your assertion that fiat money precludes the possibility of a free market is refuted by centuries upon centuries of commerce.
In light of this, your whole rant here strikes me as incoherent.
There is some real irony here in your post.
If you believe fractional reserve lending is, in fact, fraud, then what you are advocating is...drumroll please.... a regulation prohibiting that practice.
In fact, the federal reserve system imposes a minimum required reserve on bank systems, which artificially decreases the quantity of money "fraudulently produced" through fractional reserve lending.
They used to take much greater risks in their lending because the first rule of the free market is profit. This resulted in a lot of people losing their savings when banks lost all their liquid assets in loan defaults during the depression.
Re:Libertarians say Federal Reserve is Theft. (Score:3, Interesting)
Many people like gold for its beauty. This is a utility, and one people are ready to pay a huge lot for.
So the value of gold as a currency would depend entirely on enough people thinking "Ohhh shiny!"? Beauty is highly subjective.
I'd rather base a currency on something that has more objective utility. Stored energy would be a good example, though I think people would object to enriched uranium coins.
Re:Not to mention Freddie Mac and Fannie Mae (Score:3, Interesting)
Which are about as "capitalist' as the post office. Government-created monstrosities exempt from the law, which were leaned on by Barney Frank [wsj.com] (see also, Barney's Rubble [wsj.com]) and Chris Dodd to lend to poor people with bad credit.
I have to ask the question - if the Libertarian ideal of laissez-faire capitalism is so obviously the "correct" way for the fundamental economic idea of maximization of utility to manifest itself, why are there such problems creating a pure free market system in the U.S. instead of the quasi-socialist current system? I find it very difficult to believe that, given the power of American corporations, that somehow the Democrats could enforce such a system without their consent. The only conclusion I can draw is that the current economic system must exist because it creates a symbiotic net benefit for both government and corporations that's better (at least for those parties involved) than pure LFC. That or the economic theories that pure LFC are based upon are incorrect.
Re:Outsourcing Their Decisions (Score:3, Interesting)
Fractional reserve lending is a red herring; all currencies are fiat, including gold. The benefit of gold, when it was chosen, is that it:
1. Doesn't corrode.
2. Is dense and therefore doesn't take up a lot of space.
3. Had no value.
Read #3 again. Gold was too soft to be useful for anything. Now we use it as a conductor, but for the most part it is still useless. That is why it makes a good medium of exchange. No one is going to melt it down to make a coffee pot out of it.
Another way of saying that is gold has no utility. Something is valuable because of what one can do with it. Gold/silver have value only because the government (or your trading partner) has declared that they will be accepted as payment, that is, they have value by fiat. People go to great lengths to obtain them because of that declaration, not the other way around.
The difficulty of procurement of gold tends to encourage a less inflationary economy but it also means that only gold miners can increase wealth. Everyone else is just shuffling money around. In a non-backed economy anyone who can create a product can create wealth by getting the government (or their agents--the banks) to create money for them.
Another way of looking at this is to consider the copper penny. It isn't used any more because copper gained value beyond it's use as money. Once that happened it became worthless as money because people would rather melt it down and use for other things than keep it as money. If that doesn't occur with Gold it is because gold isn't valuable beyond its use as a fiat currency.
--
JimFive
Re:Not to mention Freddie Mac and Fannie Mae (Score:4, Interesting)
Frankly, at the heart of this problem, the markets massively over-priced these mortgages, and insurance companies under-priced default insurance. Under a free-market framework... this shouldn't have happened.
Did the government "force" AIG to underprice the risk of default on these risky loans? Did they "force" investment banks to make multi-trillion dollar CDS and CDO's that brought down the global financial system?
This issue has highlighted that systemic risk in our markets is pervasive, and that there seem to be externalizations associated with risk taking. And blindly shouting "Capitalism!1!" isn't very useful for solving it.
Re:Outsourcing Their Decisions (Score:3, Interesting)
exactly, as soon as the first person loans their gold bars to another to build a bridge and pay workers, then they have just "created" fractional value because they still claim that gold loaned out as their property but somebody else is spending it, hence the problem magnified by millions doing it.