Industry Open-Sources Model For Infamous CDS 161
GlobalEcho writes "Credit default swaps (CDS) are infamous for bringing down AIG and requiring a bailout of hundreds of billions of dollars. Because the market for these was so murky, the US government has insisted that Wall Street create a clearinghouse for these contracts. In a fresh twist, part of the deal is that the models used to price CDS have been standardized, and that the pricing code was made open source, under a somewhat BSD-like license. The source code (originally written by JPMorgan) provides the basic pricing routines, plus an Excel interface. To my knowledge this is the first significant migration of an investment bank product platform from its usual super-secret proprietary home to the rest of the world."
Reason: Security (Score:4, Insightful)
Maybe financial institutions are catching on to the idea that open source provides a far greater degree of security, accountability, and maintainability than closed source? Just a thought. Because part of the reason why this situation arose is because of black-box money transfers that didn't have any oversight, and were largely automated. This way, financial institutions can get a far better picture of risk exposure -- and know that everyone else is doing the transactions in the same fashion. In short, everybody knows the rules of the game and who the teams are, unlike before where the rules weren't known until a referee called a foul.
Re:But... but... (Score:3, Insightful)
For the past four months, all the CEOs of all the banks have been singing the praises of communism.
Actually, no: the parasites running American banks have been singing the praises of National Socialism, which is a political and economic doctrine that states certain industries or companies are so important to the wellbeing of the Reich... err... Homeland that they must not be allowed to fail even though they remain in private hands.
Most of the American political class of both parties are also in favour of national socialism. So far it seems that most individual Americans are opposed to it, but have been so completely disenfranchised by the political class that they can't do much about it... yet.
well, the market also needs information (and time) (Score:3, Insightful)
What is a potential purchaser going to want to know before deciding how much to offer for a security? Well, something about its characteristics. If it's a derivative of other securities, they might want to know how its value relates to the values of underlying securities.
You first need to know the qualitative information of course: how does a change in the underlying securities result in a change in its price? What additional risk components (such as counterparty risk) does it have? Etc. Then the potential purchaser might want to a way to estimate how much they ought to pay for the derivative given some numbers for the values they place on risk, the inflation they expect, etc. That's what pricing models are. Unless you can actually work through all these interrelations in your head, you need some sort of model to even figure out what a reasonable offer for the security is.
Now maybe markets could also discover this through trial and error. Securities are valued in one way, and it turns out (as it recently did) that they were actually overvalued, because they failed to sufficiently factor in a significant component of risk. Refine for the next iteration. But this also requires infinite time to get it right, or at the very least a few major business cycles (i.e. decades). In this case, I'm not actually sure the market discovered a flaw in the previous pricing model per se, but rather in the parameters people were commonly plugging in: models generally have terms for estimates of underlying default rates, counterparty default rates, etc. and they were all massively underestimated (by the market).
Re:Reason: Security (Score:5, Insightful)
Yeah, because the main problem with Credit Default Swaps is that the pricing code used internally in banks wasn't distributed under an open source license, not (among other things) that the distribution of risk of default away from those making lending decisions encouraged those making the lending decisions to commit and encourage others to commit frauds which made the inputs into any pricing model unreliable.
Re:Open does not make them any better (Score:4, Insightful)
CDSs, priced with open software or not, are the ticking time bomb of the world economy. Nothing better than bookie betting they have created an inflated payout of $50 trillion dollars worldwide that only takes the fall of a few big banks to start.
The lack of regulation surrounding CDS's is just nuts. As explained in that excellent TAL episode you linked to - the situation amounts to people gambling on the banks to fail, with "insurance policies" (what a CDS basically is) having been issued to the extent they amount to 10x the value of the assets being "insured". It's as if 9 other people bought fire insurance on your home, basically hoping for it to burn down.
The whole situation is just absurd - and it's world-wide to boot.
Re:But... but... (Score:5, Insightful)
No, we got a much worse deal than communism.
Had this been a communist maneuver, "we the people" would now own these companies -- and that's something bank CEOs wouldn't stand for for one second. Instead, we got nothing in return for our money.
No, bank CEOs will never support communism. A true communist revolution would strip them of their wealth and their companies
Re:But... but... (Score:2, Insightful)
Had this been a communist maneuver, "we the people" would now own these companies
Actual reality: the government would now own those companies. They would run them inefficiently, and only members of the ruling party could obtain its products without restriction - others would have to wait in kilometer-long lines and have government-issued coupons. The prices for the coupons on the black market would be several times the shelf price for the item. And even if you had coupons and money you would have to find a store which actually has the items, which would be impossible.
This would only strip the elite status from the capitalists to give it to the politicians, who in the end care about the companies (they don't belong to them but "to the people"). So instead of a greedy elite we would have a greedy, incompetent elite that is not bound by law.
Of course this doesn't fit e.g. China, but they are not really communist - they only pretend to. They are just an authoritarian regime with an ideology. However, the above description fits the former Soviet bloc countries.
Communism != communism either (Score:4, Insightful)
Hey, don't you remember that "spam" has replaced "libertarians vs. socialists" as the default Internet discussion topic for the last decade? :-)
Marxism-Leninism doesn't actually work that way - the workers may get oppressed under capitalism, but they don't get around to developing the class consciousness that they're supposed to, so the elitist vanguard has to lead them in a revolution and stomp out the bourgeois classes. Since Marxism fails to recognize the value of creativity and risk-taking that entrepreneurs provide, that work doesn't get done after the revolution, so the economy recovers very slowly if at all from the damage done in the revolution, with idealist dogmatism as a poor replacement for the information provided by prices in a market, and the elites end up becoming the new class of bosses, not even the same as the old bosses, and the final stage of Marxist-Leninist communism is a chaotic transition to something like less competent capitalism.
Back in the early 90s, I was at economic conferences in Eastern Europe, and one of the fundamental issues that those societies were trying to solve was how to give the means of production to the workers before the ex-Communist bosses stole all the good stuff; in some cases the former state companies gave stock to the workers, but that didn't happen all that often, and usually only on businesses that weren't worth stealing.
On the other hand, the current top-down government aid paid to huge corporations is not only not either theoretical or real Communism, it's a great reminder that Ayn Rand's morally pure capitalists were more of a fictional device than a description of real capitalism. I don't think I agree with your assertion that the aid is getting paid for by "workers" - after all, we're taxing the "rich", and have been taxing businesses all along, and the bailout money's mostly getting borrowed, either from China or from Westerners who still have assets to invest in T-bills. Some of it will get paid back by your kids, and some of it will get defaulted on somehow, either by finding a way to restart inflation (which is a lot tougher in today's global economy than it was when Reagan did it) or by some new scam.