How Wall Street Lied to Its Computers
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How Wall Street Lied to Its Computers
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Re: How Wall Street Lied to Its Computers
#2The impression I got was not that they lied to their own computers, but rather those who programmed the alarms did so inadequately and could not handle the complexity of the transactions.
His doctor analogy is good, but not exactly perfect. Something more along the lines of hiring a med student for your physical instead of a grey-haired professional.
Re: How Wall Street Lied to Its Computers
#3Well, that explains that. Now explain this: If these MBSes were so complex that Wall Street MIT-trained quants and Wharton-trained traders and their computers didn't see it coming...how exactly did I see it coming? Me.
I mean...liar loans and ARMs starting at record-low rates and housing prices that looked like the NASDAQ right around AD 2000? I mean, the reason they didn't see it was...because they did see it, but the hand that picked up the commissions had a mind of its own.
Re: How Wall Street Lied to Its Computers
#4I'm going to draw the obvious conclusion that most of the models were built on the premises of mediocristan, when in fact the world they were modeling lived in extremistan.
The thing is that quants who come up with models showing large amounts of risk to otherwise profitable investments aren't as popular as ones who say everything is just fine. So there is a clear incentive for models to be optimistic.
Re: How Wall Street Lied to Its Computers
#5The models should penalize investments that are complex, hard to understand and infrequently traded, she said.
...by how much?
Re: How Wall Street Lied to Its Computers
#6Well, that explains that. Now explain this: If these MBSes were so complex that Wall Street MIT-trained quants and Wharton-trained traders and their computers didn't see it coming...how exactly did I see it coming? Me. I mean...liar loans and ARMs starting at record-low rates and housing prices that looked like the NASDAQ right around AD 2000? I mean, the reason they didn't see it was...because they did see it, but t…
In the short run, these markets selected for people who didn't properly analyze the risk. If the average CDO makes you 7% a year until one day it loses 20%, it's not a prudent investment -- but if you somehow estimate that the maximum loss is 2% instead, you will be willing to buy many more of them, and your return on capital will look a whole lot better. If you're not the only one doing this, the flow of all that money into risky products will give you returns even higher than you expected -- and if you're like the average investor, you will adjust your reasoning in retrospect to make yourself as brilliant as possible.
So it's actually unsurprising that people outside of the finance business were disproportionately aware that the whole real estate bubble was crazy. Someone with your views working for a big bank would be the equivalent of a peacock who realizes who impractical those feathers are.
Re: How Wall Street Lied to Its Computers
#7The models should penalize investments that are complex, hard to understand and infrequently traded, she said. ...by how much?
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Re: How Wall Street Lied to Its Computers
#8This is really rather simple to understand: Part of the motivation for inventing complex new derivatives is to create things that look conservative to the model but are actually risky.
The personal incentives for traders are to get big returns, which implies making risky bets. But your risk management system won't let you make risky bets directly. So instead, you make risky bets indirectly through instruments specifically engineered to game the risk management system.
It's nothing new. Michael Lewis' excellent book "Liar's Poker" describes how Solomon Brothers invented ways to obtain triple-A credit ratings for incredibly risky forex trades so that they could be sold to S&L's with strict rules about the credit-worthiness of their investments. And that was at least twenty years ago.
Re: How Wall Street Lied to Its Computers
#9I'm going to draw the obvious conclusion that most of the models were built on the premises of mediocristan, when in fact the world they were modeling lived in extremistan. The thing is that quants who come up with models showing large amounts of risk to otherwise profitable investments aren't as popular as ones who say everything is just fine. So there is a clear incentive for models to be optimistic.
I thought this was a great analogy to express your conclusion:
"It was like a weather forecaster in Houston last weekend talking about the onset of Hurricane Ike by giving the average wind speed for the previous month."
Re: How Wall Street Lied to Its Computers
#10The impression I got was not that they lied to their own computers, but rather those who programmed the alarms did so inadequately and could not handle the complexity of the transactions. His doctor analogy is good, but not exactly perfect. Something more along the lines of hiring a med student for your physical instead of a grey-haired professional.
Not so.
"So some trading desks took the most arcane security, made of slices of mortgages, and entered it into the computer if it were a simple bond with a set interest rate and duration."
I find the lying to your doctor analogy very good to describe this kind of behavior.