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I Blame Computers For This Crisis

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http://www.independent.co.uk/opinion/comme...is-1451417.html

So we taxpayers are called upon to provide another £100bn or so (no one quite knows, least of all us) – and the cry goes up once again: who is to blame for the banking crisis?

The most obvious answer is: the bankers themselves. On the day that the Government injects yet more cash into Royal Bank of Scotland's smouldering hulk of a balance sheet, perhaps there is some weird patriotic pride to be had in the fact that Newsweek has ignored all the notable American candidates to name Sir Fred Goodwin, chief executive of RBS from 2000 to October 2008 as "The World's Worst Banker".

There are many other candidates for blame, however. The economists' own favourite villain is the former Federal Reserve Chairman, Alan Greenspan. Actually it's "Sir" Alan Greenspan: Gordon Brown made sure that he got a KBE too, before it dawned that the owlish American was not, after all, the world's wisest life-form.

Then there is the nexus between the property business and politicians – the former having speculated colossally on the latter's belief that there were votes to be had in keeping that market inflating into infinity. These are also good people to kick as you contemplate your ever-diminishing pension.

Yet with all these human targets, there is one often overlooked candidate for blame which is not constructed of carbon (and which will not feel any pain when you kick it). This is the silicon microchip. The astonishing growth in the calculating power of computers is a wonderful thing, enabling us to do things we would never have dreamed of even a decade ago. Electronic calculation, however, is not the same thing as wisdom; and there are great dangers in confusing the one with the other.

Two early books on the financial crisis have made this point well. The first, an American's account, is the Trillion Dollar Meltdown by Charles Morris; the second, written by a British investment analyst called George Cooper, is The Origin of Financial Crises.

Morris points out that we had already had notice of the havoc that could be wrought by computerised trading programs; first, on 19 October 1987, when Wall Street fell by 23 per cent in one day, as earlier movements in share prices triggered massive selling by computers, quite independently of any decisions by humans. It caused all-too-human panic across the globe.

The second warning sign was the collapse of the hedge fund Long Term Capital Management in 1998. LTCM's partners included two Nobel prize-winners, Myron Scholes and Robert Merton, celebrated for their mathematical models for the pricing of financial derivatives. LTCM scoured the market looking for price relationships deemed anomalous by the Nobel Prize winners' algorithms. These quantitative anomalies were tiny, observable in real-time only by computers, so LCTM needed to back its bets with vast sums (which, of course, were borrowed). Yet their models had not factored in the possibility that the Russian government of Boris Yeltsin would default on sovereign debt. They were left with billions in unsaleable futures contracts, and were dead in the water.

Perhaps, if LTCM had been allowed to go under, this would have caused later so-called "quant" investors and "algo-traders" to exercise more caution; but the Fed instantly decided that the financial markets would have become too destabilised, and twisted the arms of the investment banks to take over LTCM's positions. This prepared the way for a much bigger destabilising financial crunch a decade later – only this time there were no investment banks left to lean on, leaving only the taxpayer to do the mucking out.

George Cooper's account of the crisis makes a further point about the problems caused by basing investment decisions on computer programmes; the computer will always come up with a price which even a very damaged derivative should rationally fetch, based on the possibility of some remaining value in a debt gone sour. Yet because humans react emotionally and in a herd-like fashion, they will refuse to assign any value to such "toxic" paper: hence a bank might think there would be a reasonable limit to the downside of risky investments, while, in the real world, when fear takes over from greed, there is no such limit.

There is also the simple fact that computers enabled the bankers to contemplate, with just a mere push of a button, trillions of dollars worth of derivative contracts. Figures which might cause a nervous collapse, when analysed within the human brain, seem soothingly manageable when generated by the click of a mouse: and, of course, there is the usual tendency to think that because it is generated by a computer, it is in some sense "right"– even if the assumptions on which the computer based its calculations were originally fed in by a human who had never spoken to, still less met, the end user of the financial instrument.

This was especially true of the market in so-called "Collaterised Mortgage Obligations" (CMOs). As the former banker Charles Morris notes: "In 1983, modelling the payout scenarios on a comparatively simple three-tranche CMO took a mainframe computer a whole weekend. But by the 1990s, when Sun workstations were standard furniture, CMO shops gleefully turned out phantasmagorical 125-tranche instruments that no one could possibly understand." Least of all, one might add, the pre-computer age senior non-executive directors of the banks, who were the official guardians of shareholders' interests; but which of them were clever enough to say "I don't understand"?

Anyone prepared to defend the shit computer models they use?

If LTCM had gone under would we have avoided this mess now or would our bankers have created even better models to screw the world up with?

Computer modelling appears to be like improving car safety only for the driver to drive like a loon because if they crash they'll get out alive so take even more reckless risks.

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Guest KingCharles1st

computers "should" have helped bring down costs for the banks, but instead, they paid select factions f their employees HUGE sums of money once it became apparent that these staff had become totally indispensible in their daily quantitive easing of their customer's bank balances. Computers did a lot of good, they also did a huge mount of bad.

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http://www.independent.co.uk/opinion/comme...is-1451417.html

Anyone prepared to defend the shit computer models they use?

If LTCM had gone under would we have avoided this mess now or would our bankers have created even better models to screw the world up with?

Computer modelling appears to be like improving car safety only for the driver to drive like a loon because if they crash they'll get out alive so take even more reckless risks.

I agree with the sentiment expressed here. I'm sure that computers have a place in the modern society but wholesale reliance on the power of computers is insane. Even intelligent people sometimes forget that computer programmes are written by other human beings. As the saying goes "To err is human but to really screw up you need a computer".

As for LTCM, it is hard to say what would have happened if it was allowed to fail. However but my instincts are that any mess created then would have been less than what we are seeing today. It is total madness what we are witnessing now.

Edited by FreeDoc

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Anyone prepared to defend the shit computer models they use?

I'll happily defend the models. They're innocent, inanimate logical constructs created entirely by human hand, and therefore their output, and the limitations of that output, are entirely comprehsible by those who created them.

Effectively, all "computer modelling" does is allow human beings to think very quickly.

This is entirely a human problem. People got it badly wrong.

Okay, I might be wrong, but if I am the Great Depression is entirely the fault of ticket-tape and mechanical calculating machines.

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Who designed the models? Computers or people?

Who fed decided what was data and what to feed into the models? Computers or people?

Who read the data, interpreted it and took action based on those interpretations? Computer or people?

I'm afraid it's Garbage In, Garbage Out.

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They're innocent, inanimate logical constructs created entirely by human hand, and therefore their output, and the limitations of that output, are entirely comprehsible by those who created them.

I write models all day long but they are entirely incomprehensible the day after :)

VMR.

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Who designed the models? Computers or people?

Who fed decided what was data and what to feed into the models? Computers or people?

Who read the data, interpreted it and took action based on those interpretations? Computer or people?

I'm afraid it's Garbage In, Garbage Out.

It's amazing that these so called clever people who programmed them believed in there own genius and never queried the data or the models.

Hey it works fook it lets bet a couple of hundred billion on us being right, it can't possible go wrong.

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It's a bit like the weather - the more the Met Office spends on supercomputers and models, the worse their predictions become. I don't even bother looking these days as my own forecasts tend to be almost always accurate.

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According to whom?

Well the LTCM boys queried what they where doing didn't they.

They managed to get the Nobel Prize for economics (97) for a theory that nearly collapsed the financial system and required $100bn + bailout in 98.

So all the clever academics that awarded the prize didn't bother stress testing the theory before awarding. If they had known what would have happened the following year do you think they would have won?

How many bank CEO's at investment banks bothered to check the maths used to sell securitisation? Or do you think they took the fook it approach I'll have the profit sod the risks and the huge pay packet?

Answers on a postcard.

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Well the LTCM boys queried what they where doing didn't they.

They managed to get the Nobel Prize for economics (97) for a theory that nearly collapsed the financial system and required $100bn + bailout in 98.

So all the clever academics that awarded the prize didn't bother stress testing the theory before awarding. If they had known what would have happened the following year do you think they would have won?

How many bank CEO's at investment banks bothered to check the maths used to sell securitisation? Or do you think they took the fook it approach I'll have the profit sod the risks and the huge pay packet?

Answers on a postcard.

I am unaware of this nobel prize winning theory that nearly collapsed the financial system and required $100bn + bailout in 98. Please enlighten me

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It's amazing that these so called clever people who programmed them believed in there own genius and never queried the data or the models.

Sorry IRR, but that completely ignores the conditions under which said models were created. Personally, I'd be absolutely stunned if the modellers weren't "highly, if not completely" aware of the limitations of what they were doing, and that those who authorised the live use of products created as a result of said modelling were also fair from totally in the dark.

Quite simply, they were the justification for a get-rich-quick scheme. Nothing more, nothing less.

Sometimes this place (hpc) baffles me. We're got hordes of posters who saw "this" (or variations on "this") coming a long time back, and yet we still get posts that assume those who were instrumental in creating the mess but were raking in sums of money of such size as to mean they could happily retire when the mess arrived had no idea that said mess would, in fact, arrive. I'll never get my head round it.

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It's a bit like the weather - the more the Met Office spends on supercomputers and models, the worse their predictions become. I don't even bother looking these days as my own forecasts tend to be almost always accurate.

Actually, their forcasts are generally very good over a couple of days, BUT, they will happily say 'might' or 'probably' in their forecasts, and they will also happily tell you that a forecast more than 5 days ahead is extremely uncertain. Furthermore, there is no huge bonus resting on their ability to forecast 10 days ahead, so they don't pretend to be able to.

Problem is, if the quants had taken the same approach of acknowledging the limits of their knowledge and the uncertainties, they would have talked themselves out of a huge paycheque.

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i think there is too much interaction with computers nowdays

people "bank" online , "shop" online , "buy" (or "steal) music online , apply for jobs online , talk to friends online , even many club DJs just sit in front a laptop nowdays when they "mix"

might as well just hook everyone up to the matrix soon

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Once we'd invented the wheel, it was all downhill from there...

We were headed downhill before then, the wheel just sped things up. :)

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I am unaware of this nobel prize winning theory that nearly collapsed the financial system and required $100bn + bailout in 98. Please enlighten me

http://en.wikipedia.org/wiki/Long-Term_Capital_Management

Long-Term Capital Management (LTCM) was a U.S. hedge fund which used trading strategies such as fixed income arbitrage, statistical arbitrage, and pairs trading, combined with high leverage. It failed spectacularly in the late 1990s, leading to a massive bailout by other major banks and investment houses,[1] which was supervised by the Federal Reserve.

LTCM was founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Board of directors members included Myron Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences.[2] Initially enormously successful with annualized returns of over 40% (after fees) in its first years, in 1998 it lost $4.6 billion in less than four months following the Russian financial crisis and became a prominent example of the risk potential in the hedge fund industry. The fund folded in early 2000.

Keep watching too much TV where they hype what happened.

On something I watched last night they said the losses where up to around $150bn.

Reading this they obviously managed to lose a mere $4.6bn

Obviously a huge success story.

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Anyone prepared to defend the shit computer models they use?

Those kind of models seem to still work perfectly for the Global Warming crowd... so you might want to try your luck with some of those guys... :lol:

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http://en.wikipedia.org/wiki/Long-Term_Capital_Management

Keep watching too much TV where they hype what happened.

On something I watched last night they said the losses where up to around $150bn.

Reading this they obviously managed to lose a mere $4.6bn

Obviously a huge success story.

I don't see how the theory you mentioned almost brought about the financial system. What theory was it. Also note that another early quant, Ed Thorp, sais he wouldn't touch LTCM with a bargepole, allegedly.

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I don't see how the theory you mentioned almost brought about the financial system. What theory was it. Also note that another early quant, Ed Thorp, sais he wouldn't touch LTCM with a bargepole, allegedly.

So your saying if Russia hadn't have defaulted it's debt LTCM wouldn't have kept increasing there positions with even more leverage?

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  • 284 Brexit, House prices and Summer 2020

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      • down 5% +
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