POINT OF VIEW

Why The Banks All Fell Down

Published Oct 18, 2008

From the magazine issue dated Oct 27, 2008

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In Joseph Sargent's 1970 film "Colossus: The Forbin Project," the U.S. president loses confidence in his judgment about how to manage nuclear weapons and turns over control to a computer named Colossus. Soon after the change is announced, Colossus displays a message on its main console: THERE IS ANOTHER SYSTEM. It turns out the Soviets have done the very same thing. Soon the two machines are communicating with each other. After a struggle resulting in the detonation of two nuclear bombs, the computers gain complete control over both governments.

"Colossus" may have something to teach us about the current financial crisis. It is certainly more instructive than the two most common explanations. The first is that banks recklessly gambled in uncertain and unproven markets. The second is that regulators took a holiday while this party raged on.

But the banks didn't "gamble." Instead, they locked themselves, Forbin-like, into computer-based financial models that have an obvious systemic flaw. As Avinash Persaud, an economist and chairman of Intelligence Capital, argued in an award-winning essay almost eight years ago, the dominant models for market-sensitive risk management, whether they're run on computers or not, are missing a critical piece: herd behavior. When such incomplete models get wired into the investment houses of every major economy—with servers sometimes co-located to avoid the millisecond lag that bicoastal or intercontinental communication necessarily creates—this omission leads inevitably to the kind of terror we've seen the past few months.

The models governing our financial system were developed in the 1950s. They were built, as Persaud explains, upon the assumption that "each user is the only person using them." That assumption may have made sense when only the Rand Corporation (which developed the models) had the data to act upon them. But as Persaud wrote in the Financial Times in March, in "today's flat world, [where] market participants from Argentina to New Zealand have the same data," the assumption is nothing short of nuts. As the market shifts, the models used by all the major investment banks "throw up the same portfolios to be favored and those not to be." This is the Heisenberg uncertainty principle for financial markets: by being observed, the observed gets changed. The global, simultaneous and practically instantaneous "adjustments" lead "the herd" (a.k.a. our financial system) right off the cliff.

"But why," faith-based free marketers will ask, "doesn't the market figure this out? Why don't newer models outcompete the old?"

The answer is in part (and weirdly) cultural, and in part regulatory. To resist the models requires a George Soros-like confidence. Few have the courage to stand up to the "quants"—math geniuses, or engineering wizards, who feign certainty despite running models that largely omit the most basic John Nash-based insights into strategic thinking. The safe thing (for a financial manager) is to follow the numbers, even if that leads the financial system off the cliff.

Member Comments

Posted By: Nowforthetruth @ 10/24/2008 2:06:57 PM

Spread the wealth how? Look at his past. Obama in this video, addressing his work with ACORN litigation against the banks and relating to the Community Reinvestment Act and the failure of Freddie Mac and Fannie Mae, as they relate to the current real estate and financial crisis, states that, and I quote:

"Subprime lending started out as a good idea, helping Americans buy homes who previously could not afford to. Financial institutions created new financial instruments that could securitize these loans, slice them into finer and finer risk categories, and spread them out among investors and around the country, as well as around the world. In theory, this should have allowed mortgage lending to be less risky, and more diversified."

"The original idea was a good one, which was, lets see if we can distribute risk more broadly, and make it easier to provide loans to people who otherwise might not be able to get one."

Listen for yourself. You cannot dispute the mans on words recorded live:

http://www.youtube.com/watch?v=Lr1M1T2Y314&feature=related

Obama in this second video is campaigning at a convention of Acorn and I believe two other Community Activist's organizations. Ask if he will be their ally if he becomes President, Obama says, quote:

"Yes, but let me say that before I even get inaugurated, during the transition we are going to be calling all of you in to help us shape the agenda."

See and hear it for yourself. Obama promised that Acorn and other groups like it will setting his agenda if elected:

http://www.youtube.com/watch?v=8vJcVgJhNaU
Below is a link to C-SPAN video clips of the Congressional hearings at roughly the time McCains attempt at S.190. to fix Fannie and Freddie. See for yourself who said what.

http://www.youtube.com/watch?v=_MGT_cSi7Rs
See also
http://www.newsweek.com/id/164732 from this web site. (oops!) stating that Freddie Mac was spending tax payer money to target Republicans in 2005 who were trying to regulate Fannie and Freddies fraud. Democrats were not targeted, as the were all in the tank with Fannie and Freddie to kill the regulations. Hear that, the article admits that Republicans were trying to regulate Freddie and Fannie, and Democrats were trying to stop it from happening as a means to facilitate the Community Reinvestment Act.

See also: http://www.newsweek.com/id/164972
Stating that Gramm-Leach-Bliley Act wasn't what caused the meltdown, and noting that "economists on both sides of the political spectrum have suggested that the act has probably made the crisis less severe than it might otherwise have been."
Posted By: Nowforthetruth @ 10/20/2008 7:16:11 PM

Who "Joe the plumber" may be is not the issue, though it's easy to see why the Dems want it to be. That's because the real issue is what Obama's comments to him revealed about Obama. In the exchange with "Joe the plumber" we find out that Obama really is as radical as his early political acquaintances, Davis, Ayers, Wright, etc., and that he is into the failed economic policy of wealth redistribution. Obama's tax and spending plans alone would be bad enough, but add Reid and Pelosi to the mix, with the three of them controlling both houses of Congress and the executive branch without any effective restraint, and you have something that should causes concern even among moderate Democrats.
See Wall Street Journal: A Liberal Supermajority:

http://online.wsj.com/article/SB122420205889842989.html

And whether McCain won or lost the third debate is also not relevant. He succeeded in the first half hour to plant the seeds of a Reagan style wipeout. Reputable historians and economists overwhelmingly agree that the taxation imposed by Hoover and FDR, and the "stimulus" spending and public works programs of FDR, actually deepened and prolonged the Great Depression. It was the production demands of WWII that got the economy going again. And when the war was over, the economy promptly went into recession.

See e.g. http://www.cbsnews.com/stories/2008/10/03/opinion/main4499465.shtml
And
http://newsroom.ucla.edu/portal/ucla/FDR-s-Policies-Prolonged-Depression-5409.aspx

Point is, Obama's programs are to tax, and it does not really matter who he taxes, those taxes are going to be passed through the economy. He has to tax, because it is they only way he can pay for his massive social engineering experiments. Any first year economics student knows that taxation is a tool used to contract an economy experiencing inflation, because it reduces demand by reducing the amount of money individuals and businesses have to spend. It is contractionary, which is exactly what you do not want to do when the problem is that the economy is contracting already into recession. Like Hoover and FDR, Obama's plans will only make it worse for longer.
Posted By: Nowforthetruth @ 10/20/2008 7:16:01 PM

Look and listen for yourself. Hear Obama in his own words discusses his links to both ACORN and the mortgage meltdown, and praises bundling and securitizing mortgages by banks as a means to float loans to the poor. Never mind the link commentators point of view, just listen to what Obama says in his own words. A picture is worth a thousand words. Maybe more in the case of the last half of the second link.

http://www.youtube.com/watch?v=8vJcVgJhNaU

http://www.youtube.com/watch?v=Lr1M1T2Y314&feature=related

See also:
http://boards.msn.com/MSNBCboards/thread.aspx?threadid=808692&boardsparam=Page%3d2

This is a link to C-SPAN video clips of the Congressional hearings at roughly the time McCains attempt at S.190. to fix Fannie and Freddie. See for yourself who said what.

http://www.youtube.com/watch?v=_MGT_cSi7Rs

The link below contains a purported list of the top 25 in Congress who got contributions from the folks at Fannie and Freddie. Obama is listed third, after Dodd and Kerry, even though Obama is just a junior Senator. Obama is followed next by Clinton. Barney Frank and Nancy Pelosi are on the list as well.

http://www.investors.com/editorial/IBDArticles.asp?artsec=16&artnum=1&issue=20080918

And the link below describes how some Democrats in Congress tried to use the original version of the bailout bill to divert money eventually recovered to groups like ACORN, a group Obama has a long association with. See:

http://online.wsj.com/article/SB122247015469280723.html?mod=googlenews_wsj