Sunday, January 29, 2012

Fear-Driven Economy

The Wall Street Wiz Kids took a whizz on us all and destroyed the economy to boot.  Dodd-Frank will only ensure that there is a bigger crowd of clueless government bureaucrats in the bleachers when the next spectacular crash happens...

Jeffrey Snider is a smart man who understands the murky world of modern-day global finance, and he has a gift for explaining it. His articles are not short, and they are complex, but arcane artifices such as Gaussian Copulas do not lend themselves to shorthand. Still, he does a good job helping the ordinary Joe understand very complex financial subjects.

In The Fed is Actually Bailing Itself Out, he explains Credit Default Swaps.
“It all worked so well, until it didn't.”
“Since credit default swap trading had been growing in substance and depth since their first use in the 1980's, this market-based correlation assumption fit nicely into the expectations of structured credit investors and traders, offering real-time pricing of the previously illiquid asset class.
The proliferation of securitization came directly from this complex math, which itself was nothing more than a shortcut of circular logic (the market needs estimates of future default correlation to price assets, so the assets get their correlation estimates from the market).”
They constructed mathematical models to price previously-unquantifiable tranches of securitized debt. The models relied heavily on recent history, violating the simple truth, “Past performance is no guarantee of future returns.”

You don’t need to be a math genius to see the tragic flaw to all of this: Hubris. And a naïve credulity and blind obeisance to mathematical modeling, all at the expense of common sense, human nature, and financial history. The greedy bastards chucked it all over for the fantasy of an eternal fountain of wealth.

The Loop: “correlations of greater than 100%”
A rush of demand for default swaps pushed many idiosyncratic instruments in the same direction at the same time. Since the Gaussian copulas interpreted similar moves as correlation, this meant that the mathematical indication of correlation "measurements" rose with these new fears. And of course, as interpretations of rising correlations made their way into the math of pricing models, tranche pricing became even more problematic. That forced incrementally more demand for credit default swaps, feeding back into estimates of correlations rising even higher, further heightening fear and the need to hedge, and so on.

[…] it was not uncommon for traders to quote various mortgage bond tranches in correlations of greater than 100%. Of course that makes no logical sense within the confines of what correlation is supposed to confer or what mathematics actually defines, but the market realities of the period introduced by David Li's shortcut undercut the ability of the marketplace to make sense of itself.
This is the result of the folly that government-funded central planning and sophisticated modeling can replace human nature and common sense. More insidiously, it takes away our economic freedom and erodes our savings and buying power through monetarism’s manipulation of fiat currency. It is the antithesis of the free market.

27 comments:

Christopher - Conservative Perspective said...

Ah, the webs we weave.

The question and might add the actions "we the people" will ask and may take is yet unanswered.

Further inquiry would pose; Are we up to the task?

Always On Watch said...

The credit default swaps were all smoke and mirrors and amounted to kicking the can down the road.

Well, the road does eventually end.

Now look at the intricate mess we've got.

There are no easy solutions to the economic disaster. It's an economic Armageddon.

I'm glad that I'm as old as I am. The worst is yet to come -- and will be a cycle that will last for decades, I think.

bunkerville said...

The conclusion to this fiasco is hard to think about. Yet the same players continue the charade.

Ducky's here said...

You carry a huge volume of unmarketable paper that has no defined market value and the stuff would eventually go into the fan especially when nearly all the paper was bets that housing prices would perpetually rise.

The smartest guys in the room bet everything o the over.

Then you blame the CRA, the suckers believe you. Scream Barney Frank and Chris Dodd at the top of your lungs in case the suckers didn't hear. Then get back to doing it all again.

Ducky's here said...

But the mistake would e to assume that the likes of Chuck Schumer (D - Wall Street) don't know exactly what they are doing.

And your interests have jack shite to do with it all.

Z said...

Ducky, WHY are the likes of Schumer doing this?

Silverfiddle said...

Ducky: Its not just CRA, or just Dodd-Frank, it is the totality of it. Government enters into a market and distorts it all out of reality with perverse incentives.

To answer Z's question, the Schumers of the world, which includes the statists of all parties, make laws, and then make money selling exemptions to them.

That's how DC works. The croniest government money can buy...

Me? Opinionated? said...

Obama is the most incompetent, narcissistic, America-hating, Godless worm that is hellbent of ruining this country, he is by far the worst that this country has ever had the displeasure of having and yet we see people like Ducky Boy defending everything he says and does. What does that tell us about Ducky?
I will respect the blogs author and I won't put it in writing.

KP said...

Great article Silverfiddle. It's frightening. As Hardy would say: "Well, here's another nice mess you've gotten me into!"

@ Me? Opinionated? From what I can gather Ducky is not happy with Obama. He calls him Obummer; albeit for his displeasures stem from different reasons than the right :)

Ducky's here said...

KP, I am a leftist (democratic socialist).

I despise a right of center triangulating influence peddler like Obummer much more than I do Romney. You know what you're getting with Romney and it's even possible that a progressive opposition would form.

Too many suckers still believe The Black Messiah is something but a Wall Street/military stooge.

Silverfiddle said...

@ Ducky: KP, I am a leftist (democratic socialist).

This is why I enjoy interacting with you, Ducky. Unlike so many on the left, you are honest and upfront about who you are and what you believe. No weasel words. I admire that, even as I disagree with much of your economic and political philosophy.

Ducky's here said...

Well, if we broke it down, Silverfiddle, our goals are not that dissimilar in the abstract.

We have virtually no agreement on means.

Silverfiddle said...

That's a concise and accurate summation.

Leticia said...

I believe the whole meltdown of our economy was strategically planned by Obama and his administration. A weakened economy means a lot of frightened and desperate people and when people are in some kind of mental pandemonium they are easier to influence and control.

Don't get me started on what he has done to our military, I could spit, shoot and throw nails at the man.

I must say, I agree wholeheartedly with Opinionated.

KP said...

Ducky: << I despise a right of center triangulating influence peddler like Obummer much more than I do Romney. You know what you're getting with Romney and it's even possible that a progressive opposition would form.>>

Ducky; that is exactly how I understand you when it comes to politics. Like SF, I respect the straight forward approach.

KP said...

Ducky: << I despise a right of center triangulating influence peddler like Obummer much more than I do Romney. You know what you're getting with Romney and it's even possible that a progressive opposition would form.>>

Ducky; that is exactly how I understand you when it comes to politics. Like SF, I respect the straight forward approach.

KP said...

As well, in my view, people can strongly disagree with another's political opinion and still enjoy their neighbors, co-workers, families, food and the arts.

Jersey McJones said...

"This is the result of the folly that government-funded central planning..."

No. This is the result of unregulated trade. How the fuck does any of that have to do with government funded anything? Show me where I'm wrong. Please. God, you f'n "capitalists" are so f'n defensive these days.

JMJ

beamish said...

I remember when I was working as a mortgage default settlement agent (that's suit and tie code-speak for "annoying bill collecting harasser of people about to lose their homes") all the unpaid housing loans I was inquiring (er, hounding people over the phone) about and how many of them were in amounts the indebted couldn't possibly afford to pay back - indeed, housing loans they had been given with absolutely no collateral or income / credit history to make it look like a financially feasible arrangement for them to have bought their house in the first place.

All the CRA housing market regulation / banking scandal arguments are interesting, but SOMEBODY in the food chain said "Let's make home loans available to broke ass people that can't pay spit back."

At least, that's my limited desk jockey perspective.

Man, I hated that job.

Silverfiddle said...

Beamish (and you should listen in, Jersey):

If mortgage lenders had to sit on those loans like they did back in the old day, they would not have made irresponsible loans.

The government backstopping them allowed them to fire and forget. Write that mortgage that they knew the owner couldn't pay back and the pass the bag of crap off to Uncle Sucker or package it up and sell it to the rubes shopping at Wall Street.

When government enters the marketplace, irresponsibility and irrationality soon follow.

dmarks said...

Jersey needs to do more research on this. The meltdown was mainly caused not by the free market, but by imposition of govermnent regulation. Regulation which forced banked to behave badly.

Beamish said: "All the CRA housing market regulation / banking scandal arguments are interesting, but SOMEBODY in the food chain said "Let's make home loans available to broke ass people that can't pay spit back."

That is exactly what CRA demanded. And its initial intent was racist: to try to give African-Americans some sort of special right to get homeownership loosening the rules for black people (while leaving similarly unqualified would-be white homeowners without home loans).

If left to the free market, banks would not have given loans to pepple who could not pay them back... and, thus, no mortgage crisis.

dmarks said...
This comment has been removed by the author.
dmarks said...

Leticia said: ""I believe the whole meltdown of our economy was strategically planned by Obama and his administration."

I disagree strongly, because this started before Obama took office. However, Obama has a negative role in this prior to his inaguration. Senator Obama voted for the destructive TARP legislation (opposed by most Republicans).

And after Obama was elected, this encouraged businesses to fire more and more people, in the period between Obama's election inauguration, due to the threat of Obama policies to discourage companies from keeping employees: worse overtaxation, regulation, health care mandates, and forced unionization.

Considering this, it is not surprising that Obama's policies caused unemployment to soar by 20% after his inauguration.

The policies he campaigned on were hostile to both Main Street and Wall Street, and especially workers.

Leticia said...

dmarks, I am standing by my words. Unemployment went up 9% which means, Gas prices up 83%, Federal Debt went up 43%, there's more, but I believe I made my point.

dmarks said...

The wheels came off before the inauguration. You might want to look at the results of the Congressional election in 2006. That was the start of the indicators starting to go bad.

Ducky's here said...

Leticia, have you heard of the fallacy post hoc ergo propter hoc?

dmarks said...

Not applicable. Ducky, as Obama's policies DID make things a lot worse.