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Computer Models and the Global Economic Crash

kdawson posted more than 5 years ago | from the not-able-rightly-to-comprehend dept.

The Almighty Buck 361

Anti-Globalism passes along a review in Ars of some recent speculation on the role of interconnected computer models in the global economic crash. "If Ritholtz, Taleb, Mandelbrot, and the rest of the computer modeling and financial engineering naysayers are correct about the big picture, then we really are arguably in the midst a bona fide computer crash. Not an individual computer crash, of course, but a computer crash in the sense of Sun Microsystems' erstwhile marketing slogan, 'the network is the computer.' That is, we have all of these machines in different sectors of the economy, and we've networked all of them together either directly (via an actual network) or indirectly (by using the collective 'output' of machines in one sector as input for the machines in another sector), and like any other computer system the whole thing hums along nicely... up until the point when it doesn't."

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361 comments

Can somebody 'splain this? (5, Interesting)

seanadams.com (463190) | more than 5 years ago | (#26138259)

I am not an economist but I have owned a couple businesses and consider myself a reasonably practical person.

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features. The only reason you "need" all that is because the banks created all these funny rules so that they could introduce more and more products and services. This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.

Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?

And don't even get me started on real estate lending...

It's like freaking starbucks - you can get your banking services just as special as an upside-down triple no foam half calf non fat 160 degree two splenda mocha. But it's one thing for a coffee company to cater to every individual snowflake's desire, and quite another IMHO for something as important as our financial system to become as absurdly complex and fragile as it is.

As for the people who are really benefitting from all this complexity - well, it's only during recession that we all collectively take a good hard look at who's making a contribution to society and who isn't. Unfortunately the powers that be think they can beat a recession by tweaking some rates, stealing from taxpayers, or shuffling money from one hand to the other. That's just going to hurt us more in the long term. We need to clean this shit up now - get rid of unnecessary products and overhead, and let the unproductive companies go bankrupt. Let the UAW strangle themselves to death. Just get it done.

Re:Can somebody 'splain this? (4, Insightful)

cbiltcliffe (186293) | more than 5 years ago | (#26138295)

It's easily explained by the Golden Rule:

He who has the gold makes the rules.

There. Explained.

Re:Can somebody 'splain this? (2)

mikiN (75494) | more than 5 years ago | (#26139365)

No gold no more (for the banks at least). That went in '76 in a puff of heady smoke (remember Nixon?) Just bits'n'pieces.

It's (almost) the oldest trick in the book in a new guise. First they used smoke and mirrors, now they use smoke screens (TFTs and plasma).

Same result: deception.

Re:Can somebody 'splain this? (2, Insightful)

flajann (658201) | more than 5 years ago | (#26138335)

Not that we "need" it, but that the overall system dynamics evolved it that way.

Re:Can somebody 'splain this? (3, Interesting)

Anonymous Coward | more than 5 years ago | (#26139005)

We don't need it. But the system made people borrow more than they could.

First it was "minorities" (or rather ACORN's definition of a minority "someone who votes for us") that got suspended rules on borrowing, thanks to the CRA, introduced by one disaster president without teeth, Carter, also known for being the cause of the human rights situation in Iran, and activated by the next disaster president, Clinton.

But the damage that this inevitably caused was seen by many opportunists that were just about everyone. So just about everyone, not just Americans, but Europeans, Arabs, Japanese, Chinese, ... the whole nine yards, was given relaxed loaning standards. Since that money ended up in banks, it could be paid to their investors as intrest.

So why did this system work ? Well mostly the money paid for houses was put in bank deposits. So let's depict the money flow :

bank -> lender -> seller -> bank

This is however not how it looks in the administration. Let's check how the accountants enter this scheme :

bank -> lender
bank : + $loan_amount in future income
              - $loan_amount in money
lender : + $loan_amount in money

lender -> seller
lender : - $loan_amount in money
seller : + $loan_amount in money

seller -> bank
seller : - $loan_amount in money, + (100+x)% * $loan_amount in future income
bank : + $loan_amount in money

So now let's look at the total balance of the banks, in the short term :

+ $loan_amount in future income (slightly more)
- $loan_amount in future liability (slightly less)

Ultimately, however, this is a ponzi scheme, but for society as a whole. Everyone who connects is vulnerable in exactly the same way. Even black gold will provide no release, nor will a "knowledge economy".

As long as the pie constantly grows there is no real problem, as the banks control all money (through association with "government banks", or by simply being those banks). They literally print money, which represents value.

But the system needs an ever increasing input of value, or it falls down. As any ponzi scheme does.

Right now the input of 1 subsystem fell *slightly*. Very, very slightly. Eventually the value input will stop altogether (esp. if "peak oil" theories are right, but if they're wrong that will simply provide a delay).

The system is, as they say, doomed.

*AND* we should destroy anyone who was involved in shortselling any commodity related to loans, they should be prosecuted for making (and winning) the bet that tens of thousands of people would lose their livelihoods, their houses. These people's gains should be impounded, their bets imposed for the total disasters that they were. And all other short-selling should be suspended as too risky to the economy.

Or at the very, very least, banks should be prohibited from loaning money to allow shortselling, and they should be forbidden from using money invested in shortselling practices as collateral for loans.

But we won't do that. If we did, the financial sector would shrink to 10% of it's former size, which would put much less money in Obama's hands to work with. Much, much less. And it will mean telling hundreds of thousands the truth, that they cannot be trusted with enough money to buy a house. Many of them will be "traditional americans", but obviously both the poor and "minorities" will be overrepresented, and won't be able to buy a house. (who are the original spark that started the fire, I do not want to claim it's "their fault", but they are part of the problem)

Re:Can somebody 'splain this? (4, Funny)

Anonymous Coward | more than 5 years ago | (#26138339)

It all goes back to the "invisible fist" of the free market...

Re:Can somebody 'splain this? (4, Insightful)

Z34107 (925136) | more than 5 years ago | (#26138473)

I am also not a financial expert, but I can see a bunch of reasons why financial paper exists.

Maybe they're like payday loans for corporations. You have a long-term contract due, but not 'till the end of the month, and you want to keep your employees in the meantime. (I'm guessing this isn't as likely; only corporations with outstanding credit ratings can actually have any success in issuing corporate paper.)

Maybe it's a way of getting a loan without going through a bank or issuing stock. Say you want to build a new factory with payroll rather than actually pay your employees; maybe you're assuming the factory will pay off the interest on the corporate paper and then some.

The biggest thing at the end of the Wikipedia article you read is that, whatever the reason the money is needed, it's cheaper than getting it from a bank. If a corporation is big enough and has good enough credit, they can issue corporate paper, at a lower interest rate, instead of paying interest to a bank.

So, that one, at least, wasn't invented by bankers just to secure their own employment. Maybe somebody who actually knows something about this (a banker, maybe?) could enlighten me.

Re:Can somebody 'splain this? (2, Insightful)

Lumpy (12016) | more than 5 years ago | (#26138699)

Ohhh I have an idea.

Instead of doing Shady and immoral accounting practices why not do what honest small business do.

YOU HAVE THE CASH ON HAND TO PAY YOUR BILLS.

Accounting has turned into VooDoo and it's what causes these messes.

I dont run out and buy a shitload of gear on credit for my video and photography business. I do what sane people do.. when I can afford it I buy it. when the hard times hit, I ride it out easily while my competition scrambles to try and pay off the 60 some loans and their credit lines.

What if I need a new piece of gear for a job?? That's what the 50% down for the job is for. I need $8500 in gear for a corperate shoot? I get the $9500.00 downpayment at contract signing and buy the gear, do the shoot, collect the rest at delivery, and call it done. really simple.

Re:Can somebody 'splain this? (3, Insightful)

DNS-and-BIND (461968) | more than 5 years ago | (#26138919)

Cash in the bank is money sitting idle. You want your money out there, earning for you. If you choose an overly conservative strategy where you don't borrow money, then your business isn't running efficiently. I assume you're an owner...in a corporation, you would be subject to lawsuits and removal if you are not getting the shareholders the maximum benefits available. Remember, a CEO's goal (lawful duty, actually) isn't to make a profit, it's to maximize profit.

Re:Can somebody 'splain this? (5, Insightful)

HisMother (413313) | more than 5 years ago | (#26138999)

This bullshit is exactly what's wrong with our entire capitalist system.

Re:Can somebody 'splain this? (2, Insightful)

DNS-and-BIND (461968) | more than 5 years ago | (#26139327)

What, so you should have a ton of money in the bank sitting around doing nothing? I live in China, and everyone here does exactly that...it keeps a lot of otherwise useful money locked away where it can not influence anyone, nor make more money. Leveraging isn't what's wrong with capitalism, the current crisis was caused by breaking the law (mortgage fraud) on a massive scale.

Re:Can somebody 'splain this? (4, Insightful)

SerpentMage (13390) | more than 5 years ago | (#26139169)

Oh come on...

Here is a question do you have a mortgage or did you pay for your house UPFRONT?

What about a car? Pay for all of it upfront?

I am not saying over leverage yourself, but to say companies and businesses don't need credit is completely fool hardy.

Credit is needed in a system where you are able to make purchases in certain items. The problem is when people over leverage themselves.

Re:Can somebody 'splain this? (0)

Anonymous Coward | more than 5 years ago | (#26138495)

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

See Manulife One [manulifeone.ca]

Re:Can somebody 'splain this? (5, Insightful)

2nd Post! (213333) | more than 5 years ago | (#26138505)

I am not an economist but I have owned a couple businesses and consider myself a reasonably practical person.

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Actually, probably not. I suspect (I'm a programmer by nature, so my experience with code may apply here) it's more of each institution and "network" offering redundant services until multiple institutions mature to the point where these services collide and become confusing.

For example, lots of people have a checking account, savings account, credit card, personal line of credit, HELOC, brokerage account, and more.

That wasn't true one generation ago. My parents had only a checking acount, savings account, and credit card.

I see absolutely no reason why a single account could not offer all those features.

With the advent of computers and networks, now it is possible. But 20 years ago? Not possible.

How would a bank know how much equity you had in your house? How would your credit card company know how much you had in the bank? How would your mortgage company know what your investment amount was?

Today, you actually have one company that handles all of it (and in cases where they don't, they can still trade information). So now I can have a HELOC, personal line of credit, credit card, savings account, etc, all tied together, in that credit from one reduces the amount of credit available on another, and all paid from the same account.

The only reason you "need" all that is because the banks created all these funny rules so that they could introduce more and more products and services.

In this case I actually disagree. Different people have different had different "collateral", so different kinds of credit were available to them. That explains why different products exist. Someone with a house vs someone with a strong credit rating vs someone who had lots of money all had access to different products. Now a single person has access to all of them.

This is done so they can charge you more for each of those things, and also to differentiate them from their competitors.

Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?

As before, commercial paper was "invented" before credit cards (or business lines of credit or whatever) existed. It satisfied a market need that probably doesn't exist today.

And don't even get me started on real estate lending...

It's like freaking starbucks - you can get your banking services just as special as an upside-down triple no foam half calf non fat 160 degree two splenda mocha. But it's one thing for a coffee company to cater to every individual snowflake's desire, and quite another IMHO for something as important as our financial system to become as absurdly complex and fragile as it is.

It's this statement that brought me to this answer. Software is flexible (soft), so it can be molded quite easily to different needs according to different usages. The problem is that after four versions needs have evolved, but the original code has not, so now you have something complex and fragile that was originally quite simple and straightforward.

As for the people who are really benefitting from all this complexity - well, it's only during recession that we all collectively take a good hard look at who's making a contribution to society and who isn't.

So like software, it's only when something breaks when it's actually worth fixing the code. To fix the code before it breaks is almost a waste of effort as you are more likely to break it in the process!

Unfortunately the powers that be think they can beat a recession by tweaking some rates, stealing from taxpayers, or shuffling money from one hand to the other. That's just going to hurt us more in the long term. We need to clean this shit up now - get rid of unnecessary products and overhead, and let the unproductive companies go bankrupt. Let the UAW strangle themselves to death. Just get it done.

I'm not sure how to fix this, however, as there are still people I know that don't own credit cards, don't have savings accounts, don't have checking accounts, don't have homes, etc, so there still remains a need for HELOCs for people with homes, checking accounts for people with paychecks, savings accounts for people with a little money, credit cards for people without lots of money, personal lines of credit for people without homes, etc.

Re:Can somebody 'splain this? (2, Informative)

AdamInParadise (257888) | more than 5 years ago | (#26138759)

My parents had only a checking acount, savings account, and credit card.

In many developed countries (Europe, Japan, ...), many people have a single account which supports both checks and debit cards. Mine is also used as a brokerage account, but I'm probably not a typical client.

Re:Can somebody 'splain this? (0)

Anonymous Coward | more than 5 years ago | (#26139075)

Most of the banks in the US also offer (force) Debit cards on Checking account holder (your ATM card doubles as a Debit card in most cases unless you explicitly ask for a regular ATM card).

At least in the U.S. Credit Card != Debit Card.

Besides the obvious (credit vs. debit), there is also a difference in the responsibilities in cases of fraud. The simplest explanation is that in the case of fraud with a CC you still have possession of your money until you pay the CC company, and it is often up to a Vendor to prove a charge is legitimate. In the case of a DC, the bank has already deducted the money from your account and it is up to you to prove the charge is false.

Re:Can somebody 'splain this? (1)

ArsonSmith (13997) | more than 5 years ago | (#26139143)

seems like a busness opertunity here. If someone was looking to build an independant bank perhaps a model of the "one account" may be a way to do it. One number that says how much money you have. You could give yourself logical views of it for planning reasons, but it would be a way of holding your savings, checking, credit, mortgage, etc all into one account with one true number. Probably -200k+ for most, but that's where the planning logical views are. You could say to yourself, "my house is worth $230k so I can change that number to $30k" add in your savings and checking of which you may give a logical view of those as well. Or the purest could just leave it at the -200k and pay off everything directly into that number.

Re:Can somebody 'splain this? (2, Informative)

NotQuiteReal (608241) | more than 5 years ago | (#26138523)

...banks created all these funny rules...

I think you meant to say "banks created all kinds of workarounds to funny rules that politicians created"

Re:Can somebody 'splain this? (0)

Anonymous Coward | more than 5 years ago | (#26138601)

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

Er - a savings account has higher interest which you pay for with limited rights of withdrawal. You can't have an account with the higher rates without giving something up. So there can't possibly be "a single account" offering "all those features". The same for commercial paper versus other debt instruments - they have different terms and conditions, and different law applies to different instruments, so they're different. You get to choose the one that you like best.

Re:Can somebody 'splain this? (1)

dgatwood (11270) | more than 5 years ago | (#26139109)

That would make sense if it were true. Federal law limits the number of withdrawals from certain accounts to six per month. That's not a bank policy. It's a law. Basically, the government wanted to force banks to keep a certain minimum amount of cash on hand (not loaned out to customers), and to preserve that, they put in place both dollar limits and that cap on transactions. Presumably this was because (at the time) computing the amount of cash on hand at the bank took a significant amount of effort. These days, the regulation is just plain idiotic, serves no real purpose, and should have been removed years ago.

That's the problem with laws designed based around limitations in technology. Technology very quickly renders those laws obsolete, but the laws never get removed from the books. Indeed, that's why I feel that all laws beyond a very small core of crucial laws (your basic murder, theft, etc.)---certainly all civil laws and regulations---should be required by the Constitution to have a sunset provision and should be reviewed at minimum every 10-15 years to determine whether the laws are still useful.

Re:Can somebody 'splain this? (5, Insightful)

uncreativeslashnick (1130315) | more than 5 years ago | (#26138617)

Most of it is the way it is because it evolved that way, and because of the laws/rules under which it all evolved. You paint with too broad a brush when you say that the vast majority of today's financial instruments have been created out of thin air. That's nonsense spoken out of ignorance, the same way a non-geek might say, "why can't software designers create programs without bugs?"

Commercial paper is a very broad term and encompasses everything from promissory notes to normal consumer checks. Just about any transaction not involving cash or electronic transfer is done with commercial paper. A huge portion of financial transactions are still done with commercial paper. So in the general sense of the term, it is still very, very necessary.

Now if you want to start examining specific financial instruments, like the derivatives backed by (partially) crap mortgages, we can have a conversation. I think the idea behind those instruments was basically sound, but the things ended up being a lot more complicated than people thought. It makes sense that if you lump a bunch of mortgages together, only a small percentage of those will default, thereby distributing your risk. But in a climate where fraud was rampant and the people signing people up for mortgages had no incentive to make sure people could actually pay those mortgages back, your lump of mortgages has a much higher chance of containing too many bad mortgages to make the resulting instrument profitable.

The derivatives market had the perverse effect of creating and encouraging that climate, because the mortgage buyers would buy without enough questions because they knew there were buyers who would buy the derivatives without too many questions. The fundamental problem with the whole concept, it seems to me, is that the derivative buyers and sellers forgot to insist on and question the credentials of the individual mortgagees they were investing in. Had they done a little bit of verification there, we might not be in this place right now.

Re:Can somebody 'splain this? (1)

xtrafe (1262576) | more than 5 years ago | (#26138641)

Sure. There's a pretty simple explanation:

Somebody decided to offer these products and services, and one way or another, some other people decided to buy them.

Of course, we could (and do) make regulations that proscribe certain products and services... but our track record in doing this demonstrates less than stellar results. i.e. A lot of the stranger derivatives exist solely to circumvent regulation.

I think, very generally, 'the economy' adapts and optimizes against any regulations that are imposed on it. And unfortunately, the more effective regulation is, the more inefficiency it creates.

So before anybody proposes how the system should be manually 'tweaked', they have the burden of proving that an economy can be effectively regulated -at all- over the long term.

Re:Can somebody 'splain this? (1)

afidel (530433) | more than 5 years ago | (#26138661)

Theoretically it's about risk assessment and market segmentation, allow the people making the loans set their acceptable level of risk and required rate of return. Obviously the system broke down, but that's because they came up with instruments so complex that they eliminated information from the system and thus hid the risk.

Re:Can somebody 'splain this? (1)

nelsonal (549144) | more than 5 years ago | (#26138815)

Many are developed to not be something that was or is heavily regulated by the government. Commerical paper arose because banks charged high spreads between savers and borrowers mostly because the government put them in a regulated, but market with a raised barrier to entry. Commercial paper side stepped the existitng market to reduce capture that spread (by both borrowers and lenders). Rather than a bank making 3% on a loan, a money market fund manager makes about 0.3% (which is much closer to the actual costs). The major difference between the two was that the government promised to make good on $100,000 of the savers' money which is great for small savers but pretty meaningless when you are a pension fund with $50,000,000 in short term funds.

Short term loans are needed for businesses to invest in long term assets that pay out infrequently but who have cash needs along the way. Think of a farmer. They have a big annual investment (planting) some small cash needs along the way and a bigger future payment. They can get a term loan (with the land as collateral) for the planting, but they'll need something to cover all the fertilizer costs and such in betweeen. The problem arose when the fed used it's monopoly position to make financing cheap for banks (the Fed monopolistically sets wholesale bank costs) to impact the economy after the dot com collapse. Almost everyone could see that it was cheap to finance a whole lot more of their operation with short term loans because now they could tap into the same market or markets tied to wholesale bank funding costs, and save 60-80% of their financing costs.

Re:Can somebody 'splain this? (0)

Anonymous Coward | more than 5 years ago | (#26138819)

You're looking at it from the small business, I need credit, I need cash, I need inventory, I need to make money point of view and in that case you're correct. One or two accounts suffice.

If on the other hand you want to make a market that lets you share risk and implement hedging strategies much less create value through speculations because you believe you're better at modern market price prediction than your competition then of course one or two accounts don't cover it and you need a liquid marketplace where traders can compete with each other.

Re:Can somebody 'splain this? (0)

Anonymous Coward | more than 5 years ago | (#26138887)

This may seem like a snark, but it is the plain truth: the financial models failed because none of them allowed for the possibilities that housing prices can go down. The "Real Estate always goes up" myth was baked into the models. It was not physically possible in my experience to plug in a negative number into these predictive models. Look into Quaint Funds - they used these models alot.

Re:Can somebody 'splain this? (0)

Anonymous Coward | more than 5 years ago | (#26138915)

not just type of accounts, but types of securities and ways of calculating performance. I work in the finance industry and have to write programs to calculate performance and evaluate and present holdings in many ways.

I think most of it is marketing. the different security types exist because of how they are sold. I am sure accounts are the same way. All in one accounts may make the most sense, but many people do not make purchasing decisions based on logic.

Re:Can somebody 'splain this? (1)

countach (534280) | more than 5 years ago | (#26138975)

Essentially, every debt has a risk. Risk determines interest rate. 2 week commercial paper for Ford has a different risk to 2 year commercial paper for Ford (which is different again to GM etc etc). You might have confidence Ford can pay up in 2 weeks, but you're not sure if the economy will tank in 2 years.

Now if Ford needs money for a certain period of time, whether to finance some car leases that are expiring in a month, or to finance some new ones that expire in 2 years, they've got to go to the market who will evaluate all the details of the risk and make you pay the appropriate rate.

The complexity of the system is people's attempt to defray risk. The problem is, the risk of the entire system became too aggressive, so all this defrayment of risk meant that nobody had more risk than anyone else, but everyone had too much.

Re:Can somebody 'splain this? (1)

fucket (1256188) | more than 5 years ago | (#26139003)

I'm at work and want to buy a coffee but I don't have any cash on me. I could put in on my credit card (and pay interest on it) or I could just borrow two bucks from the guy that sits next to me. He knows that I'm getting a paycheck and knows that I'm good for it. That's commercial paper in a nutshell.

Re:Can somebody 'splain this? (1)

gregbot9000 (1293772) | more than 5 years ago | (#26139015)

Loopholes have a lot to do with it, a whole lot. They aren't making all those exotic things to keep busy, they are making them to shave a few points off the tax burden, or to sell risky debt for a higher price.

Mainly though it's is liability, security, and liquidity. You have a separate checking account and savings account for stability.

The bank can write off your savings as stable and secure to lend out, since they tend to be stable, where as checking accounts fluctuate wildly. The amount of interest paid reflects that.

Same with loans, you have different types of loans based on your security and the liquidity of the lender. The way you pull credit is what really matters. Commercial paper is drawing on your credit but in different way. It is cheaper because of where the money comes from. The roots run to different places.

You should think of banks and lending institutions as being like any business, they buy up money by offering security and interest payments cheaply, Then they add utility and loan it out for more then they paid. The more they can cater means the more added utility, hence profit for everyone. This Has Worked. The problems with the sub prime, derivatives, and alt-A's isn't from the selection being to large. It would be as if Starbucks was cutting their coffee with radiator fluid and when they got caught they paid off the inspector and told the press it was OK because they were giving coffee to poor people.

Re:Can somebody 'splain this? (1)

SerpentMage (13390) | more than 5 years ago | (#26139121)

Why do we need commercial paper? Why do we need longer terms?

Banks operate in spreads and there are jolts to the spreads namely payroll, etc, etc. Thus to smooth the jolts you issue paper which gets you over those jolts in a very easy manner.

Let me illustrate. A speaker buddy had to pay a sum of money to his ex-wife. She demanded the lump sum and he did not have the money right away. He said he would have had to sell stock. So I said, do the following:

Go to the bank for 50 cents on the dollar to get a loan. Then use that loan to pay off the wife, and make payments until necessary. In other words it is all about the cash flow and utilizing the money you have.

This is not that complex actually. It is rather easy.

Why is the system fragile? Easy too much leverage. Do some history checks and it never is the instrument itself. Each and every bubble can easily be traced to people leveraging themselves. Leverage is death because with leverage you race time.

For example did you know what brought down the market in 1929? What we now call Mutual Funds! Don't believe me, read The Death of the Banker.

Re:Can somebody 'splain this? (2, Insightful)

thpr (786837) | more than 5 years ago | (#26139181)

I have always believed that the vast majority of today's financial instruments have been invented out of thin air for no reason other than to ultimately ensure the employment of bankers and brokers.

Actually, many of them have a good basis in logic, but are used beyond their original purpose.

For example.... I see absolutely no reason why a single account could not offer all those features.

Part of the reason there are individual companies that separated items like brokerages and commercial banking is historical structure created in the Great Depression, known as the Glass Steagall Act [wikipedia.org]

Other responders to your post have pointed out various specific details, e.g. reason for commercial paper, but let me cover a more general point of view on why so many different products exist: Risk.

The issue, however, is that risk doesn't come in only one form. There are different types of risk:
- Default Risk (if a company goes bankrupt, you don't get back your principal)
- Inflation
- Interest rate risk (if interest rates change, then the value of underlying loans change)
- Tax Rate Risk (different tax rates due to different income or time)
- Counterparty Risk (risk of entering into a contract, but the other party failing to fulfill the contract)
- Secured nature of the debt (recovery in case of default)
- Opportunity cost (cost of not doing an alternative with the money)
- etc.

Looking at various products we can see how they are different. An IRA vs. a Roth IRA actually transfers the Tax Rate Risk onto the government (you pay a known tax rate, and the unknown benefit or penalty due to the future difference is absorbed by the government)

A TIPS (Treasury Inflation Protected Security) vs. a normal Bond issued by the government transfers inflation risk onto the government (presumably the normal bond is accounting for perceived inflation in the offering price, but the TIPS accounts for real inflation, thus allowing one to eliminate the risk of the perception of future inflation being incorrect.

We can see today that today's 4 week Treasury Bill Auction [treasurydirect.gov] resulted in zero yield (give money to the government for 4 weeks, no interest). This presumably would mean the return one could get in a non-FDIC insured bank account (over the current $250K limit) is entirely bankruptcy risk premium.

Also there are organizations that do market clearing of bonds and stocks that absorb counterparty risk. Part of the problem with credit default swaps was that the holders of those products actually bear the counterparty risk, as they are not regulated like other products. (When combined with a lack of market data on quantity and concentration of the risks around default of bonds, this led to one of the underlying issues in the problems we have right now)

Lastly, there are also "positive" values that are priced into different financial products, such as recovery in case of default. That's why secured loans of [statistically] appreciating assets (e.g. home mortgage) are lower rates than loans on depreciating assets (e.g. automobile) and those are lower than unsecured personal loans. Same reason bonds will maintain value longer than preferred stock.

As a specific example of what is good (and bad), look for a moment at interest rate swaps [wikipedia.org] . They actually serve a valuable purpose, in allowing an investor (or the loaning company) to convert a variable-rate instrument into a fixed-rate one (or vice versa). This is valuable to companies to be able to "lock-in" lower interest rates when rates fall, for example. What is risky is when someone speculates on interest rate swaps without having an underlying asset. This results in significant leverage that can be wiped out very quickly if interest rates (in this case) move unexpectedly in the "wrong" direction.

If you lay out the different forms of risk (to both parties in a transaction) and level of security in a loan, I'd suspect you'd find very few financial instruments that significantly overlap (There will be a few, but in many cases, those can be differentiated by size, e.g. commercial paper vs. personal loans). The problems come in speculating on items to make money.

Re:Can somebody 'splain this? (2, Informative)

S77IM (1371931) | more than 5 years ago | (#26139185)

Our economy is a giant pyramid scheme. Wealth is created through lending by investing in business ventures. It's good for the borrower, who gets the capital to grow their business; it's good for the lender, who gets interest on their loan; it's good for the banks, who take a cut; and it's good for everyone, because savings that would otherwise be sitting in a vault gathering dust is instead flowing through the economy being exchanged for goods and services, etc.

But eventually, when things are going well, we run out of things to invest in. Times are good so people have a lot of cash and they would like to loan it to someone, but all the sensible ventures are already funded. So banks and other financial institutions invent riskier and riskier lending schemes, so that they can get a return on their capital. Eventually the banks, brokers, etc. start making bum loans and the money goes down the tubes. There's a chain reaction as investors pull their money (a run on banks, a selling of stocks, etc.).

Every economic downturn includes risky lending as a major contributing factor. The investors who pulled out early, and the financial institutions that take a cut without accepting any risk, are the top of the pyramid. The people who wind up holding the risky loans during the collapse are the bottom of the pyramid. Those guys thought the interest would always come rolling in.

The complexity of the system is there to try to hide this interaction. The rubes at the bottom of the pyramid wouldn't by into it, except that it is so obfuscated that no one can really tell what's going on. (Honestly, selling badly insured bundles of mixed-risk mortgages cost the taxpayers a trillion dollars? How is Joe Six-Pack supposed to guard himself against that?) And like any good pyramid scheme, the con involves great returns for people who get in early. Remember when your 401(k) was trending ever upwards? "Put some of that in real estate, it's huge!"

  -- 77IM

Re:Can somebody 'splain this? (1)

lawpoop (604919) | more than 5 years ago | (#26139233)

For example, lots of people have a checking account, savings account, credit card, poersonal line of credit, HELOC, brokerage account, and more. I see absolutely no reason why a single account could not offer all those features.

I don't want a single account. I don't want my bank or "Financial institution" fucking with my IRA or checking account if I'm a few days late on my credit card bill. I keep all my financial serviced housed with separate institutions.

Let's try... (2, Informative)

Estanislao Martnez (203477) | more than 5 years ago | (#26139341)

Besides consumer banking, can somebody explain to me why we NEED "commercial paper"? Yes, I've read the wikipedia page and I know how it's used, but I don't understand why it's needed. If you can't make payroll then you're pulling from your credit one way or another - why do we need separate instruments for a 2 week loan versus a longer term loan, or a credit card, or whatever?

Because the risks, terms and structures of the loans are different between the different products, and it requires different expertise to successfully make loans of one kind vs. another. Not to mention that the borrowers are different for each product. This means that the separation of the loans into distinct product types represents a division of labor among lenders.

Just to list some of the important factors:

  1. Commercial loans vs. consumer loans
  2. Large corporations vs. small businesses
  3. Large loans ($100k+) vs. smaller loans
  4. Fixed term and rate vs. revolving loan
  5. Secured vs. unsecured loans
  6. Secured loans with different types of collateral
  7. Large volume of small transactions vs. small volume of large transactions
  8. Prepayment options
  9. etc.

This is not to say that the line of product offerings doesn't have any significant overlaps, but most pairs of products you can think of are differentiated along at least one of these, if not others. The commercial paper market, for example, exists because large corporations seeking large ($100k+) short-term loans can get better rates than at other kinds of credit product. Large corporations with good credit ratings also get better rates on long-term borrowing by issuing bonds than they could by going to a bank. Credit cards feature point-of-sale networks and allow for a large volume of small transactions, while personal lines of credit require you to borrow in much bigger chunks at a time in exchange for a better rate (a volume discount, so to speak). And so on.

Re:Can somebody 'splain this? (2, Interesting)

PingPongBoy (303994) | more than 5 years ago | (#26139391)

How red is the herring?

The masterminds are devious? The ignorance is enforced in the entire system?

Maybe, but could it just be the sheer sustained growth of knowledge and the lack of ability to handle the knowledge? I see people grasping at straws and stepping on each other to acquire not knowledge but wealth. The successes of the few trigger the enthusiasm of the masses. That is exactly what happened until the slippery slope became the avalanche. The funny thing is, what is in this simple analysis that could not find its way into a computer model?

For years, I have heard the occasional debate in the media about how unsustainable the increase in housing has to be. I wasn't even listening to financial gurus. The words of wisdom were coming from typical journalists who were sort of in tune with the common man.

Clearly the missing factor in the computer models, the X factor, is the belief that world progress itself was going to sustain the affordability of the high cost of living. Higher housing costs and education costs were to some people an unavoidable way of life, and a benchmark of progress, and somehow everyone else is able to get into the game no matter how high the stakes are. The message was simple: if you bother yourself in the age of fun-on-the-internet and really-cool-lifestyles to drill down into this mindset, you will see that the whole economy is sound and proper because the wealth is easily sustainable via production on the backs of the third world. Then immigrants will come, cluster, and afford the million dollar 2-bedroom bungalows with no garage, a bizarre effect that will exist in only a few years if housing prices were to maintain their collision course. This mathematics somehow did not appear in a computer model because our ability to control computers has not advanced to the level of simple linear projection.

So what is the data telling us now? The stock market is down because businesses have just focused on raking in as much money as they can from the economic situation of Christmas past. Now it is Christmas present, and there is no real plan for Christmas future. As a result, people are scared shitless to invest anything. The fear can only be allayed with real results. Trust has to be won. These are sweeping concepts that are not that easy perhaps to quantify and observe, not that easy to run on a computer model...

The source of the problem (5, Insightful)

Anonymous Coward | more than 5 years ago | (#26138285)

has nothing to do with computers. The source of the problem is the source of money. Who decides how much money there is? Who reaps the benefits of creating money which is not backed by real productivity? If you're truly looking for the root of the problem instead of symptoms, then you have to find out about the inner workings of the money system. In other news, the "Federal" "Reserve" bank has once more lowered the interest rate. The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.

Re:The source of the problem (0)

Anonymous Coward | more than 5 years ago | (#26138483)

Parent AC is especially poignant when taken in concert with cbiltcliffe's post [slashdot.org] above. Guess who has all the gold?

/alreadymodded

Re:The source of the problem (2, Interesting)

megamerican (1073936) | more than 5 years ago | (#26138683)

Don't worry, I'm sure Congress will audit the Federal Reserve and we'll get to the bottom of this mess!

The Federal Reserve recently refused to disclose $2 trillion in loans requested by a FOIA request citing "trade secret" clauses.
http://www.bloomberg.com/apps/news?pid=20601109&sid=aGvwttDayiiM [bloomberg.com]

In response to Bloomberg's request, the Fed said the U.S. is facing "an unprecedented crisis" in which "loss in confidence in and between financial institutions can occur with lightning speed and devastating effects."

In other words, we'll tell you when we're ready to finally destroy the economy!

No wonder Congressman David Scott said we've "been bamboozled!"

The real number of the bailout is actually $8.5 trillion (as of two weeks ago and is probably closer to $10 trillion now.

http://www.sfgate.com/cgi-bin/object/article?f=/c/a/2008/11/26/MNVN14C8QR.DTL [sfgate.com]

Re:The source of the problem (1)

amliebsch (724858) | more than 5 years ago | (#26138685)

That's not what a .25% interest rate means. It means that a dollar a year from now is .25% away from being worth the same as a dollar today. It doesn't say anything at all about the current value of the dollar.

Re:The source of the problem (2)

DragonWriter (970822) | more than 5 years ago | (#26138963)

That's not what a .25% interest rate means. It means that a dollar a year from now is .25% away from being worth the same as a dollar today.

It doesn't mean that, either; the fed funds rate might rationally be expected to have some loose correlation with the value of the dollar over time, but its not the same thing. It relates to how many future dollars someone privileged to borrow at the fed funds rate must sacrifice to get a current dollar, not what the dollar will be worth at the time that bill is due.

(Of course, for anyone to borrow at that rate, the borrower must expect that the expected return of what they can do with the dollar exceeds the interest rate by enough to compensate for the risk of failure, but that's about return, not value of the final dollar.)

Re:The source of the problem (1)

Znork (31774) | more than 5 years ago | (#26139065)

It doesn't mean that either; the value of the dollar is also driven by demand and supply, and the supply is currently simultaneously in freefall due to credit destruction in combination with fractional reserve banking and rapidly being inflated through 'quantitative easing', ie, the Fed running the printing presses (they've expanded the money supply by some 150% since september).

Currently the credit collapse is winning out, meaning more money is getting destroyed than the Fed manages to print and distribute, leading to deflation. Which means that with a rate of 0% you're still better off having your money in your mattress (or treasuries, as is more common), as its purchasing power will increase anyway (and particularly you're better off with the money safe than lending it to some deadbeat for minimal interest and who'll probably default anyway).

Eventually, of course, the mass printing will probably lead to a collapse in the value of the dollar, but not until either the credit destruction is complete or an external asset makes a massive carry trade lucrative.

Re:The source of the problem (1)

DragonWriter (970822) | more than 5 years ago | (#26138899)

The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.

A fed funds rate near 0% doesn't mean the dollar is near worthless, it just means that borrowing them has a low nominal cost for those who can borrow at that rate. (Usually, this would mean even a lower real cost, as well, but not in the case of deflation, and the perceived cost could by higher than the nominal cost if deflation is feared/expected, even if it didn't occur; expectation of deflation would also explain otherwise irrational results like the recent dip in short-term T-bill returns into negative territory, meaning that people were actually willing to pay to lend the US government money rather than expecting a positive nominal return for such lending.)

Re:The source of the problem (0)

Anonymous Coward | more than 5 years ago | (#26139145)

That characterization was intended to be a dramatization, not a mathematically precise analysis. Free money would result from a -100% interest rate, obviously: Get some money, pay nothing back. At 0%, you still have to pay it back, just no interest on it. That said, consider the effect that 0% interest money has on market prices and the amount of money in circulation, especially in the face of the "too big to fail" psychology fueled by the government bailouts. Just take a look at DOW, USDEUR and USDJPY today.

Re:The source of the problem (1)

DNS-and-BIND (461968) | more than 5 years ago | (#26138945)

An interest rate of 0% means that your money will be worth the same tomorrow as it is today. What other financial instrument today offers this sort of certainty?

Re:The source of the problem (1)

andreasg (1010787) | more than 5 years ago | (#26139219)

Without knowing the real interest rate there's no saying that your money will be worth the same tomorrow as it is today, even with a 0% nominal interest rate.

Re:The source of the problem (1)

Tomfrh (719891) | more than 5 years ago | (#26139125)

The dollar is now less than 0.25% away from being free (i.o.w. worthless) money.

It doesn't mean the dollar is worthless, it just means the exchange rate between the future and the present is approaching parity. I.e., no-one expects much to happen for a while...

Re:The source of the problem (1)

gregbot9000 (1293772) | more than 5 years ago | (#26139195)

OMG I love AC's, lets go over this:

you have to find out about the inner workings of the money system ... once more lowered the interest rate. The dollar is now less than 0.25% away from being free

You don't even know how inflation works! And you want people to learn about the banking system? Why? So they can laugh at you? Inflation is caused by a little more then just how much money the Fed prints. And how much inflation occurs has to do with the banking system, and if there is a signifigant Zero bound problem this may not be enough.

I'm no fan of counter cyclical monetary policy, but if you're going to critique the system you might want actually know what your talking about instead of parroting the John Birch society or wherever you get you kool-aid from.

Re:The source of the problem (1)

khallow (566160) | more than 5 years ago | (#26139355)

Even a negative interest rate doesn't automatically result in free or worthless money. You still have to pay the principle back and the interest comes (as a payment) in the future where the currency may be worth a lot less.

Right, this is all a big computer crash (2, Funny)

BadAnalogyGuy (945258) | more than 5 years ago | (#26138291)

Funny how all the computers seem to be working properly when the prices are going down, but not working half the time when prices need to go back up.

I guess it's like how gas pumps will correctly increase the price of gas when the price per barrel of oil goes up, but are buggy and won't reduce the price later when the costs come back down.

Re:Right, this is all a big computer crash (2, Informative)

amliebsch (724858) | more than 5 years ago | (#26138383)

No it isn't.

For one, the price of gasoline is not directly tied to the price of crude oil - it's also affected by refinery capacity, supply and demand of other petroleum products, and the varying supply of gasoline in particular.

For two, I've recently witnessed gas prices fall from around $4 to almost $1.50. Am I hallucinating this?

Re:Right, this is all a big computer crash (0)

Anonymous Coward | more than 5 years ago | (#26138433)

The joke is that he was blaming the price movement on the gas pump rather than on all the other factors that actually have an impact on the price.

Garbage In - Garbage Out (1)

theaveng (1243528) | more than 5 years ago | (#26138307)

An old, old saying but many of the "newbies" who have adopted computers since the Dot-Com genesis haven't learned the lesson yet. You can't just blindly believe the computer's projections - you need to doublecheck what data was fed to it & if it was valid.

Most financial planners did not do that, and they bet their millions on faulty data or assumptions.

Re:Garbage In - Garbage Out (0)

Anonymous Coward | more than 5 years ago | (#26138375)

The data was valid, the predictions were correct, the reactions were prudent. Just because you don't take first-mover-advantage in order to avoid upsetting the market doesn't mean nobody else will. Everything worked as advertised.

Economics models are like goat entrails predict... (3, Insightful)

tg123 (1409503) | more than 5 years ago | (#26138311)

Economics models are like using goat entrails to predict the future so this wouldn't surprise me. sorry just had to put my 2 bits in

Death to the quants! (0)

Anonymous Coward | more than 5 years ago | (#26138317)

Long live the stockpickers!

Snow Crash? (1)

dosh8er (608167) | more than 5 years ago | (#26138325)

Isn't the system based on 'speculation' ? I suppose it's different when my broker misplaces a decimal point, versus a computer program that misplaces a decimal point for thousands of 'clients'. Technology might be a great thing for convenience, but it's certainly starting to show its limits in the scope of what humans expect from it.

pointing fingers (4, Insightful)

girlintraining (1395911) | more than 5 years ago | (#26138327)

I'd just like to point out the bleedingly obvious: That people programmed these computers. They are functioning exactly as they should be. If they weren't, we'd have heard about it by now. So the problem is not the computers, or the network, but rather the people who control them. Thank you. You may now resume your regular ranting, already in progress.

Re:pointing fingers (2, Insightful)

dosh8er (608167) | more than 5 years ago | (#26138397)

which, i believe is why the garbage in garbage out syndrome is affecting 'users'. I can't imagine what the 'QA/QC' is like involved in the development of the modeling software for financial sector. shouldn't it be as regulated as, perhaps, the nuclear industry? Or maybe nobody can maintain all those lines of COBOL...

Re:pointing fingers (2, Insightful)

girlintraining (1395911) | more than 5 years ago | (#26138461)

It's very tightly regulated, and the source code must be independently reviewed prior to certification. They're very ugly about that kind of thing. Computer models might be a problem, but only because they were based on bad assumptions made by the designers... That is a human failing, not a machine one.

Re:pointing fingers (4, Interesting)

BigTom (38321) | more than 5 years ago | (#26138577)

What is tightly regulated? Half the Quant algo trading models get thought up in the evening, coded overnight and activated in the market the next morning.

If you try and slow them down they just run to the head of the desk bleating that the "nasty IT man stopped me making $1000,000,000 for the bank with his silly QA nonsense" and whoosh, its in production. It is prop trading so its their risk.

Re:pointing fingers (2, Insightful)

girlintraining (1395911) | more than 5 years ago | (#26138651)

the systems are designed to have transactional integrity. it doesn't prevent someone from making idiot trading decisions.

Re:pointing fingers (3, Insightful)

BigTom (38321) | more than 5 years ago | (#26139351)

The plumbing is not the problem here. It is the Quant models that _are_ the market in many cases (certainly where ever hedge funds are significant players).

Re:pointing fingers (5, Insightful)

Znork (31774) | more than 5 years ago | (#26138665)

Considering the fundamental basis of the whole system is based on the flawed assumption that credit can be infinitely expanded the current failure is hardly surprising. The Austrian school pointed out the fallacies that caused both the last depression and the current one almost a hundred years ago.

Computers have very little to do with it. Constructing models to fit political economics rather than to reflect reality is closer to the actual problem.

Re:pointing fingers (0)

Anonymous Coward | more than 5 years ago | (#26138967)

I can't imagine what the 'QA/QC' is like involved in the development of the modeling software for financial sector.

the most important stage in QAing a new model is seeing if it crashes with array bounds checking turned on. if it does, you fix it by turning array bounds checking off. then you put it into production and bet a couple of billion dollars on what it says.

Re:pointing fingers (5, Interesting)

AJWM (19027) | more than 5 years ago | (#26138507)

Two words: "emergent behaviour".

No one group of programmers programmed all these computers, there was no single set of specs for the whole network. All the components may well be "functioning exactly as they should be" (although in reality I'm sure there are a few bugs in the systems, but that's irrelevant here), but the system overall may behave in an unexpected way.

(That said, I don't think that's the whole problem either -- too many people playing a bit fast and loose and less than honestly with other people's money is also part of the problem.)

Re:pointing fingers (4, Insightful)

DragonWriter (970822) | more than 5 years ago | (#26138695)

Two words: "emergent behaviour".

Its not emergent behavior of computer systems. Its the exact same kind of behavior markets have displayed without computers.

Sure, things haven't been this bad recently, so some elements of it are new, at least in the short term, and the details change always. But none of the big picture stuff has much to do with computers, fundamentally. Economic markets are vastly interconnected because their substantive outputs and inputs (not just data outputs and inputs of the computer systems currently used as tools in managing them) are directly linked.

Blaming computers is about as justified as blaming witches.

Re:pointing fingers (4, Insightful)

girlintraining (1395911) | more than 5 years ago | (#26138749)

No one group of programmers programmed all these computers, there was no single set of specs for the whole network. All the components may well be "functioning exactly as they should be" (although in reality I'm sure there are a few bugs in the systems, but that's irrelevant here), but the system overall may behave in an unexpected way.

There's a bug in Internet Explorer. That must mean the entire internet is broken. No. Financial transaction systems are heavily audited, rigorously tested, and subjected to heavy regulation. They are the most hardened systems in wide use in the commercial sector. Period. That doesn't mean there aren't problems, but a problem big enough to cause a network-wide malfunction are very, very low.

What we're dealing with now are people who made bad assumptions about the economy, got cocky, and now we all are paying the price for the lack of oversight and auditing done on the decision-makers responsible. Looking for simple solutions (ie, "the computer did it") to complex problems is naive at best. This took many several thousand people, all making the same bad decisions, to bring us to where we are now. I will say it again -- this is not a technological failure, it's a failure of people. And if you ask me, we should start publishing the "bugs" -- ie, the names and faces of these people, so the rest of us know to never let them anywhere near the financial sector ever again.

But that would just be too easy.

Re:pointing fingers (1)

martin-boundary (547041) | more than 5 years ago | (#26139107)

Financial transaction systems are heavily audited, rigorously tested, and subjected to heavy regulation.

No. The amount of auditing, testing, and regulation varies widely depending upon the type of transaction (the consumer banking market is much more regulated than exotic derivatives).

Re:pointing fingers (1)

girlintraining (1395911) | more than 5 years ago | (#26139153)

No. The amount of auditing, testing, and regulation varies widely depending upon the type of transaction (the consumer banking market is much more regulated than exotic derivatives).

It's still more audited and tested than the overwhelming majority of software, even on a bad day.

Re:pointing fingers (1)

martin-boundary (547041) | more than 5 years ago | (#26139359)

It's hard to audit statistical processes, and modern trading in investment banks involves a combination of many individual transactions to achieve an overall stochastic goal over time. The protections can easily fail, eg Nick Leeson [wikipedia.org] , Jerome Kerviel [wikipedia.org] .

Perhaps a good analogy is with internet peering. There is no attempt to price every packet of data correctly, instead the telecoms just keep tabs on volume.

One problem with that. (1)

khasim (1285) | more than 5 years ago | (#26139393)

What we're dealing with now are people who made bad assumptions about the economy, got cocky, and now we all are paying the price for the lack of oversight and auditing done on the decision-makers responsible.

But those same people were "geniuses" for making so much money for their investors BEFORE it all collapsed.

See Bernard Madoff.

And it will happen again.

Re:pointing fingers (2, Insightful)

martin-boundary (547041) | more than 5 years ago | (#26139001)

They are functioning exactly as they should be. If they weren't, we'd have heard about it by now.

Not always. Many finance outfits use Excel a lot, which doesn't do statistics properly [forecastin...ciples.com] . However, modern finance has become very statistics heavy in the last ten years, so this shortcoming matters now a lot more.

As with anything man-made. . . (1)

mosb1000 (710161) | more than 5 years ago | (#26138349)

It works well as long as you aren't too dependent on it or too obsessed with it. We often hold ourselves and others to an unreasonable standard of perfection.

Understand the System Dymanics of Emergence (3, Insightful)

Anonymous Coward | more than 5 years ago | (#26138499)

It is not just the computers, but the humans as well. The entire interconnected system of humans and computers in one planetary collective. A planetary economic dynamical system emerges from this, and takes on a life and behavior of its own, including organizing itself towards a "self-organized criticality" state that would eventually avalanche as it is doing so now.

The system grew far faster than it's underlying resources would allow for, ultimately driving it to a point of exhaustion and shock, leading directly to a cascade of failures spreading around the globe to nearly all segments of the market. It was inevitable, and I saw it coming many years ago, though I could not predict when it would transpire.

It's kinda like earthquakes. You can see the tension between the tectonic plates building up, but you can never be sure when that pressure will release itself. So it goes with the global financial marketplace.

Many parts of this market is zero-sum, yet predicated on the fallacy of "infinite-growth". You cannot have it both ways, my friends. It must fail, and that can "easily" be shown mathematically.

And so my "Greater Fools" theory of the market stands. If you hold a stake in it, your only hope is to find a "greater fool" than yourself to take it off your hands at a higher price. Since the supply of fools are finite, and the resources they hold are also finite, someone *must* be left holding the bag, due to the zero-sum dynamics of the market.

Computers being in the mix only make the shocks more severe and dramatic; but the same applies regardless.

Re:Understand the System Dymanics of Emergence (1)

DragonWriter (970822) | more than 5 years ago | (#26139043)

Many parts of this market is zero-sum, yet predicated on the fallacy of "infinite-growth".

Many parts "is" zero-sum? Name, say, three parts that are zero-sum. Or even constant-sum.

Can't model in human traits (4, Interesting)

HW_Hack (1031622) | more than 5 years ago | (#26138581)

How can you model in greed - corruption - and the ever popular human trait of freaking out ?

Tech bubble - Real Estate bubble ... next time I even see/hear the word bubble in the markets I'm cashing out for a while

Does the argument support the conclusion? (3, Interesting)

MoellerPlesset2 (1419023) | more than 5 years ago | (#26138587)

Seems to me the author is repeating the mistake himself: By drawing a conclusion not supported by the data, in this case being the evaluation of the role played by computer models here.

And I agree with that datas: The problem isn't the computer/mathematical models. It's how they were used. In particular, people were using models designed to evaluate one kind of mortgage asset, and plugging in an entirely different kind of mortgage, etc.

The author grants that conclusion, but then makes the claim that although the problem wasn't caused by the computers themselves, that it was somehow exasperated by them. - I don't see how that's the case.

Computers and computer modelling makes it easier to create advanced derivatives and such. But it doesn't make us do it. Just look at the engineering world; We don't choose technically advanced solution just because we can. In fact, the tendency is to go for the simplest possible solution. ("KISS rule")

There's only one reason why you would create advanced, incomprehensible derivative structures: To con people, essentially. To obfuscate the risks. To create money out of nothing. (the most profitable way to make it)

That's not a new problem. There's a reason we created financial regulations, why we have book-keeping, demand financial transparency, auditing, etc. This happened because it was allowed to happen. Because nobody stepped in and stopped this obfuscation from happening. I don't blame the computer models. If someone cons you into signing a bogus, misleading contract - the problem isn't with the paper it was written on or the language that was used. The problem is with the law allowing such contracts to have legal force (which is a regulatory problem from another century).

To extend that analogy, this is a bit like standing in that situation and asking whether or not written contracts are a bad thing, and whether we shouldn't go back to simpler, oral contracts. The bottom line is: As long as it's profitable, there will always be people trying to obfuscate and hide information for economic gain, and there will always be a need for regulation and oversight to stop people from doing that. But blaming the methods by which it's done is pointless.

Re:Does the argument support the conclusion? (0)

Anonymous Coward | more than 5 years ago | (#26138901)

A scientist trained a frog to jump on verbal command.
The frog jumps a distance of 8 feet.

The scientist chops off a leg, now the frog jumps 6 feet.

The scientist chips off another leg, now the frog jumps 4 feet.

The scientist chips off the 3rd leg, now the frog jumps 2 feet.

The scientist chops off the final leg. The frog jumps 0 feet.

The scientist comes to the conclusion that the frog is now deaf.

Anything blamed on a computer... (1)

DragonWriter (970822) | more than 5 years ago | (#26138599)

...involves at a minimum two human errors, one of which is the error of blaming it on the computer.

The scariest thing about high finance these days (1)

David Gerard (12369) | more than 5 years ago | (#26138609)

The very scariest thing about the computers sending serious amounts of money around?

They're almost all Excel spreadsheets.

Yes, seriously.

Gaming the system (2, Interesting)

Anonymous Coward | more than 5 years ago | (#26138657)

I was actually pretty involved in automated trading systems until a few months ago. The over-arching problems with the systems is they can either be tactical or strategic. Tactical systems make trades in milli-seconds and make decisions based on a dozen or so parameters. There is no human intervention. The money is made getting your trades in faster than the other guy. The problem is there are a lot of reactionary traders out there who see this movement and then react... without really determining what caused the movement. They just see a large percentage of stock moving and follow the lead.

Strategic trading is data-mining and looking at hundreds of factors and incorporating expert opinion into and making decisions based on long term movements and not singular announcements.

A very good example is Enron. Tactical trading systems would have always bought it because it meet or exceed it's numbers. A through analysis such as the one done by Daniel Scotto [wikipedia.org] would have seen through the fraud.

Unfortunately ... tactical trading is fast and sexy and attracts the Gordon Gecko/Boiler Room types. Very few college grads aspire to be Warren Buffet.

What does it have to do with computers? (0)

Anonymous Coward | more than 5 years ago | (#26138689)

You kids and your newfangled things! No good will come of it!

The current problem is due to borrowers taking out home loans that they couldn't repay, and lenders assuming, based on no evidence at all, they the borrowers could repay. One day, the lenders found out that borrowers weren't paying, and therefore the lenders were hundreds of billions (or trillions) of dollars poorer than they thought they were. How is that the fault of computers?

Also, asset bubbles, based on 'irrational exuberance' for something that people think will always increase in value (from tech stocks to houses to tulips [wikipedia.org] ), existed long before computer models existed. I don't see the relationship of asset bubbles to computers.

the current global system is in an "undefined state." This means that there's no way to predict what its output will be

Are they suggesting that we can't predict the economy and markets? Think about it for a minute: If you knew that for certain, at any point in history, would you be reading Slashdot? Could we predict the markets before the advent of computer technology?

established modeling techniques presume falsely that radically large market shifts are unlikely and that all price changes are statistically independent; today's fluctuations have nothing to do with tomorrow's--and one bank's portfolio is unrelated to the next's. Here is where reality and rocket science diverge.

He's saying that the models didn't take into account 'systemic' risk. First, I wonder to what degree that's true. Second, were our models any better when we used slide-rules? Computers somehow make our models less sophisticated?

I think he identifies some problems, especially garbage-in-garbage-out, but I don't see how they are related to computers.

Re:What does it have to do with computers? (1)

David Gerard (12369) | more than 5 years ago | (#26138735)

Computers allow you to make Godawful mistakes so much faster than your competitors.

And we all thought Skynet would use nukes!!! (1)

tjstork (137384) | more than 5 years ago | (#26138779)

Instead, its a financial meltdown by a suddenly emergent AI. Why destroy the planet when it is so much easier to just starve humanity to death!

In all seriousness though, the usual anti-globalism doomsayers are not the only one. A careful reading of the insurance industries actuarial newsletters will show a growing skepticism of computer modelling. It's kinda funny but remember the big brouhaha over Mann's Hockey Stick was that he used some software, I think, that was also used for Wall Street trading models. What if he just royally screwed up?

Log Normal Assumption (1)

DJ Jones (997846) | more than 5 years ago | (#26138841)

The vast majority of financial models (including the dreaded CDO models) use stochastic calculus to predict price movement by setting up individual security prices as random variables. By doing this, you are making a very broad primary assumption that the markets for these securities, as a whole, are log-normal.

Right there, from the beginning of all these models, you are making a broad assumption. No one has ever proven that any of the financial markets are actually log-normal.

The model assumptions were ideological (5, Interesting)

grandpa-geek (981017) | more than 5 years ago | (#26138849)

There are two equally valid descriptions of markets. One is by Adam Smith, with the "unseen hand" guiding the markets. Smith markets are well behaved, efficient, and amenable to analysis by what amount to small-signal statistics.

The other description is by Charles Mackay in his book "Extraordinary Popular Delusions and the Madness of Crowds." In that book he describes the Dutch tulip craze and other bubbles in history prior to the mid 1800's. This economic crash is more of the same.

The models, probably because of "free market" ideology, assume a market where Adam Smith's "unseen hand" is at work. The modelers don't consider the kinds of markets described by Charles Mackay. Most of the models are based on the Black-Scholes option pricing theory. If you look at the assumptions underlying that theory, they describe good behavior, efficiency, and changes describable by what amount to small-signal statistics.

Mackay markets are boom and bust, with greed and lies and herd behavior all around. That's what we had. The underlying mathematics has been studied, but not for markets. If you have a pre-LCD TV, an electronic circuit that is non-statistical but related to boom-and-bust market behavior creates the sawtooth sweeps that paint the picture onto your screen.

Turner (2, Informative)

Elektroschock (659467) | more than 5 years ago | (#26138871)

Probably the best comment on the current financial crisis comes from Mr. Adair Turner [ft.com] .

It is not the computers or the communication standards. Sorry, not our poor computers, not the right target for the blame game.

The challenge of the crisis is intellectual. Look, I remember that economists always explained me that they have no clue where the US growth rates come from systemically or can explain where the financial markets make all that money. The surprise was that it didn't crash earlier.

Don't Worry... (0)

Anonymous Coward | more than 5 years ago | (#26138879)

It's all part of The Plan [wikipedia.org] .

Re:Don't Worry... (1)

mosb1000 (710161) | more than 5 years ago | (#26138993)

I always think it's funny when people discuss putting the laws of robotics into practice. They seem to forget (or perhaps did not notice) that Asimov's short stories concluded that such laws and rules won't work. I think in this case it is a very apt comparison.

Strategic Military Significance (0)

Anonymous Coward | more than 5 years ago | (#26139017)

Forget the Fed.
Forget the Treasury.
The most sophisticated global economic simulations are done by the DoD.
Weather is important.
Foreign logistics need to be tracked.
Nuclear device simulations maintain the arsenal.
BUT THERE IS NO ASSET WITH MORE MILITARY SIGNIFICANCE THAN OUR ECONOMIC POSTURE.
More DoD resources are spent tracking, forecasting and simulating the global economy than any any other military resource.
AS IT SHOULD BE.

My investment advisor ... (2, Funny)

PPH (736903) | more than 5 years ago | (#26139261)

...Bernie Madoff assures me that my portfolio is safe and I shouldn't worry.

Don't blame the computers (3, Insightful)

deodiaus2 (980169) | more than 5 years ago | (#26139399)

There are lots of problems in the financial system that have nothing to do with computers. If anything, computers have brought these problems to light.
You see a lot of this pointed out on Jim Cramer's show "Mad Money", http://madmoney.cnbc.com/ [cnbc.com]
Most of our problems have to do with the lack of transparency in financial systems on supposedly public traded companies. As Cramer pointed out, "How can you have these levels of fiction after Sarbone-Oxley?" Moreover, with the recent Ponzi scheme uncovered, it makes you wonder just how interested is the SEC in maintaining the integrity of the financial system? That and allowing the short sellers to destroy the banks, leaving the tax payer to bail out the investors in order to preserve the financial system.
Thank god, we have the best form of government money can buy. Unfortunately, it even works to preserve the status quo when the original players are bankrupt. Nothing new here, after all, Japan's emperor was able to maintain control long after he had been defeated.
I am sure the US empire will survive this minor setback. The Hessian empire was bankrupt for hundreds of years before it ultimately collapsed. Maybe we can drag this on until the next Ice Age or until we poison all life to extinction, so who cares about the messes in the meantime?
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