Garbage In, Financial Crisis Out

from the so-much-for-the-quants dept

Fri, Sep 19th 2008 7:55am — Mike Masnick

With everyone trying to figure out just what went wrong to cause the rather spectacular financial mess Wall Street finds itself in these days, Saul Hansell over at the NY Times wanted to find out why all the sophisticated risk management quant algorithms that Wall St. has been so big on lately failed to warn of impending doom. His answer, basically, is that people on Wall St. were lying to the algorithms, coming up with ways to purposely enter data such that the risk seemed much less than it actually was -- in order to let them keep pushing the boundary. Then, it became a situation where people start relying on the computers just because the computer says so -- even though the data is bad. This happens time and time again. Even when people know that computers make mistakes, it's just so convenient to have a computer "confirm" your thinking that you start ignoring other warning signs.

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Filed Under: algorithms, computers, quants, trust, wall street

44 Comments

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PaulT (profile), 19 Sep 2008 @ 8:24am

Rule #1 when people are dealing with a computer system: if there are limitations, people will find their way around them.
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Joseph Durnal, 19 Sep 2008 @ 8:31am

Saw it coming
Anyone who didn't see this coming had it coming. I don't know if it is good or bad that I'm just a regular working guy. Hopefully I'll stay employed and all will be well. The spend and tax solutions are not the best idea though, the economy won't truly recover until the risky investments that lost, cost the risk takers dearly, and they start investing with some sense again.
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- Lehman's ethical brother, 19 Sep 2008 @ 10:11am
  
  Re: Saw it coming
  "The economy won't truly recover until the risky investments that lost, cost the risk takers dearly, and they start investing with some sense again."
  
  Didn't this happen in 2001 with Enron? Get rid of all the accountants and speculation marketplace. This is evil!!! No more creative ways to figure the balance sheets!
  AIG said they will be able to pay back the $84B loan within two years! Who is going to pay for that? [Facepalm]
  
  Consumers, of course, in the form of higher premiums!
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NeoConBushSupporter, 19 Sep 2008 @ 8:40am

I KNEW IT
Look supply-side, deregulated capitalism works, we all know that. The Reagan revolution created an economy so strong and vibrant it carried us right through the Clinton years and beyond. It was simply the lying and cheating of numerous recent bad apples that caused this collapse, not poor economic policy.

VOTE McCain 2008 - The economics of failure have failed, together we can make them work again.
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- Ima Fish, 19 Sep 2008 @ 9:03am
  
  Re: I KNEW IT
  "It was simply the lying and cheating of numerous recent bad apples that caused this collapse, not poor economic policy."
  
  I realize you're kidding, but some will not. Some will actually agree with you. So I'm responding.
  
  The problem with this argument is as follows: The reason we have regulations over corporations is the same reason we have criminal laws over people. People are by their nature selfish and need some limits.
  
  Am I saying that all criminal laws are good or that everything should be regulated? No. What I'm saying the issue is not whether we should regulate. The issue is only how much.
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  - hegemon13, 19 Sep 2008 @ 9:18am
    
    Re: Re: I KNEW IT
    Very true. However, I think that the knee-jerk reaction now will be a slew of unnecessary and preemptive regulatory measures that will cost corporations a lot of money. Of course, they wouldn't be in that situation if they hadn't already screwed things up so badly.
    
    Over time, it will balance out to a happy medium, just as it has done in other industries. In the mean time, we will see a lot of overcompensation and in-fighting. The economy can't be good all the time, but we can learn from our mistakes to minimize the peaks and valleys. If nothing else, the last several years have been an interesting experiment of "trust the market until it shows that it can't be trusted." Let's hope we learn the right lessons from that experiment.
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  - Anonymous Coward, 19 Sep 2008 @ 10:02am
    
    Re: Re: I KNEW IT
    "The reason we have regulations over corporations is the same reason we have criminal laws over people. People are by their nature selfish and need some limits."
    
    BEWARE the love of money!!
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  - Tony, 22 Sep 2008 @ 10:45am
    
    Re: Re: I KNEW IT
    Of course, let's not forget that it was REGULATION that got us into this mess in the first place - regulations that forced banks to make loans that they otherwise wouldn't, with the intention that "the poor" be able to buy houses.
    
    "People are by their nature selfish and need some limits."
    
    The free market deemed lending to "the poor" to be a bad risk. The government said this was selfish and greedy.
    
    Yes, it was. And it worked. Government regulation changed that, and look where we are now.
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- jonnyq, 19 Sep 2008 @ 10:31am
  
  Re: I KNEW IT
  Mike, I don't think anyone would be offended if made a "no trolling" rule, especially for repeat offenders, especially if a good chunk of a comment thread goes to feeding the troll.
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  - NeoConBushSupporter, 19 Sep 2008 @ 10:38am
    
    Re: Re: I KNEW IT
    "Mike, I don't think anyone would be offended if made a "no trolling" rule, especially for repeat offenders, especially if a good chunk of a comment thread goes to feeding the troll."
    
    I think someones a grumpy hedge-fund manager whos had a few rough days . . . those credit default swaps would put anyone in a bad mood.
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  - Anonymous Coward, 19 Sep 2008 @ 6:29pm
    
    Re: Re: I KNEW IT
    I may not agree with what you say, but I will fight and die for your right to say it.
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Ima Fish, 19 Sep 2008 @ 8:40am

This is related to the problem of drivers trusting their satellite navigation systems more than their own eyes and common sense:

AN ambulance took almost 90 minutes to collect a girl and take her to hospital 10 minutes away after satellite navigation blunders.

The crew was misdirected by the equipment to the wrong street, eventually reaching road crash victim Chloe Banks after 32 minutes.

Chloe, 10, kept asking her mum "Am I going to die?" as she waited.

The ambulance spent 14 minutes at the scene. The crew then took 40 minutes to reach the hospital 10 minutes away after its satnav system sent it through villages instead of by the main road.

Since a road closure, dozens of drivers have blithely followed directions from their satellite navigation systems, not realising that the recommended route goes through the ford.

Normally the water — the start of the River Avon — is about 2ft deep but it can swiftly double in depth after heavy rain.

Every day since the main B4040 was closed after a wall collapsed on April 8 one or two motorists have been towed out, having either failed to notice or ignored warning signs. Some farmers have been charging £25 to give a tow with tractors.

My generation (40 years old) grew up with a sense of mistrust of technology. I'm really worried about people growing up without that mistrust. I mean, who in their right mind would drive into a river because a computer told them to?!
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- Hulser, 19 Sep 2008 @ 10:35am
  
  Re:
  My generation (40 years old) grew up with a sense of mistrust of technology. I'm really worried about people growing up without that mistrust. I mean, who in their right mind would drive into a river because a computer told them to?!
  
  I've actually found the opposite to be true. The older you are, the more likely you are to have a blind faith in the accuracy of computers. To use your example, I wonder what the average age of the drivers they had to tow out of the Avon River? I'm guessing that it wasn't a bunch of teenagers.
  
  My friends and family jokingly say "It must be true because I read it on the Internet", but the reason that it's funny is because people give more credence to information if it's in printed form, even if it's on a blog or a regular web site. And I think this phenomenon is more prevalent the older you are. If you grew up where anything printed was in books and newspapers, you probably had an inbuilt assumption about the accuracy of that information. But the younger you are, I think the more likely you are to view information, printed or otherwise, with a critical eye.
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Anonymous Coward, 19 Sep 2008 @ 9:06am

If you put bad data in to begin with, it doesn't matter if computers make mistakes. The program could run flawlessly and you will still get bad data out in the end.
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Dave (profile), 19 Sep 2008 @ 9:11am

Grabage is the foundation of our monetary system.
Do you really think it is that hard to predict a financial crisis when unelected foreigners control the flow of money; making it tight and creating unemployment or printing more and giving it to select few - creating inflation?

I am not saying I could come up with a system that works better, but at the very least shouldn't we be thinking of a new open monetary system so that the power to control the value of currency is a function of the people who use it?
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- hegemon13, 19 Sep 2008 @ 9:20am
  
  Re: Grabage is the foundation of our monetary system.
  Errr, interesting idea, but it has nothing to do with our current financial crisis.
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  - Dave (profile), 19 Sep 2008 @ 9:35am
    
    Re: Re: Grabage is the foundation of our monetary system.
    @hegemon13
    
    The current financial crisis has everything to do with market participants inability of coming together to determine a market interest rate. This interest rate is set by foreigners (and some domestic) running the Federal Reserve System.
    
    The Fed's actions in setting the federal funds rate is central economic planing, because it reflects the price of money to a borrower and thus affects demand for money, affecting prices throughout the economy in a manner less pervasive but just as damaging as direct price controls.
    
    If you look at low interest rates and think its a good time to buy a house, you are being mislead. These interest rates are not set by the market. It is being used to manipulate the markets so that knee-jerk reactions will be used to enhance power to the Fed.
    
    You have been warned.
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    - Kiba, 19 Sep 2008 @ 10:12am
      
      Re: Re: Re: Grabage is the foundation of our monetary system.
      We should let these investors die and also kill the feds from regulating the money supply.
      
      And make the feds pay their debt.
      
      At the very least, the damage is localized to investors of a country instead of the whole country(the taxpayers).
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Anonymous Coward, 19 Sep 2008 @ 9:41am

Good data or bad, it's difficult to see how this wasn't planned. Just like the creation of the Federal Reserve was planned and pushed through congress over Christmas Break. Now McCain is spreading the populist gospel after getting support from a member of the Rothschild banking family earlier this week. The Government always gets what it pays for, but people are distracted- running around saying the market is up! The market is up! But the reason it's up is because the dollar has been devaluated on a global scale. Every dollar we spend is a dollar we don't have and eventually, the debts will come due, and unfortunately it won't be our generation that looses and is enslaved as a result of these errors, but our children's and grandchildren's.

Isn't it amazing how easy a focused goal of wiping out the middle class can be accomplished within 8 years?
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Kilgore Trout, 19 Sep 2008 @ 10:01am

What a system
Privatized profits, and socialized losses. Gotta love America.
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- Anonymous Coward, 19 Sep 2008 @ 10:05am
  
  Re: What a system
  Could be worse. Could be socialized profits and privatized losses.
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  - John Maynard Keynes, 19 Sep 2008 @ 11:08am
    
    Re: Re: What a system
    Why would that be worse????
    
    Socialized profits for stuff like Medicaid, social housing to the poor, free high level education, and what not, versus private greedy individuals taking losses. Sounds like a Swedish system, or even Cuban system. There are a lot and growing number of US citizens that will be needing this. Where is the US moral and ethical responsibility for it's own people??? Gone with US corporate greed and to hell with the poor of the US.
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Edgardo, 19 Sep 2008 @ 10:03am

Isn't that an old Issac Asimov story? Multivac, a super computer, made all the decisions for humans. But in the end it was revealed that the human operators were all "adjusting" the inputs to get the result they were biased for.
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Jon Avinir, 19 Sep 2008 @ 10:57am

What do you think?
What do you think about all of these massive bailouts? Do you think that the moral hazard of doing the bailout mean that as soon as this hole is filled folks from the remaining institutions will start digging the next hole?

Does anyone know how hedge funds have faired? Were they hit more or less? Is this a concentrated problem or are all institutions exposed?
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- Heidi Brennan, 19 Sep 2008 @ 4:11pm
  
  Re: What do you think?
  There are a lot of important and risky policy decisions that will be made in the next couple of years that will have a generational impact on the way the economy runs. Traditional approaches of political constituent pleasing will fail to address important parts of the solution as the answer requires both regulation improvements and good free market thinking with an appreciation of how the intellectual capital of the business world improves life for most people.
  
  Acknowledgment of the power and imperfection of free markets is required, and some well designed friction is needed to prevent the system from spinning itself apart because it builds too much momentum. Most mechanisms have failure modes due to positive feedback leading to a runaway condition, and the solution is frictional - counter cyclic regulation in economic terms.
  
  Do note, the risk of declining capital margins through wholesale deflation of collateral is a general problem and is capable of destroying the patterns of activity that have been built over the last 50 years. Since much of the value of firms and the prosperity we enjoy is the dividend from these processes, we should be very concerned about the broader impact.
  
  Everybody will pay to some degree, whether through higher costs, reduced wealth or reduced labor income. The real questions is whether there is widespread job loss, as that will lead to a real loss in world economic welfare - as work is the source of prosperity - rather than a widespread but manageable redistribution of consumption away from luxuries to necessities. I suspect the US will pay more than most, since we bear the most of the burden of inflating away and/or paying down the debts that were incurred and replenishing the capital lost. That is on top of the war costs of the last 5 years. I suspect a connection, as something similar happened in the late 60 and early 70's, but the connection between war and runaway credit expansion in the 2000's will need to be explored by historians.
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Grammar Police, 19 Sep 2008 @ 11:36am

Data
...even though the data are bad. ;)
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FiscallyAccountableObamaSupporter, 19 Sep 2008 @ 11:46am

I KNEW IT
Look supply-side, deregulated capitalism has clearly failed, we all know that. The Reagan revolution created an economy so weak and corrupt that there was no place in it for the middle class and none of the supper wealthy/mega corporations wealth TRICKLED DOWN to us. It was simply the Clinton era that stayed off the inevitable current collapse.

VOTE Obama 2008 - The economics of failure have failed, together we can make them work again
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- Dave (profile), 19 Sep 2008 @ 12:09pm
  
  Re: I KNEW IT
  Let me clue in as to what Clinton actually did since your party affiliation is clearly covering ur eyes. Clinton stood idle while Greenspan manipulated the interest rates, the price of money to a borrower, such that everyones dream of owning a home could be fulfilled. And Obama will do the same when the Fed makes `affordable health care` I.E creating money from nothing.
  The problem is that money doesn't grow on trees and when money comes from nothing it dilutes the value of everyone else's money. Once you realize this, things might make more sense...
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  - J King, 19 Sep 2008 @ 12:54pm
    
    Re: Re: I KNEW IT
    "when money comes from nothing" - You don't seem to understand. Money IS nothing, except a counter for empty promises. Our entire economy and our entire monetary system is built on nothing but promises and counters for promises. Money has not had a definable fixed value in goods or services for many decades. Stocks are shares in a company, but their so-called value is based only on the number of counters some speculator (gambler) thinks he can get some idiot to pay for them, not on the value of the material assets that the company owns nor on the stream of income that the company actually generates. Only when money has a fixed value tied to person-hours of labor, and stock value is tied to profits actually generated by a company's production of goods and services, will the economy be both stable and fair. The financial system is "built on trust" because it is simply a house of cards constructed of empty promises and deals made to skim value from people who actually work.
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  - Phil GrahamGramm, 19 Sep 2008 @ 4:35pm
    
    Re: Re: I KNEW IT
    Yes, I agree one hundred percent with your assessmant.
    
    Oh, and wikipedia is full of lies.
    http://en.wikipedia.org/wiki/Phil_Gramm
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- Anonymous Coward, 19 Sep 2008 @ 6:41pm
  
  Re: I KNEW IT
  Nice line rip. :-p
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another mike, 19 Sep 2008 @ 11:50am

how's that old quote go
a computer is an electronic appliance which assists a person in making mathematical errors at very high speed.
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Johan Vega, 19 Sep 2008 @ 12:07pm

Insurance swaps
A problem with insurance swaps is that they are generally illiquid. One thing we can do is pray that we don't see a costly natural disaster in the upcoming years. It would spell certain disaster for the US banking system.
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FiscallyAccountableObamaSupporter, 19 Sep 2008 @ 12:38pm

I KNEW IT
Really.......

So it had nothing to with McCains Financial advisor Phil Gram's & his "Commodity Futures Modernization Act" of 2000?
http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html
The same guy who said this is a "mental recession" & "the US is a nation of whinners"

Oh yea.... sign me up for that... now who's got the blinders on?
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- Call the Press, 19 Sep 2008 @ 12:53pm
  
  Re: I KNEW IT
  >>So it had nothing to with McCains Financial advisor
  >>Phil Gram's & his "Commodity Futures Modernization Act"
  >> of 2000?
  >> http://www.motherjones.com/news/feature/2008/07/foreclosure-phil.html
  >> The same guy who said this is a "mental recession" &
  >>"the US is a nation of whinners"
  
  HOLY CRAP!!! THAT SHOULD BE ON THE NEWS!!!
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- Dave (profile), 19 Sep 2008 @ 1:03pm
  
  Re: I KNEW IT
  I'm not saying one party is better than the other. I am saying they are both working against what is right. Freedom is what is right and both parties think you and me are too weak to make decisions for our selfs.
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  - World valuation of freedom's pricetag, 19 Sep 2008 @ 1:52pm
    
    Re: Re: I KNEW IT
    After 9/11, remember the bumper-sticker everyone put on their car? "Freedom Isn't Free"??
    
    (Dr. Evil Voice) We hold the world ransom for $1,000,000,000,000.00!! Muhahaha!
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- John McShame, 19 Sep 2008 @ 1:45pm
  
  Re: I KNEW IT
  Well, in some positive news, Gram's baby was castrated yesterday. H.R. 6604, "The Commodity Markets Transparency and Accountability Act of 2008", passed and it's on the way to the Senate.
  
  http://thomas.loc.gov/cgi-bin/bdquery/z?d110:H.R.6604:
  
  How does a blowhard like Gram get into office?
  http://www.salon.com/tech/htww/2008/05/29/treasury_secretary_gramm/
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Anonymous Coward, 19 Sep 2008 @ 12:43pm

Clancy Predicts....
That reminds me of a Tom Clancy book.
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Anonymous Coward, 19 Sep 2008 @ 1:30pm

by Dave - Sep 19th, 2008 @ 1:03pm
"I'm not saying one party is better than the other. I am saying they are both working against what is right. Freedom is what is right and both parties think you and me are too weak to make decisions for our selfs."

No... what you were trying to say is that somehow Clinton who was president nearly a decade ago was responsible for our current economic situation which if you read the Phil Gramm article is clearly false.

Not that I am all "Oh Clinton is the greatest!"... Let me give you a tip.... if I were going to attack Clinton.. I would bring up his "not so fair trade with China" agreements.

I do agree with you though... that neither party really represents the majority of Americans. Although I'm going to be voting for Obama, I can't stand his anti gun position.

The fact is though... I'm not going to let a wedge issue make me vote for the wrong candidate/McCain. Where's my third choice?
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Dan, 19 Sep 2008 @ 11:19pm

Con game
All the financial wonks are saying, its all about confidence in the markets. Damn right it is. Wall street has been has been building this house of cards for a long time and it got tall enough for the first breeze to blow it over like a tent in Galveston. Now the government has replaced the golden parachutes with platinum and we get the bill along with our great grand children.
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RD, 20 Sep 2008 @ 5:58am

There are only 4 things certain in life
There are only 4 things certain in life - death, taxes, stupidity and greed. And almost all of human suffering flows from the last 2 in many ways. Thanks, human race, you are proving to be asshats of the highest order.
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exitstageleft, 20 Sep 2008 @ 5:29pm

no mistakes
"Even when people know that computers make mistakes,"

Computers don't make mistakes.
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Deja Vu, 21 Sep 2008 @ 3:01pm

Follow the money
I'd like to know where all the money went.

I've read that the investment bankers and those that rate the instuments have made millions ... why is no one being prosecuted ? Where is the inquiry ? There has been a rather large breach of the established law ........

Your congress critters (republicans) removed safe guards put in place after the great depression, look what happened as a result.

Oh crap, they will get away with it again. wtf
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