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 FORUMS > Economics Forum < refresh >
 Topic Title: It's a structural crisis Created On Fri Feb 27, 09 05:49 PM Topic View: Branch View Threaded (All Messages) Threaded (Single Messages) Linear

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torontosimpleguy
Senior Member

Posts: 1010
Joined: Jul 2004

Fri Feb 27, 09 05:49 PM

Though I am currently much more concerned with my personal situation of job search I will take few minutes to explain people here (an perhaps few ones outside) my view on the magnitude and intractability of modern financial crisis.

As Chairman Bernanke recently said to Congress the lending process in the US is provided half through commercial banks' credit and half through securitization (read CDOs).

I repeat: half of credit is coming through securitization channel. And it is this half that creates the most difficult problem. As was pointed out recently, the core of CDOs pricing is performed based on David Li's formula, which allowed a huge expansion of securitized products. And now his model is considered to be corrupt in the sense that model doesn't match the market reality.

So, we are in a very difficult situation. The credit market is not functioning (since securitized products can't be priced reliably anymore), we can't go back to pre-securitization stage (it's like going to pre-computer stage after you computerized the whole country), and we can't go forward (since Gaussian copula is not trusted anymore). Such situation is called "zugzwang" in chess -- any move will only impair the situation.

Objectively speaking, it looks like a "Chinese sabotage." Chinese guy came to America, and gave Americans nice formula. "Stupid" Americans used it and created a whole bunch of financial products, which eventually failed. And they don't know how to fix the situation now (and Chinese guy is now back to China where he works for Chinese government currently). Of course I don't believe that it had been done deliberately. But one can see here the hand of Providence to destroy the American Empire. And another one can say that we have a big theoretical challenge ahead of us to solve the situation.

P.S. Actually you can't say that it's the David Li's approach that failed. He just took CreditMetrics empirical approach, generalized it and formalized it from the mathematical point of view.

P.P.S. Former Chairman Volcker was calling to copy the Canadian oligopoly approach (where 5 banks control the whole country). I don't think it will help here. It will stiffen the financial system and just cause the world economic stagnation IMHO.

Cuchulainn
Senior Member

Posts: 29265
Joined: Jul 2004

Fri Feb 27, 09 11:05 PM

Quote

As was pointed out recently, the core of CDOs pricing is performed based on David Li's formula, which allowed a huge expansion of securitized products. And now his model is considered to be corrupt in the sense that model doesn't match the market reality.

Look at/examine the *political* climate at the time that led to the circumstances that enabled CDOs to come into existence. If you don't have a suitable incubator your formula will never come into existence.

-------------------------
www.datasimfinancial.com

Edited: Sat Feb 28, 09 at 06:57 AM by Cuchulainn

list
Senior Member

Posts: 2034
Joined: Oct 2005

Sat Feb 28, 09 01:06 AM

What do you think? For instance hypothetically assume that there is no CDO in the market and also another trouble like CDS has not been invented. Do you sure that we do not observe the Crisis? Though it looks premature to consider conditionals like what will be if …
I heard to day a quite profound comment on the radio unfortunately I did not hear the beginning. The thought was that people institutions and banks will not spend the additional money they will hide them. In 2-3 years when the real economy will start to recover all accumulations will over flood the market that will lead us to huge inflation. It sounds pretty much reasonable.
For a current moment while  still grows and correspondingly others weakening and there is no other good real news then one could patiently wait inverse movement that actually could be more sharp. Then… people probably will begin to talk about other financial problems and forget about structuring at all. Now the subprime problems completely disappeared from discussions. More actual is to talk about regulations. I am curious about what a reasonable world class solution could one expect from the person who could not note the approaching Lehman troubles? One of the modern regulation problems that people who make a decisions are match for the plain periods of economic development and looks rather inexperienced in the current period.

ppauper
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Sat Feb 28, 09 03:33 PM

torontosimpleguy
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Posts: 1010
Joined: Jul 2004

Sat Feb 28, 09 09:24 PM

Quote

Originally posted by: Cuchulainn
Quote

As was pointed out recently, the core of CDOs pricing is performed based on David Li's formula, which allowed a huge expansion of securitized products. And now his model is considered to be corrupt in the sense that model doesn't match the market reality.

Look at/examine the *political* climate at the time that led to the circumstances that enabled CDOs to come into existence. If you don't have a suitable incubator your formula will never come into existence.

Cuchulainn, why did you delete your question? But I will answer it.

Since David Li used CreditMetrics approach here comes two outcomes,

1. One can't blame him for losses because it's not purely "his" model.

2. It explains why industry easily adopted "his" model.

torontosimpleguy
Senior Member

Posts: 1010
Joined: Jul 2004

Sat Feb 28, 09 09:31 PM

Quote

Originally posted by: list
What do you think? For instance hypothetically assume that there is no CDO in the market and also another trouble like CDS has not been invented. Do you sure that we do not observe the Crisis?

I guess that crisis would be less severe.
Quote

Now the subprime problems completely disappeared from discussions.

Actually it's the same problem of wrongful pricing of CDOs (read Gaussian copula).
Quote

I am curious about what a reasonable world class solution could one expect from the person who could not note the approaching Lehman troubles?

People made billions on their proper understanding of economic situation. Why would one with "knowledge" give it away for free? I personally probably wouldn't ...

Senior Member

Posts: 14043
Joined: Sep 2002

Sat Feb 28, 09 10:49 PM

Quote

Originally posted by: torontosimpleguy
Quote

Originally posted by: list
What do you think? For instance hypothetically assume that there is no CDO in the market and also another trouble like CDS has not been invented. Do you sure that we do not observe the Crisis?

I guess that crisis would be less severe.
That's not clear to me at all.

Yes, CDOs did facilitate a lot of the flows of capital into subprime mortgages in the US, but can CDOs explain all that has happened such as the bankruptcy of Iceland, the housing bubble in many parts of Europe, or excessive lending of fx-rate adjustable debt to subprime countries in the Eastern/Central Europe? Nor do CDOs or any other type of magical mathematical incantations explain the asset bubbles of the dotcom era, the Japanese real estate bubble, or the roaring 20s, etc.. I see CDOs as proximate causes, not ultimate causes. Even if Li had never created the copula equations, some clever folk would have crafted some form of nifty debt/equity structure for pooling mortgages and selling that. No doubt we'd have seen some form of REITs, SPACs, or HF entities.

All we need for a good asset bubble is a mechanism for leverage and enough years of steady price appreciation to convince everyone that prices can only up. Erroneous equations such as Gaussian copula are neither necessary nor sufficient to cause global financial crises.

-------------------------
"It often happens that a player carries out a deep and complicated calculation, but fails to spot something elementary right at the first move." -- grandmaster Alexander Kotov --inscribed on gift chess sets given by Amaranth hedge fund.

Edited: Sat Feb 28, 09 at 10:50 PM by Traden4Alpha

penguina
Member

Posts: 174
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Sun Mar 01, 09 02:42 AM

Quote

All we need for a good asset bubble is a mechanism for leverage and enough years of steady price appreciation to convince everyone that prices can only up. Erroneous equations such as Gaussian copula are neither necessary nor sufficient to cause global financial crises.

fully agree. This crisis is caused by too much leverage.

The precise mechanisms are irrelevant - next time there will be different mechanisms but the underlying cause (over leverage) will be the same. Anyone who has any knowledge of financial history should know this. I don't understand why this is so hard for people to understand.

Cuchulainn
Senior Member

Posts: 29265
Joined: Jul 2004

Sun Mar 01, 09 12:38 PM

Quote

Originally posted by: torontosimpleguy
Quote

Originally posted by: Cuchulainn
Quote

As was pointed out recently, the core of CDOs pricing is performed based on David Li's formula, which allowed a huge expansion of securitized products. And now his model is considered to be corrupt in the sense that model doesn't match the market reality.

Look at/examine the *political* climate at the time that led to the circumstances that enabled CDOs to come into existence. If you don't have a suitable incubator your formula will never come into existence.

Cuchulainn, why did you delete your question? But I will answer it.

Since David Li used CreditMetrics approach here comes two outcomes,

1. One can't blame him for losses because it's not purely "his" model.

2. It explains why industry easily adopted "his" model.

1 and 2 are clear; but that was not my point. How did it get so far to enable such models to be accepted in the first place?

-------------------------
www.datasimfinancial.com

list
Senior Member

Posts: 2034
Joined: Oct 2005

Sun Mar 01, 09 01:31 PM

The first law of the financial business: you paid for what you are said. That means that you are paid in order to make money your Company or others. The problem of weather it is good or bad, correct or not is the second or lower kind of problems. If you have another approach you can wait. It might be your turn comes out.
CDO looks rather the way how internal problems came into surface. The underlying main problem is the wish to increase capitalization institutions or countries by using derivatives. I also think that CDS spread is the very important characteristic though I think that its value should be converted say into a linear decreasing function. The losses at the beginning are more painful than at the end.
The money from this market sooner or later begins to leak out into other markets. And the prices will grow up for some saturated period then will drop down. And cycle will be repeated again. A technical problem is globalization of the underlying. Companies and countries have used the same underlying securities. Though Crisis first appeared in US the particular place of the US is that its huge debt is hold by others which should be found the way to facilitate its dependence from US debt but as 0onehas seen do not find the appropriate way. As a conclusion all other countries began to use their accumulations.

katastrofa
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Posts: 1471
Joined: Aug 2007

Sun Mar 01, 09 07:09 PM

Quote

Quote

or excessive lending of fx-rate adjustable debt to subprime countries in the Eastern/Central Europe?.

I doubt that any Polish bank ever bought a single bespoke CDO tranche.

Fermion
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Posts: 4488
Joined: Nov 2002

Mon Mar 02, 09 04:04 AM

Quote

Originally posted by: penguina
Quote

All we need for a good asset bubble is a mechanism for leverage and enough years of steady price appreciation to convince everyone that prices can only up. Erroneous equations such as Gaussian copula are neither necessary nor sufficient to cause global financial crises.

fully agree. This crisis is caused by too much leverage.

And too much over-capitalisation in few hands. When those who are over-capitalised andover-leveraged and all making the same bets like sheep, why would anyone expect anything other than a short period of glorious market manipulation with big bonusses for a few followed by social disaster.

Martinghoul
Senior Member

Posts: 2449
Joined: Jul 2006

Mon Mar 02, 09 10:38 AM

Slightly off-topic, but here's a scary take on this by Stephen King (the economist, who's increasingly starting to sound like his more famous namesake):

Stephen King: As capitalism stares into the abyss...

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"Insofar as I may be heard by anything, which may or may not care what I say, I ask, if it matters, that you be forgiven for anything you may have done or failed to do which requires forgiveness."

exneratunrisk
Senior Member

Posts: 2728
Joined: Apr 2004

Mon Mar 02, 09 10:40 AM

Yes it is IMO.
Take the balance sheet of the "world corporation".
a) If the passive side of the balance sheet is growing exponentially and there are not enough (innovative) ideas (active side), the world corp needs to start risky developments and/or transactions?
(If risky transactions are, say, risky credits, the system desperately searches for risk distribution. CDOs (and alike) are designed as kind of bulletproof vests . Market participants, thinking they are invincible, move into the most chaotic core of the battle).
b) if there are innovative ideas (paradigm shifts, ..) and they grow exponentially (the innovative spiral), but the passive side is not able/does not want to serve them immediately, a bubble might be created by focussing (dot-com).

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Our news and views: UnRisk Insight

Paul
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Mon Mar 02, 09 11:32 AM

Anyone here going on the demonstrations starting April, and the May Day one?

P

penguina
Member

Posts: 174
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Mon Mar 02, 09 11:45 AM

I'm considering it but fear it will be dominated by the usual socialist fools

Vegawizard
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Posts: 157
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Mon Mar 02, 09 11:55 AM

There seems to be a continual witch hunt to pin blame for the crises over the years on someone or some group, and typically end up lynching the messenger.
1929 was the bucket shops & brokerage houses offering excessive leverage. 1987 was "futures" and portfolio insurance programs run by rubinstein & others that "caused" the crash.
This time round it is either the greedy banks originating low quality loans, packaging them up, slicing and dicing with CDO's CDO^2's, throw in a CDS & get a AAA rating. - Li's copula & Credit rating agency's lack of understanding what they were rating and using inappropriate assumptions in an inappropriate model.

Hang on a moment, what about the creation of excess liquidity from the late 90's - Starting from the asian contagion, LTCM debacle, .com bust, 9/11, each time the market was not allowed to have a healthy & natural correction because Greenspan did not want another market correction on his watch (he assumed the position of chairman of Fed shortly before '87 crash), and Gordy Brown had already discovered the holy grail of "No more Boom & Bust" These clowns provided too much liquidity to the system in the first place. The (capitalist) free market simply did its job trying to find the best use for this excess liquidity - the housing market, as Equity was overpriced - consider long term PE ratios!, credit spreads were already at historic lows, so the last option was relatively safe & secure property.

Sure the whole thing was overdone, but was it the "fault" of quants using poor models & assumptions, was it regulators asleep on the job, excessive bonus's for originating toxic waste loans (subprime) - well I guess they all played a part, AFTER the central bankers provided the catalyst of excessive liquidity.

Was this provision of excessive liquidity for a fundamentally sound reason, or for political / ego purposes that there will not be a market downturn on their watch?

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I would rather have a bottle in front of me than a frontal lobotomy

Edited: Mon Mar 02, 09 at 12:07 PM by Vegawizard

penguina
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Posts: 174
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Mon Mar 02, 09 12:01 PM

@Vegawizard: I agree and they're trying the same thing again now. There is no political leadership anymore, just timidity. They do not have the will to stop taking the easy route of ever more ad hoc bailouts and pouring ever more money down the financial black hole. There is no political will to take the necessary painful and radical action. This can only end one way - catastrophically.

VIGO
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Mon Mar 02, 09 12:07 PM

Quote

Originally posted by: Paul
Anyone here going on the demonstrations starting April, and the May Day one?

P

Wrong forum - created social_unrest forum - long time ago i saw this one coming!!

exneratunrisk
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Posts: 2728
Joined: Apr 2004

Mon Mar 02, 09 05:16 PM

Quote

Originally posted by: Paul
Anyone here going on the demonstrations starting April, and the May Day one?

P

When I get my Yohji Yamamoto-designed

Can'T
Calculate
Hero

T-shirt in time.

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