
After the Crash: How Software Models Doomed the Markets - prakash
http://www.sciam.com/article.cfm?id=after-the-crash&print=true
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mixmax
A friend of mine does financial software modelling that is used in a number of
major banks. According to him these models have predicted a major crash for
the last couple of years. They weren't able to see when the crash would occur,
but they could see that certain relationships such as household
income/mortgage payments were diverging further and further from a historical
mean.

~~~
pasbesoin
Just observing the property value increases in my area made me nervous. I
could observe no inherent basis for their magnitude. Housing was experiencing
a surge not reflected in the broader economy; it was feeding upon itself. The
penultimate "house of cards".

There was no sustaining model for the demand. The population wasn't increasing
that rapidly, and people's productivity (or earnings) wasn't rising in a
fashion to enable them to afford to occupy an ever increasing quantity of
living space.

~~~
allenbrunson
nitpick: the word "penultimate" means "next to last."

~~~
pasbesoin
Thanks. Guess I'm getting a bit sloppy in my phrasing.

Or maybe it was my subconscious? If so, I'm not sure I want to know / learn
what is the ultimate house of cards. The current one is already proving
challenging enough for me. ;-)

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jerf
The more I learn about this crisis, the more I am convinced it all came down
to one thing, and one thing alone: leverage.

Now, the situation is obviously complicated and can't be pinned down to one
factor like that, so let me be clear: I'm not saying that one fact explains
every last detail about the crisis. What I _am_ saying is that the grotesque
overleverage we saw was sufficient to cause _a_ crisis. Exactly how it
manifested depended on computer models and dumb loans and all the other little
details. But the situation where banks and large financial entities were
leveraging 30x meant that a crisis of this type was inevitable; the only
question was the details.

When you set up a scenario such that any 3% drop in asset value has driven you
bankrupt and 4% means you're in horrific debt, you have _already lost_. How
exactly this loss manifests, and how many smart people there are with
computers trying to put off the day of reckoning there are hardly matters;
epic failure (and I mean that in the original sense, not the meme sense) is
inevitable.

Did the geeks tell the banks to overleverage? Quite possibly. If so, then yell
at them too. This article doesn't support that claim, though. (In fact it's
very vague in general.)

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sh1mmer
There was an article on HN a month or so I can't find a link to which
discussed how a number of major banks didn't properly update their models to
knowingly take greater risks. It explored how a number of banks were using
outdated models to allow them to bundle risks to create short-term profits at
increased risk without upsetting the feds.

So, sure, the models were wrong but was the reason the inability of the
modelers?

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run4yourlives
Seriously? Any chimp with half a brain - including me - saw a crash coming. I
didn't need software models, and I may have been unable to pinpoint it, but
all you had to do was use a little common sense.

When you're pretty confident that you're making market - more or less - and
yet you can't possibly understand how your peers afford $500K houses and 2
$40K cars, the writing is on the wall.

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lutorm
I bet Nicholas Nassim Taleb is getting a lot of calls these days... Seems his
criticisms of economic quantitative modeling have been vindicated more than he
probably wished to see.

