Niall Ferguson [Laurence A. Tisch Professor of History at Harvard University and a Senior Fellow of the Hoover Institution at Stanford, and the author of The War of the World: Twentieth-Century Conflict and the Descent of the West.] offers analysis and conclusions on the world of financial services, and the historic lead up to the current financial crisis.
Wall Street Lays Another Egg | Vanity Fair
The author charts the emergence of an abstract, even absurd world—call it Planet Finance—where mathematical models ignored both history and human nature, and value had no meaning.
Its a long piece and worth the read for those interested. He speaks of systemic issues and highlights one in particular – the obscure world of derivatives, which amount to over $400 trillion around the world. This amount is significant, when compared to world GDP of $49 trillion, or the combined stock markets’ value of $51 trillion. [note: 1 trillion = 1,000 billion]
All this to display the runaway value in a financial market that surprisingly few understand, and which is hidden behind a complex mathematical formula developed in the late 90’s. The results of this formula drove the derivatives market. 
The result of the belief in this formula, developed by Nobel prize winners, was as Ferguson goes on, that normal lending practices and risk assessment were replaced by computer models based on the formula. Thus we saw securitized sub-prime mortgages magically transitioned into AA commercial paper, and sold off around the world.
If ever there was a time to bring back transparency of information between borrowers and lenders, that time has come. While mathematics will always play a part, the relationship between lenders and borrowers is more than mathematics.
For borrowers transparency allows them to be assessed on their merits, and the right balance of information about them. For lenders transparency offers the insight and information to get back to basic risk assessment, and to provide appropriate to the right borrowers.
2 responses so far ↓
Alan // November 11, 2008 at 6:20 pm |
Agree wholeheartedly.
A system that has allowed borrowers who cannot qualify for a regular $250K mortgage despite proof of income and some savings and a good credit record, but that _does_ allow them to get a $500K junk mortgage without much supporting evidence is clearly way out of kilter. This has only benefitted lending agents. They have pocketed their money and run.
An inherent fault at investment banks is that the lending officers are given bonuses based on their volume of activity. They are motivated to move money out. The risk assessment officers are not rewarded for preventing bad loans. Indeed they are reviled by the lending side as being obstacles to their bonuses. Until a sane system is established to balance risks, the investment banking world is doomed to repeat the past.
The basic problem is that while some amount of greed is good, unfettered greed is bad.
Unfettered greed is unstable. Case in point: While GM, Ford and Chrysler suffer at present due to a lack of smaller, efficient vehicles to sell, the big oil co’s are reaping unheard of profits. What is ironic is that it has always been big oil and the big three who blocked all efforts to tighten up CAFE rules over the past 2+ decades. Adding insult to injury, where the big three only developed electric and hybrid vehicles under subsidies (and the Japanese were locked out of those subsidies, of course) it scared the Japanese into action. They built the Insight and the Prius. GM abandoned its electric vehicle as soon as the subsidy ran out – they recalled all the leased cars (none were sold) and scrapped them.
Of course Toyota has been eating Detroit’s lunch ever since.
Unfettered greed is what has gotten Detroit and investment banks into the mud. And this is due to political influence of oil and Detroit to the detriment of shareholders, workers and American consumers.
Some effective and enforced regulation is always needed. It stabilizes at a minor cost to efficiency. (much like the vertical and horizontal stabilizers on an aircraft. They create drag and thereby cost fuel, but they are required for stability).
Hedge funds have proven what has always been suspected. In turbulent times they cannot be stable. Hedge fund managers have wanted to be free of oversight and rules since their inception. Recent times show that (like everything in the past) they must be regulated or they will become unstable.
Greed = good.
Unfettered greed = bad.
Not only do financiers and governments need to accept and enforce the notions of reasonable regulation, oversight and enforcement they need to adopt it as absolutely necessary to long term stability and growth. And in 20 or 30 years when the next class of rocket scientists come along and declare that the latest investment/financial tool is infallible and perfectly safe, they should be forced to write an essay beginning with tulip bulb markets right through to the present. That or bullwhipping. I have to think about it.
Colin // November 12, 2008 at 6:10 am |
@Alan … terrific comment!! Thanks.