"The recent financial crisis was an accident, a “perfect storm” fueled by an unforeseeable confluence of events that unfortunately combined to bring down the global financial systems. And policy makers? They did everything they could, given their limited authority. It was all a terrible, unavoidable accident. Or at least this is the story told and retold by a chorus of luminaries that includes Timothy Geithner, Henry Paulson, Robert Rubin, Ben Bernanke, and Alan Greenspan.

In Guardians of Finance, economists James Barth, Gerard Caprio, and Ross Levine argue that the financial meltdown of 2007 to 2009 was no accident; it was negligent homicide. They show that senior regulatory officials around the world knew or should have known that their policies were destabilizing the global financial system, had years to process the evidence that risks were rising, had the authority to change their policies--and yet chose not to act until the crisis had fully emerged.

The current system, the authors write, is simply not designed to make policy choices on behalf of the public. It is virtually impossible for the public and its elected officials to obtain informed and impartial assessment of financial regulation and to hold regulators accountable. Barth, Caprio, and Levine propose a reform to counter this systemic failure: the establishment of a “Sentinel” to provide an informed, expert, and independent assessment of financial regulation. Its sole power would be to demand information and to evaluate it from the perspective of the public--rather than that of the financial industry, the regulators, or politicians."

--- I quite fail to see how this would solve the problem.

"We show how text from news articles can be used to predict intraday price movements of financial assets using support vector machines. Multiple kernel learning is used to combine equity returns with text as predictive features to increase classification performance and we develop an analytic center cutting plane method to solve the kernel learning problem efficiently. We observe that while the direction of returns is not predictable using either text or returns, their size is, with text features producing significantly better performance than historical returns alone."

Interesting as a case study in economic sociology, though none of the participants seem to be equipped to recognize this.
(Predictably, the comments section is full of hurt bitcoin boosters.)

I find this rather plausible: "rapid economic growth in China is creating the largest pool of suckers the world has ever seen. Real world individuals exhibit bounded rationality, and lots of Chinese people who may have been extremely smart at getting rich in China’s industrial revolution may be quite foolish about their decisionmaking regarding complicated western financial products. American rich people are much better-positioned than Chinese rich people to avoid getting ripped off, and yet a large number of people were taken in by Bernie Madoff’s rather crude fraud. China is a treasure trove of potential marks and Pharo is getting in on the game."  (It also echoes some of the opening remarks in Maurer's _The Big Con_ on where the golden age of American con artists came from.  [Everyone should read _The Big Con_.])

It says something that a man who was taking these insane risks, and engaging in massive deceptions to take these risks, is admitted even by the prosecutors to have NOT personally profited from it (beyond the usual bonuses, presumably), but rather left all the money with the organization. Now THAT is social control.

Indeed.

bruces says it well.

It is good to hang a banker from the lamp-posts in lower Manhattan from time to time, to encourage the others.

Krugman elaborates on the idea of a naturally-occurring Ponzi process. I smell a model...

Annals of financial innovation, 1920s American real-estate edition. (Note to self: Was this a direct precursor of the gov't-established secondary mortgage market? Should re-read Carruthers & Stinchcombe.) Also: more support for Galbraith's contention that there is really hard anything new in any bubble.

17th century Netherlands edition.

Color me skeptical about the recommendations (as reported in the blurb).

Shorter Krugman: the point of financial markets is not to make money. (However, I have enough residual Marxism left to suspect that framing the issue as one of "bad actors" is at least an _analytical_ mistake. The Marxist argument was that the problem with capitalism wasn't that capitalists were greedy swine; it was that the way capitalism organizes production and exchange forces capitalists to act like greedy swine, on pain of being replaced. Similarly here; put anyone in those positions and they'll act similarly. Fortunately Krugman calls for regulation rather than moral uplift.)

OK, maybe I'm missing something obvious, but what I don't get is how this buying of futures is supposed to produce a surge in the spot price, without physical hoarding/storage.

When I was growing up, I hoped to live in an Arthur C. Clarke novel. Unfortunately we seem to have gotten vintage cyberpunk instead.

I think this is slightly unfair to the 17th century Jesuits. It is not at all unfair to the Chicago School; if anything it is still too kind.

Rapidly rising derivative volume + stagnant real investment levels create prima facie grounds to doubt that credit derivatives really help capital formation. But I suppose defenders of the faith could argue that investment levels would have been even lower without the CDSs etc., and that just staying in place in investment required ever-more derivatives through the 2000s.

David Warsh writes about John Geanakoplos's models of the credit cycle (especially the role of leverage). I am surprised, because when I heard John G. talk about this c. 2000 in Santa Fe, I got the impression that it was all well-published. But evidently people didn't want to listen...

Robert Solow on the financial collapse, in the form of reviewing Richard Posner's book on the same. I am reassured to find that my own half-baked thoughts align with Solow's.

Even if this is a joke, it's great. I should definitely consider assigning this the next time I have to teach financial time series...

"In 1997 former Federal Reserve Board Chairman Paul Volcker posed a question about the commercial banking system he said he could not answer. The industry was under more intense competitive pressure than at any time in living memory, Volcker noted, “yet at the same time the industry never has been so profitable.” .. the seemingly strange coexistence of intense competition and historically high profit rates in commercial banking [is] Volcker’s Paradox. He extends the paradox to all important financial institutions and discusses four developments that together help resolve it: rapid growth in the demand for financial products and services in the past quarter century; rising concentration in most major financial industries; increased risk-taking among all the major financial market actors that has raised average profit rates; and rapid financial innovation in over-the-counter derivatives that allows giant banks to create and trade complex products with high profit margins."

A world gone mad is one where an ex-_IMF_ economist sounds like he could be writing in New Left Review... (I should ask ZMS if he knows this character)

Oh yes, an oldie-but-goodie: how to make $800k as a stock-tout in high school. Whatever became of young Mr. Lebed?

Published version, via JSTOR. (The discussants seem clueless.)

"Has the risk of a US government default risen? Probably. Nonetheless, the people buying these contracts are crazy. A world in which the US government defaults would be a world in chaos; how likely is it that these contracts would be honored?"

Hooray for financial innovation!

I feel like this can be endorsed pretty wholeheartedly (though these criticisms do not apply with full force to the "saltwater" school, that's been pretty absent in shaping policy, especially as regards to finance).

To put what Waldmann is saying a different way: markets might be able to aggregate many little inaccurate pieces of information, but if none of the participants actually know something, market prices will not by magic become informative.

Of course, since this is Wired, one has to wonder whether all the quotes are just made up to be "provocative". (But Salmon is generally trustworthy, and this meshes with what I know from elsewhere.) --- Donald MacKenzie fans will note the way the formula became embedded in market practice...

How could one discriminate between just earning returns by selling insurance (w/o building up reserves), and actual investment ability? This might make an interesting student project.

Daniel Davies, prophesying DOOM! eleven years ago.
(Less flippantly: if traders, or for that matter CEOs, get bonuses when things work well, but do not get penalties when they go poorly, they will seek risk in addition to, or even more than, higher expected returns. Application to recent events left as an exercise.)

The story gets more bizarre. "So a bunch of hedge funds invested in PSIV to go long Target (while paying Ackman his 2-and-20), and at the same time went short Target in order to hege their PSIV exposure. And for this piece of genius they charge their own investors 2-and-20."

Waitwaitwait. Why on earth would anyone need a hedge fund to go _long_ on the stock of a publicly traded company? Wouldn't you just, you know, _buy_ the stock?!? Could brokerage fees for serious investors really exceed the hedge fund's 2-and-20? --- Mystery solved, thanks to W.: "Ackmann is an activist investor who tries to get TGT to spin off its real estate portfolio and pooling together stocks is the only way to achieve that."

"Hegel is, of course, the original theorist of singularity. (He’s Kurzweil, minus the technology.) True, Prussian bureaucracy is a very weak, weak AI, but close enough for government work." --- It's funny because it's true!

(Marx, thus, was warning us that the spontaneous rogue AI in question wasn't the Prussian State but rather global Capitalism, and humanity's only hope was to _deliberately_ create a superior AI of its own.)

Charlie Stross responds to seminar participants. This bit is more general and, in my experience, absolutely true: "Trying to learn about somebody else’s discipline when you’re an outsider is an interesting experience. The first stage is bafflement, as you’re confronted by a thorny hedge of impenetrable jargon and recursive definitions. The second stage is over-simplification, as, equipped with a Bluffer’s Guide level of understanding of some of the basics, you pry apart the thorny branches and decide that the jargon is, in fact, a Shavian conspiracy against the laity and conceals the essential simplicity of the field in question. And the third stage in learning occurs when you push further into the hedge, and the branches behind you whip back into position behind and impale you on the thorns of your own misconceptions."

An essential chronicle of our time. "Are you or someone you love dating a banker? If so, we are here to support you through these difficult times. Dating A Banker Anonymous (DABA) is a safe place where women can come together – free from the scrutiny of feminists– and share their tearful tales of how the mortgage meltdown has affected their relationships. DABA Girls was started by two best friends whose relationships tanked with the economy. Not knowing what else to do, we did what frustrated but articulate girls have done since the beginning of time - we started a blog. So if your monthly Bergdorf’s allowance has been halved and bottle service has all but disappeared from your life, lighten your heart with laughter and email your stories to dabagirls@gmail.com. "

I am not sure that the martingale analogy really holds here, at least not as anything more than a highly simplified pedagogical device.

"...two market agent-based model [of] how global portfolio managers affect global financial crises and stability. The Markowitz model [plus] several insights from behavioral finance. Simulation results ... reveal that global financial crises do not occur when global managers are added to the model. However, when risk is determined based on investors’ historical losses and exponential averaging, slight global manager losses can trigger a widening of both markets’ risk premium, accelerating the decline in asset prices worldwide. ... global managers are ... stabilizing
... in smaller numbers [but] destabilizing in larger numbers. The ability to reduce risk by diversifying across markets results in excessive risk taking. If global managers exist in larger numbers, systematic over leverage may result such that a deleveraging process can lead to the spreading of financial crises."

Waitwaitwait. You start by talking about how limits on leverage and capital adequacy were loosened, and then blame for the crash on using quantitative trading algorithms? Am I the only one to see a problem here...?

I agree, but I don't think "the days when banking was populated by managers with degrees in History and who'd been leaders of the school debating team" had such a tremendous track-record either. The time when finance has done the least social harm, it seems to me, was _when it was most regulated_, i.e., the post-WWII "golden age of capitalism". The problem isn't the training of individual financiers, it's the institutions!

It is very, very hard to think of any real-world reason why a school district should participate in an interest rate swap, let alone sell options-on-swaps ("swaptions").

The always entertaining Michael Lewis looks at the financial crisis, and looks back at _Liar's Poker_...

Chronicle of a bubble foretold.

Should I be surprised that somebody was pulling the Capital Destruction Partners/Hedge Fund Wizards scam in real life? Or that they made millions and helped bring down AIG? Probably not but it's still shocking.

Yglesias calls for socialism-as-carry-trade. Works for me.

"[E]ither [collateralized debt obligations] are being used to arbitrage a substantial price discrepancy in the fixed income markets or CDOs are being used to convert existing fixed income instruments that are accurately priced into new fixed income instruments that are overvalued. The first possibility assumes the existence of a substantial market inefficiency, perhaps the most substantial inefficiency ever found in the finance literature. The second possibility seems more likely. In other words, either CDOs are evidence of a substantial and pervasive market imperfection, or they are being used to create one."

Text of the 25th annual "Milton Friedman Distinguished Lecture", as delivered by Galbraith junior at Marietta College in March 2008. "Truly I come to bury Milton, not to praise him."

To consider teaching in the financial time-series course. Probably too intricate.

"a key reason for these record-beating losses is not a failure of ultra-complex financial strategies or esoteric models; instead it arose from a humongous, misplaced bet on a carry trade that was so simple that even a first-year economics student (or Financial Times journalist) could understand it". (Cf. Galbraith in _The Great Crash_.)

Impossible to say from the article whether there's anything new here or just a rediscovery of classical herding models.

Decent piece on credit default swaps.

Financial firms claiming to values their _obligations_ at market prices? Since when has this been happening, and who did they bribe/blow/kill to get it allowed?

It looks like a lot of people have been following the Young/Foster "how to be a hedge fund wizard" strategy with credit default swaps, and it's all coming undone. Note: horrible institutional set-up.

Excellent piece on credit derivatives and the underlying institutional/cognitive problems of the markets, financial modeling, etc. Makes me extra glad I didn't agree to supervise the credit default swap thesis.

Conditions for financial markets to be useful social decision-making mechanisms != conditions under which market participants make as much money as possible.

Why yes. Yes he did.

Man, what a cluster-fuck of stupidity. (There is a decent behavioral experiment lurking underneath the, in this case, totally uninformative fMRI.)

I love the smell of bilking struggling school districts; it is the smell of alpha.

Memo to self: do not attract Tanta's attention.

Anonymous Hedge Fund Manager encore.

The best part: it's all true. (But the artwork is even worse than xkcd; it should be re-done by David "Get Your War On" Rees.)

Almost a response to Krugman's Monday editorial...

"Putting together everything we've learned over the past 10 days about high finance in Manhattan, one thing is clear: If Eliot Spitzer had saved all the money he apparently paid "Kristen" and her co-workers at the Emperors Club, he could have bought Bear