"Due to its simplicity and familiarity, the Gaussian copula is popular in calculating risk in collaterized debt obligations, but it imposes asymptotic independence such that extreme events appear to be unrelated. This restriction might be innocuous in normal times, but during extreme events, such as the housing crisis, the Gaussian copula might be inappropriate. This paper explores various copula specifications and finds that the degree to which housing prices are related based on the Gaussian copula is too small compared with real housing price data."

"distrust of traditional lending institutions such as commercial banks led some borrowers to seek out brokers from their own communities whom they felt they could trust. But these brokers were operating under high-powered incentives to inflate rates and fees and guide borrowers towards subprime products even when they were eligible for cheaper alternatives. The trust that was placed in the brokers allowed them greater flexibility to respond to these incentives and left borrowers worse off than the would have been if they had been more suspicious or better aware of the incentive structures in place.
"Viewed in this manner, the subprime saga has some broader implications. From the point of view of a company operating in multiple local markets with a diverse customer base, the strategy of giving local employees or contractors the discretion to adjust prices can be very profitable. This is especially so if these employees appear trustworthy to their customers, but are not in fact deserving of such trust. As Groucho Marx is reputed to have said: 'The secret of life is honesty and fair-dealing. If you can fake that you've got it made.' For products involving frequent repeat purchases by the same customer, reputation effects and competition can limit the degree of price discrimination. But the purchase of a home is an infrequent transaction for most people, and the complexity of the loan product precludes easy comparison with alternatives on offer. Trust then becomes a key determinant of pricing and transaction volume, especially when strong and hidden incentives for the betrayal of trust are in place.
"Betrayal also leads to the erosion of trust over time. It could be argued that trust is one of our most valuable public goods, substantially lowering the costs of transacting. In the complete absence of trust, the resources that would need to be devoted to monitoring would be prohibitive and many organizations and markets would simply not exist. Trust also comes naturally to most of us, based on simple cues such as those revealed in Reid's interviews. High-powered incentives to secure and then betray such trust are therefore costly not just to the immediate victim, but also to the community at large. This may be one of the less visible consequences of the subprime crisis."

Looks like there ought to be some sort of data collapse possible here (a common time trend multiplied by some city-specific noise?).

Unintended consequences of hubristic social engineering by ideologues (with finance degrees), vol. CCXIV.

"Take Household Finance in the early 2000s. Their aggressive lending practices where people would learn after the fact that they were mislead to how much their total monthly payments were ... led to successful settlements in Colorado, Georgia as well as a $484 million in fines joint settlement with a group of attorney generals, the largest consumer fraud settlement in U.S. history. ... That’s a lot of money, until you divide it among the amount of households that were ripped off. Even after legal fees, its hard to image it wasn’t a profitable experience. So Household Finance has to pay the largest consumer fraud fines in history. I bet you think that the investment community and elite financial institutions wouldn’t look twice at it. ... One month later Household was acquired by HSBC, the London financial giant, for $16.4 billion.... Instead of driving out fraud, the market realized, correctly, that there is a ton of money in consumer fraud, and it rewards it handsomely. "

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

Yes. This has been another edition of easy answers to simple questions.

Shorter Crotty: there was no good reason to expect a minimally regulated financial sector to stably and efficiently allocate risk and capital, and it didn't.

... in which Kieran wins the Internet.

"Citi’s problem isn’t that it has toxic assets, it’s that it made loans backed with toxic assets. You don’t rescue banks by “tak[ing] distressed assets off the balance sheet of Citigroup or other troubled financial institutions.” The problem isn’t the assets, it’s the debts. You can deal with the problem by giving the banks vast sums of money in exchange for their toxic assets but in this case what’s solved the problem isn’t that the assets came off the balance sheet, it’s that the money you gave them got on the balance sheet." (My romans.)

Hooray for financial innovation!

There is a serious selection bias issue here (disproportionately looking at the badly-performing loans), but wow does everyone come out of this looking like a dangerous idiot. (Use this as a negative example in the next incarnation of the data-mining class?)

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).

Sounds right to me: "There's just no getting around it: there might have been technical problems with the Gaussian copula function, but even if it had worked the way people thought it did it wouldn't have mattered. The rating agencies and the sell-side BSDs were just using it as an excuse to pretend that house prices would rise forever anyway. That was a far more fundamental problem than the statistical shortcomings of the formulae they used."

Some interesting notions, but way too much in the "I will reveal to you the hidden forces shaping History" mode. (Also, when someone says that Mumbai and Bangalore are part of a _single_ urban cluster, I tune out what they are saying about India, and indeed the non-US world. This is almost on a level with putting Las Vegas [NV] and Albuquerque in a single urban cluster.)

The confession of his own fraud is interesting. The core proposal (underneath the failure to write clearly) is that selectively prosecuting frauds after they happen is less effective than a regulatory compliance regime that makes fraud hard to commit in the first place. This is fair enough, but (as Tanta used to say), there is no way to actually verify the claims in mortgage applications & c. _quickly_. Requiring it would lead to massive changes in an industry which has rebuilt itself around speedy securitization. This may or may not be a bad thing.

Aaronsw channels Krugman.

I don't know that the magnitude of derivatives matters so much as he makes out, if only because so many of them have bets going the other way that the net effect is much smaller. (But uncertainty about what that net position is, on the other hand...)

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. "

Krugman's long-form take on what Obama should do, domestically, in year 1. Where do I sign up to help pressure Obama to do all this?

(And, in a "why oh why can't have a better press" moment, why does our leading public intellectual have to publish this in Rolling Stone, of all places?)

Wait - we _only_ import 30% of our steel?!?

Dean Baker makes sense.

Was I the only one who read this and then thought "I can't wait to see what Tanta has to say about this?"

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...?

Inconclusive trend piece on the demand for people with quantitative finance degrees, including our own graduates.

Stiglitz points out that he predicted securitization would lead to excessive risk, if unaccompanied by more regulation, all the way back in 1990. There is an unseemly element of gloating in this piece, but if there is a mote in Uncle Joe's eye, there are many large beams in the eyes of those who ignored him.

Robert Waldmann on why it does not profit a credit rating agency to be any better than average.

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

Joe Stiglitz on the systemic causes of the current crisis. "We are in the midst of micro-economic failure on a grand scale."

"One of my private pleasures as a historian is reading old newspapers in sequence just to see pundits and prognosticators try to guess what is coming next. They almost invariably fail badly, often because they cannot imagine either just how terrible the near-future will become or how wonderful and strange some of the developments just around the corner are going to be."

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.

Jamie Galbraith on the bailout bill (pre-Monday)

Answer: not "the Chinese", but from US taxpayers in the future (i.e., slowly).

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

Actually, most of these are good ideas crisis or no crisis.

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."

"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_.)

Brad, tricked into appearing with Grover Norquist, loses his temper with the entire establishment.

I am not sure if "daisy chain of deals" is quite the best phrase, in this context...

Decent piece on credit default swaps.

"If you make a 'liar loan,' the Judge is saying here, then you cannot claim you were harmed by relying on lies."

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.

Possible data mining teaching material - what if the data is all, or in large part, lies? If users deliberately game the classifier?

Why yes. Yes he did.

On the plus side of the real estate collapse, banks are helping to create more ruins-to-be.

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.)

That's an _interesting_ proposal...

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

"Uh oh. we’ve got a downturn that can feed itself and, at the same time, dig trenches." Cool!

Good explanation of information cascades and how they can lead to bubbles/crashes, but conflates this with an explanation for why _others_ did not see what was happening as a bubble.

_are_ people in fact "walking away" from mortgages which are bigger than their house values? how would we know? could we inject some facts into the debate?

Suggestive, interesting, and plausible - unfortunately. However, Figure 3 is painful to the eye.