Scientists and bankers — a new model army
April 12, 2012 | Source: Nature News
Bankers must surrender more information on their activities to scientists to use it to build better system-wide financial models, says John Liechty, director of the Center for the Study of Global Financial Stability and Professor of Marketing and Statistics at Pennsylvania State University in University Park.
Existing financial models failed to predict the crisis of 2008 and the follow-on crisis of 2011–12. They missed the huge system-wide risks that developed as banks promoted an undisciplined supply of mortgages and created an increasingly complex web of relationships through legal contracts that transferred risk throughout the financial markets.
For commercial reasons, banks have historically been reluctant to share this kind of information, but that is changing. Legislation in the United States now allows regulators to collect such data from banks, pension funds, insurance companies and other big players in the financial markets. Regulators in Europe are following suit, and hopefully Asia will as well. As a result, we will soon be able to model and identify potential system-wide risks.
Clearly, regulators have a responsibility to build such models and to use them to monitor for potential crisis. To do this, they will need to leverage expertise among scientists by supporting and encouraging research in universities and labs, and by hosting the more applied work to maintain confidentiality. Bankers should join this effort too, if only to avoid forcing regulators to use crude tools to set prices on these risks — through capital ratios or transaction taxes, for example.
Bankers should work in parallel and form an industry group that collects system-wide data from its members, organizes resources for scientists to develop the necessary models, and creates a secure and confidential infrastructure for members to determine the price of system-wide risks.
Everyone would benefit if bankers were to engage with scientists to build the infrastructure needed to price system-wide risk. Banks could get feedback about common holdings and trading strategies, which would allow them to adjust their behaviour and avoid following the herd. Regulators would have extra market information to help them to determine when to act to ensure stability. And the rest of us could have increased confidence in the financial system.
Comments (12)
by something
good job hahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahhahahahahahahahahahahahahahahahahahahahahahahha
by Editor
You laugh, “something,” but you won’t laugh when the Eye-bots visit! heh heh
by Ron
Pleasantly surprised by the quality of the comments here. When I first read the post, I thought I’d have point out that there were models that did predict the collapse, namely Austrian School Economics. Those models were written off because they don’t support certain political motivations. Nothing has been fixed and we continue to do the same things over and over again expecting different results, the definition of crazy.
This man predicted the crises …
http://www.youtube.com/watch?v=ZV7AFUXvHmo
http://www.youtube.com/watch?v=pvlUx5ECD2w
by laughin
somehow doesnt trust big government ‘scientific’ rationales when i.t comes to going after money Oh yes the fox just wants to study the physics of the henhouse door… to make sure the ‘design’ is optimal and ‘safe’
by 4nonduopoly
Joe B (below) has it right.. As does Ry Cooder in “Leave No Banker Behind” – However, we have an entrenched two party poliitical system. Our “elected” officials always dialing for campaign dollars.(free speach?) to pay for attack ads (which should be minimized via “real” debates on “our” airwaves). This is done hoping to “represent” those who give the most, bankers included. When the republic was founded there was no Fereral Reserve porviding a safety net for those taking risks with other peoples money.
by Joe
I read the economist, they knew it was a bubble and said so. I sold and made a $100,000 off a $12,000 investment. They said buy and I have with good results. I do not know what they are talking about when they say “Existing financial models failed to predict the crisis of 2008″.
by Tab Cocovillea
Very surprised with the quality of the bull-cutting comments here. There was nothing a good collapse wouldn’t have fixed, but by allowing corrupted markets and institutions to continue this recession/depression has been exacerbated.
by Gabe Potter
The evidence of system-wide rot that caused the 2008 crash wasn’t “missed” by financial models that “failed to predict” the crisis; it was purposefully suppressed and ignored by essentially ALL the major players because they were all in on it. Anyone who raised the rather obvious issues was shouted down or marginalized as a kook. “Don’t rock the boat” is the motto today as it was 4 years ago. I highly doubt any amount of modelling is going to save us from ourselves when we continue to be willfully ignorant about the realities of such matters, and those who hold the purse-strings still control our global institutions. See ya in 4 years guys.
by Joe B
Typical academic seeking to use state coercion to make his research a little easier.
The Austrian school of economics disregards statistical modelling in general, and was predicting the crash for years before it happened based on their understanding of dynamic capital structures and credit dynamics.
Steve Keen does use statistical models, and predicted the crash in 2005 based on debt dynamics.
All the data in the world won’t help anyone unless they have a valid theory to plug it into. Neoclassical/Keynesian economics has repeatedly been proven invalid both logically and empirically with every fluctuation in markets. That’s what happens when a theory excludes any realistic conception of time, capital structure, or money.
The cause of the crisis was credit expansion. The solution is 100% reserve requirements for demand deposits, with no central banks and no bailouts. Under these conditions, the vaguely defined “risk” data will be a small, uninteresting set. Lender assumes risk.
by spikosauropod
The banks went broke because congress made them loan money to people who couldn’t pay it back. This meddling is what caused the crisis. More meddling won’t make it better.
But that’s beside the point. Where on earth did anyone get the idea that scientists have a superior understanding of finance? How many rich scientists do you know? Did anyone look into the credentials of the people who are already in finance? Trust me, they know what they are doing.
Next problem.
by R Self
Too much “should” and “could”. It talks about not following the herd. That is human nature and part of the securitisation problems and the sub-prime mortgage problem.
Very profitable until it exploded.
Also, it would only catch a bubble like the one before (group think). It would probably not catch the next one.
He talks about not predicting either 2008 or the 20011/2012 Euro crisis. They were predicted by some “maverics” who did not follow the crowd but were dismissed as crazy. No quantitative systems model would have been able to predict the Euro crisis any better than the traders did. The Euro crisis was caused by the politicians who continually kicked the problem into the long grass hoping for a political solution, and continue to do so. Let’s wait for Greece to exit the Euro and see what happens. Most of the Finance world is predicting this.
We need to remember the following aphorism.
The government [is] extremely fond of amassing great quantities of statistics. These are raised to the nth degree, the cube roots are extracted, and the results are arranged into elaborate and impressive displays. What must be kept ever in mind, however, is that in every case, the figures are first put down by a village watchman, and he puts down anything he damn well pleases.
((1849 – 1941) UK HM Collector of Inland Revenue)
by gaoptimize
I’m afraid PhD Liechty hasn’t come to accept that all the big (TBTF) banks are insolvent and the last thing they (politicians, crony banksters) need is a calculation of the amount of inflation and bailouts that would be needed to make them solvent. It is as simple as 1) market-to-market on their real estate collateral/book, 2) acknowleging that housing will not recover for a generation, and the MBS, CDS, and all the derivatives they support come crashing down. They can’t handle the truth and they certainly don’t want some irrefutable high fidelity model exposing it.