Monday, November 22, 2010

Computing, economics and the financial meltdown (a collection of links)

This editor's letter from CACM last year is interesting: The Financial Meltdown and Computing by Moshe Y. Vardi

Information technology has enabled the development of a global financial system of incredible sophistication. At the same time, it has enabled the development of a global financial system of such complexity that our ability to comprehend it and assess risk, both localized and systemic, is severely limited. Financial-oversight reform is now a topic of great discussion. The focus of these talks is primarily over the structure and authority of regulatory agencies. Little attention has been given to what I consider a key issue—the opaqueness of our financial system—which is driven by its fantastic complexity. The problem is not a lack of models. To the contrary, the proliferation of models may have created an illusion of understanding and control, as is argued in a recent report titled "The Financial Crisis and the Systemic Failure of Academic Economics."

Krugman's essay at the time How Did Economists Get It So Wrong? gave a nice history of economic ideas, the models behind and his interpretations of their correctness.

The theoretical model that finance economists developed by assuming that every investor rationally balances risk against reward — the so-called Capital Asset Pricing Model, or CAPM (pronounced cap-em) — is wonderfully elegant
Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system.
H. L. Mencken: “There is always an easy solution to every human problem — neat, plausible and wrong.”
I read this months ago and it's been percolating in my thoughts since then. My Manhattan Project - How I helped build the bomb that blew up Wall Street by Michael Osinski. Osinski wrote much of the software and models used to form CMOs and CDOs. Essentially the software aggregates debt instruments from mortgage and other debt markets and allowed a bond designer to issue tailor-made portfolio of debt while mitigating default risk of the debt via that aggregation. He called it his sausage grinder.

“You put chicken into the grinder”—he laughed with that infectious Wall Street black humor—“and out comes sirloin.”

Here's a large collection of links from that period that are worth reading. My thought at the moment is this nugget from Twitter:

Posted via email from nealrichter's posterous