Read Slowly and Carefully
Please read Paul Jorian's blogpost regarding the implosion of the credit markets, the reasons, the influence of "The Chicago School" of economists whose assumptions continue to help us not understand how economies work, and "What it All Means".
Don't feel bad to reread each sentence, mouth-moving to form the words, just as I must do. Just read it. (plus it's fucking footnoted. My god, who footnotes a blog!!!????)
Here are some teasers:
Finance is in shambles. It has remained until now under the close supervision of economic and financial theory. In recent years, due to the overbearing dominance of views developed under the umbrella of the “Chicago School” of economics, finance has been regarded as explainable through the combination of a very simplified version of psychology: that of the “homo oeconomicus“, and of physics.
An example of the difference between theoretical economics based on "people as particles" and describing the behavior of people as more complex.
Here an example: price formation which economists explain as the meeting of a curve representing demand with another representing supply. Now tell me: has any anthropologist ever encountered circumstances where the status of buyer and seller is indifferent to the settling of price?
A clear description:
Briefly said, Asset-Backed Securities are debt instruments created by pooling several thousands of consumer loans in the likeness of a traditional bond. ABS may be backed by credit card debt, mortgages, student loans, aircraft leases, and so on. Literally speaking, Mortgage-Backed Securities (MBS) are asset-backed securities; historically though, MBS refer only to securities backed by “prime” mortgages, the less risky ones with high level of collateral (low Loan To Value)
and high borrower credit score (3).
And explanation (personal experience) of what happened to those "instruments" by their nature:
Models used to represent ABS’ behaviour were known to be inadequate, being in particular deprived of tools allowing simulating the impact of “triggers”, triggers being a setup allowing when the instrument is distressed to divert cash flows to locations where they are more urgently needed. Models used back in 2007 at Countrywide, the top institution in the United States granting mortgages, ergo the top institution of that type in the world at large, were deprived of the capacity of simulating “triggers”. This was not regarded though as an issue to be taken in earnest as Countrywide’s accounting advisor - backed in this by the United States government regulator of thrifts, the OTS - regarded that lack of understanding of the products sold to trusting patrons as “industry standard,” i.e. all right. My own insistence, in my capacity of “model validator” within the Risk Management team, that such “triggers” be added to our models explains no doubt why I belonged to the first load of Countrywide employees allowed to join back the job market in October 2007. Here was at work one well-advertised dimension of the subprime crisis: the sales by investment bankers of financial products whereof they had very little understanding.
Oh, and good, snarky writing:
Financial engineers with mathematical degrees from reputable higher education institutions will tell you that the current forward rate for a three year loan taken in nine months is a very good forecast for what the three year interest rate will be in nine months. It doesn’t make any mathematical or any other sense. But mind you, the fate of whole Wall Street or City institutions has been built on that basis.
What’s the explanation? My own hypothesis is that that belief derives from a special combination of arithmetic and optimism. I was once expounding to the late Professor Meyer Fortes my dismay that some of the sayings of fishermen I had lived with in Brittany seemed to be very reliable and based on empirical observation while others added to nothing more than superstition. A smile came upon his face, betraying his unswerving trust in human nature: “Paul, what would we be without hope?”
Much more important stuff there.
Go. Read. All. Please.