Saturday, 14 March 2009

Crisis of Credit

These are supposed to be simple explanations of the crisis of credit in the US. I guess I understand the problem, but what I don't understand is how anyone could hope that a system with so many "middle men" could be sustainable... I really don't understand macro economics...


Gary said...

Hey dude

This is Gary, long time no see!

This is a great video, didn't take sides and explained a very complex system in graphic style. For an example, the rating system of the "safe", "okay", "risky" buckets are actually called "trenches" and there are, in general, 9~15 trenches during the high times of the subprime finance.

The question "how can there be so many middle-man?" is a great one and is the fundamental of this crisis. To put it simply, increase the middlemen decrease the "foreseeable" liability of the players at each level. For an example: as long as the broker sold connected the lender and have the mortgage sold, he stopped caring, as long as the lender packaged the mortgages into securities and sold to the investment banks, they stop caring,...and so on. So it came down to the point that you can have a mortgage that's 120% of the asset (house) value and no down payment.

Then the shit hit the fan as we know it in 2007. The second video captured it quite well.

Another really good question that I asked long time ago about this financial crisis is "At least some of the multi-billion dollar investment banking community are staffed with math-adverse people who would foresee this coming, why didn't they stop the boat back in 2005?"

The answer is here:

You may get more out of this article then I do because I didn't take that much math.

Long story short, the Li's Copula function (incorrectly) correlated unrelated events (ie risk factors) together and "slapped on a number" to the unpredictable variables such as individual mortgages' default rate.

Also, at the same time the so-called "credit default swap" was just about coming into form (early 2000's), people used it in massive amounts (total CDS as of 2008 globally amounts to 10's of trillions of dollars) without actually understanding the risks.

Perfect storm.

Hey, give me a word sometimes, I'm on facebook very often as you can see. Come on facebook sometimes and we'll chat!

We are waayyyy overdue for another long episodes of exchanges!

Pat said...

Hey Gary! Thanks so much for all of this. I'll make sure to check out the link you posted. But your warning scares me a little though: your math is way stronger than mine will ever be!

We should definitely start a new email thread... Facebook: not such a big fan (still) ;-)

Cheers buddy!