By Peter Cochrane, 20 October 2008 14:53
COMMENT
Written on the Eurostar between Paris and London, and dispatched to silicon.com via a 3G Mobile Data Link an hour later
Like you, I have been watching the global banking fiasco with a mix of fascination and horror. Oh how the mighty have fallen, and how silly the masters of the universe now look.
And how silly the rest of us look for letting them do it in the first place - not to mention letting them get away with it for so long, and putting us all in financial jeopardy.
To cap this we then we dig into our tax pockets to bail them out at a cost that has yet to emerge. Extraordinary!
How the heck did all this happen? In a nutshell:
- A full understanding of the banking and financial system is now beyond the span of any one human mind - in a similar way the complexities of a 747 aircraft escape us too.
- Managers and executives have to rely on the people they employ being honest, ethical and sensible. They just can't dig down and watch every action and thought any more - the system is far too big, fast and complex.
- And of course the primary forces in any banking and financial institution - greed and fear!
- Oh, and we should mention those courses on creative accounting and banking - I'm sure they have a lot to answer for also!
So what happens after the great bailout? Regulation, lots of regulation - with lots and lots of committees, watchdogs and consultants. Will it work? No, it never does!
Within the next decade, and certainly within two, it will all happen again - all that will be different will be the precise mechanism by which it is affected.
In my short investment career we have had the dot-com bust; the Enron and WorldCom scandals; and now the banking sector collapse. All were fuelled by greed, fear and sublime optimism coloured by a total blindness to what was really happening and the certain outcome. Also they were characterised by the creation of false value that was seductive but flew in the face of common sense - until the entire economic fallacy imploded.
So what do we need to do? How about modelling and simulating the business and transaction models, all trades and networks including supply chains and dealer activity. We have the technology and ability to create electronic monitoring systems that could supervise the actual activity and not what is thought to be happening.
In this latest crisis the bankers and traders have been assigning huge values to toxic debts (that are likely to be worthless) which they sold on in 'attractive wrappers' and deals that created even more false value in the system. Ironically some banks were buying into these same enhanced deals months later, having lost track of the assets and the wrappers. And so moribund assets went around the system gaining in false value at each stage. But hey, it was huge profits and bonus time all year long.
Our only hope for any form of long-term stability is the creation of a machine-based economy with all the models and monitoring built-in. At a fundamental level our economic system is non-linear and chaotic, and with increased globalisation it will only get worse.
We (our species) are being rendered increasingly blind and clueless as to what is actually happening. We have no idea if the economy of our planet is conditionally stable or unstable - and a testable computational model is the only way we can find out.
Can we do all this today? Oh yes! Will we do it? I reckon not! Why? Vested interests in the old ways fuelled by fear and greed! We will probably have to endure at least one more major crisis before the political and commercial worlds figure it out and do the obvious.
Chaotic systems tend to fail in a series of crashes that get more intense and closer together with time. As far as I can see the stage is set and we are watching it happen, and we might expect another, even bigger event on the next cycle.
In the interim what will the big companies and banks do? The war cry will be: hunker down, cut back, get rid of the frills, back to basics, stick to the knitting and of course reduce staffing.
How do I know all this? I've been through it before. It's like déjà vu again... and again
On the other hand the really smart folks will be investing in technology, people and new market opportunities with tried and tested models.
Comments
There are 17 comments. Join the discussion
1. Stuart Fawcett
I believe the only way a model would protect us is if legislation only allowed banking players to trade within its bound and tested variables.
We are where we are through a combination of both talent and ineptitude.
True innovation is driven by genius,
true progress is driven by leadership,
true value is driven by shrewdness,
true capitalism is driven by one-upmanship.
We are more than the sum of our parts.
2. Richard Sarson
A recipe for disaster. There is a school of thought that blames the "algotrade" programmes for the crash. Algotrading represents 40% of the trades in the City and 80% of trades on Wall Street. The trouble is that the analysts have even less understanding of the risks than the seat-of-the-pants traders.
I have always felt that the City was a version of Second Life, with no connection to the real world, and money treated like Lindens. So blame the geeks for the crash.
3. anonymous
People have been warning of this for years and no-one listened as the politicians were spouting rubbish about economic miracles and the death of boom and bust. The last 15 years has been driven by nothing other than cheap debt, and payment is now due to those who sold their soul's to the devil.
Why anyone ever though rampant double digit house price rises year on year was ever a 'good thing' and would ever lead to anything other than bust is completely lost on me. Did we learn nothing from the 1980's, 'loadsamoney' and negative equity - seems not.
Add to this wholly irresponsible financial deregulation (notable Bill Clinton's repeal of the American Glass-Steagall specifically designed to prevent greed driven speculation) and it's no wonder we are where we are.
IT will only ever do what it is programmed to do - sometimes for good in failing safe in specific circumstances, sometimes for bad - see Terminator or Black Monday computer driven trading).
What banking needs is a return to being boring, making reasonable profits on doing ethical and responsible financial lending and savings.
The real evil people are the speculators/hedge funds/private equity driven by pure greed to make money off the backs of other people on shares, commodities, lending, debt etc.
A good example is the UK electricity/gas trading systems forced onto the markets earlier this decade by Labour 'to give the UK better value', which has turned out to be complete rubbish open to abuse by the speculators.
4. Karen Challinor
a fairly basic problem is that we live in a finite world and all our economic systems are based on the idea of unlimited growth and financial people refuse to believe that unlimited growth isn't possible
how much is enough ?
unless we get off this ball of rock and look elsewhere for resources then eventually we will use them all, unless we start looking at recovery of resources from waste and even then there's only so much to go round
much as I love the idea of space exploration fuelled by the financial industry requiring more resources I can't see it happening somehow
so I don't believe there is ultimately a technical solution to this problem I believe a paradigm shift in financial modelling needs to occur where we aim for "steady state" or "sustainable" as opposed to "unlimited" solutions
sadly I don't see that happening either
5. anonymous
I disagree it won't happen - I think it will happen and that will be the cause of the next massive boom followed be equally massive bust.
Throughout history people have fiddled statistics and models to produce the results they want, and this will be no different. Except that this time the models will make matters worse because people will use the (rigged) models to justify their stupidity.
6. Simon Allen
We can not yet be sure that all the big shocks in this cycle are out. I think that we will have to wait one year form the last big shock announcement - to be sure that we are not going to have a Depression. But it is going to be a very severe global recession.
On this topic, I do not agree with Peter, that we could make a tech model to run simulations and warn against developing trends. Firstly, as has been stated, the vested interests are never going to allow it but secondly, if attempted, no agreement would be reached on how the model should be constructed or run.
It has been clearly established that each generation of traders think that they are smarter than the ones before them. Which is why they make the same mistakes - just in different areas!
Each trader and financial company think that they can beat the market. But the market is made up of them! It always collapses and always will.
If today's senior banking people had listened to the stories their grandparents told of the 1930s Depression ... but we always think out grandparents lived in a different era and that things are different. Not least - we have computers!!!
7. Richard
Even treating the UK's economy as a "black box" containing incomprehensibly complexity;
Trouble has long been obvious just from seeing the "inputs" and "outputs";
Regardless of the up-beat reports of "experts" & politicians.
However, we've had no way of influencing decisions.
The answer is not some benevolent "super-state" nor some highly advanced technocratic machine;
The answer is to remove power from the present ruling cliques and return to democracy.
Perhaps technology could be used to inform the electorate better & to increase participation?
8. Peter Cochrane
Stuart = I have only ever seen legislation change the shape of the problem! Peter
9. Peter Cochrane
Richard = That is a bit like blaming your engine management system when you drive your car into a tree! Peter
10. Peter Cochrane
Anonymous Birmingham = Pretty close to the mark I would say! Peter
11. Peter Cochrane
Karen = The business schools and accepted wisdom of both economics and politics certainly have a lot of blame to share here. Trouble is - no one seems to have a voice on the 'finite resources side' - they are mostly ignored. Sad and dangerous!! Peter
12. Peter Cochrane
Anonymous London
It will happen all right - you can put your shirt on it. Greed and fear can guarantee it. Not sure if it is stupidity, blindness, ignorance, or belief - eitherway the outcome will most likely be the same - bust again and again and again! Peter
13. Peter Cochrane
Simon = You make my case for me very nicely. Than you, Peter
14. Peter Cochrane
Richard = One of the reasons democracy is such a great institution is that it is highly inefficient, slow, and thus stable. Today that is at odds with tech advances and the creation of new economies and businesses. We thus have an interesting conundrum as government proceeds to meddle with the fundamental freedoms we enjoy. For sure people monitoring people won't work! Peter
15. Graham Moore
A system, as you propose, does not need to be 'invented'or developed. The global meteorological infrastructure already does many of the things you are suggestiong. It monitors, reports, collates and models the inputs with a massive historical database providing 'forecasts' as the output. Some of the largest most powerfull computers on the planet have been developed over the years in order to achieve what we have today.
So the hardware and maybe a lot of the software is already there.
16. anonymous
the problem with our kind is that there are very few of us who would test and a whole lot of us who would try...try till it is speculated to a point it cannot withhold.
17. Murray Hynd
Tech *cannot* solve the crisis, it can only *aid* transparency (GIGO): unless categoric provenance is included in all investment vehicles, from inception (micro) right through to being re-enveloped/morphed into something else (macro), *and* that this micro-provenance is mandated to always be visible, there will always be the possibility of another sub-prime meltdown.
Peter rightly fingers 'greed' as the prime motivator. If the evidence is in plain view all the time, bad decisions would evidently be shown as arrogance, not ignorance: hence criminal and punishable. However, 5 years in a country Club Fed is not on - would prefer renting out an old Siberian gulag for these crims.