It Was a Tulip Craze

This article from Wired Magazine (somewhat similar to this article from the N.Y. Times a month ago) seems to me to confirm that the present financial meltdown was caused by a sort of modern tulip mania, this time for collateralized debt obligations. A taste:

What is the chance that any given home will decline in value? You can look at the past history of housing prices to give you an idea, but surely the nation’s macroeconomic situation also plays an important role. And what is the chance that if a home in one state falls in value, a similar home in another state will fall in value as well?

Enter [David X.] Li…. Using some relatively simple math—by Wall Street standards, anyway—Li came up with an ingenious way to model default correlation without even looking at historical default data. Instead, he used market data about the prices of instruments known as credit default swaps. . . . It was a brilliant simplification of an intractable problem. . . .

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The Limitations of “Rot”

I was going to do this as a comment to Jessica’s post on Frank Pasquale’s post on the rot in America’s financial system, but it got a bit long, so I decided to make it a post.

Jessica cites to a post on Concurring Opinions which relies, to some extent, on a comment in response to a post that I wrote on Prawfs. It’s a small blogosphere after all.

There is much to be said in response to the Pasquale post (which I agree is provocative), but I want to focus on one part that Jessica highlights:

Can anyone doubt that our economy is exposed (with each passing day) as more Sicilian in its “winners’” casual acceptance of fraud, more Russian in its oligarchic tendencies, more Brazilian in its inequality?

Well, I think I can.

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Frank Pasquale Blogging About “A Deep Rot at the Core of American Finance and Politics”

Over at Concurring Opinions, Frank Pasquale has written a post entitled “The Economics Was Fake But the Bonuses Were Real.”  If you find yourself wondering lately about whether and how we will “rebuild the trust necessary for a thriving economy” (Pasquale’s words), it’s worth reading.  He discusses, for instance, the recent and somewhat surprising statements by a “shaken Richard Posner,” who seems to be losing his faith in law and economics. And he describes the profound opportunism at the base of our economic crisis:

The current crisis exposes the fragility of markets generally. They are built on mutual reciprocity, and as more opportunism from trusted intermediaries is exposed, the weaker our faith in other market actors becomes. Both Francis Fukuyama’s work on trust and Robert Putnam’s on the “social capital” it reflects bode ill for our economy. Putnam describes a southern Italy mired in corruption and fraud, and a northern Italy whose economic success is built on its long history of civic associations and mutual endeavor. Can anyone doubt that our economy is exposed (with each passing day) as more Sicilian in its “winners'” casual acceptance of fraud, more Russian in its oligarchic tendencies, more Brazilian in its inequality? After the Madoff scandal, what are investors to do–personally spot-check their broker’s office and assure that trades are actually being made?

There is a bunch of other interesting stuff in this post, but I think I’ll just end with my favorite part.  In discussing the “worship of wealth,” Pasquale quotes from the blog of former fund manager John Bogle:

At a party given by a billionaire on Shelter Island, the late Kurt Vonnegut informs his pal, the author Joseph Heller, that their host, a hedge fund manager, had made more money in a single day than Heller had earned from his wildly popular novel Catch 22 over its whole history. Heller responds, “Yes, but I have something he will never have . . . Enough.”

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