Articles Written by Christian Grossman
This financial crisis has many people saying it was this that or the other thing. I want to present this FAQ as a reference point of what happened. If anybody wishes to add something please send me an email or comment and we can discuss it.
Who is at fault
There are two main culprits, the regulators and politicians, and the quants. Some like to argue that Alan Greenspan is the main culprit because of his low interest rate policy. I personally believe Alan Greenspan is an actor, but not a main actor. I like to think that the Fed is a catalyst.
Why are the regulators and politicians at fault?
The regulators and politicians dropped the ball and let people like Casey Serin get loans. Casey wanted to consider himself a real estate mogule and flipped one house successfully. Then he went full hog and decided to buy 7 more houses that all went into foreclosure. Casey did misrepresent his situation on paper and the banks went right along with it.
You could say, well the bank should not have given him the loan. Yes, yes all true, but like Alan Greenspan a catalyst, not the main problem.
Put this into a bigger context imagine a client that buys a large amount of widgets from you. Would you let them without any down payment, without any real proof of who they are?
Those types of loans are not allowed in countries like Canada, Germany, France, and Switzerland. They had no place in America, and the regulators / politicians should have known better. Note had these other countries allowed these practices the same thing would have resulted.
Why did the regulators and politicians drop the ball? Who knows.
Why are the quants at fault?
On this topic I am not going to get any love from my peers. The problem with the quants is that they misrepresented the risk. Let me illustrate.
Imagine setting up a credit risk profile. And in that profile you have different risk groups. You would have the people with the best credit, and then you have people with ok credit, and then unknown risk credit.
Take these risk profiles and apply some statistical analysis where 99.9999% of the people in the best credit pay their loans, and 96% of the people in the unknown risk pay their loans. A bank could then say if they have unknown risk loans on their books 4% will go belly up. Thus people in this risk profile have to pay for those that do belly up. In real life you know about this by your credit score. You know that the lower the credit score you have the more you have to pay.
The problem is that Statisticians have repeatedly said that statistics is for telling you what happened in the past and not what will happen in the future.
The quants created elaborate structures and instruments based on the 4% default rate with some play for error. When the defaults go beyond this boundary the structures collapse and due to the leverage causes a domino effect.
What happened is that as the prices of real estate went up more people wanted in and more people misrepresented their backgrounds. Thus people gamed the statistics and threw the models into a tailspin. After all it is not statistically possible to all of the sudden have everybody seem to be a millionaire.
Will the consumer suffer and end the consumer?
I actually think the consumer will pull this market out of the doldrums. Up to now it has been the hedge funds, investment banks and so on playing games with the markets. Now with the investment banks and hedge funds being squeezed we will get back to fundamentals.
Did we not go through this with LTCM?
For those wondering about LTCM please go to wikipedia and read it. And the answer is that yes we went through it with LTCM. The problem is that the quants still managed to convince enough people that their system worked.
Statistics do work, until they don’t work. To understand that you need to look at Taleb’s work "Fooled by Randomness" or "The Black Swan". I myself use statistics and probabilities when doing calculations. And I do the exact same thing as the quants. Though I like to keep my greed and risk profile in check.
Of course you could argue that, "Christian that is what the other quants said." You are right, and time will tell, but as I said statistics work so long as you are aware that things can go awfully wrong.
Is this the end of the financial system?
No, not at all. Anybody who yells and cries that the financial system will collapse does not understand the financial system. Those who participated in the risk will have problems.
I would actually argue that we will get back to normal. I think finally commodity prices will fall because those investment banks and traders that drove up the prices will have no money. Now the price of commodities will reflect the true demand. We will not get 40 USD oil, but I could easily see 80 USD oil. And that would be good.
Monday, Sep. 15, 2008
by Christian
In the fall I am giving a class at a conference that is an introduction to financial engineering for software developers. I have talked to my clients, and talked to people at the IB I work at.
Yet all of their answers results in what could be called statistical insignificance. So I thought, why not throw it out to the readers. If you were to attend a talk called Introduction to Financial Engineering for Software Developers, what would you expect to hear?
I don’t want to give any ideas since ideas lead you down certain paths…
Friday, Sep. 12, 2008
by Christian
The question is if Fanny and Freddie is the right action at the right time or if it is socialism? Many like to say hey this is an act of the USSR or what have you.
Let me give the perspective of a non-American. Though let me give you the perspective of somebody who likes America, has American friends and is pro-American.
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Wednesday, Sep. 10, 2008
by Christian
I get a magazine called Stocks. In last week’s stock magazine there was a short article on the investing habits of 2,300 private people worth a total 60 million USD. This study was commissioned by Barclays Wealth.
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Monday, Sep. 8, 2008
by Christian
Before I continue, look at the following image which represents my political leanings (courtesy of www.politicalcompass.org). I have repeatedly taken this test and it always comes out to the same thing: Slightly right, quite a bit libertarian.
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Monday, Sep. 8, 2008
by Christian
Ok what to do with Russia? It seems that there is a new power struggle yes? Between the West and Russia, yes?
Well, not so quick. My brother who works in Russia and keeps me up to date with the events within the land has a different story. Essentially what is happening in Georgia is very similar to what happened with Kosovo. The difference is that Kosovo wanted to be nearer to the West and the Georgian states want to be nearer to Russia. But we can debate this issue round and round and round.
The real question is what do you do with Russia? Answer it depends on your nationality.
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Wednesday, Aug. 27, 2008
by Christian
Fastmoney and many on CNBC say, "oh look how bad things are in Germany and how we are doing better. And how bad things will get in Europe"
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Tuesday, Aug. 26, 2008
by Christian
"Debit cards are making us more resilient in this recession… oh wait.. let me take that back…"
Friday, Aug. 22, 2008
by Christian
CNBC did an entire 3 hour expose on Buffett and I.O.U.USA. Well I don’t agree with everything. Two of his points that stuck with me are as follows:
- When the tide goes out you will see who is swimming naked, and it seems Wallstreet was a nudist beach.
- If you apply for a mortgage using the old yardsticks then you can get a mortgage.
These two points stuck in my mind because I have talked to quite a few people around this planet and asked, "is it that bad?" The answer is no, it is not that bad. BUT there is a caveat. If the person was conservative and did not buy two or three houses then all is ok. If however the people lived beyond their means then things are not great. Quite a few of those asked, including my wife and I are actually grateful for this downdraft because we could buy homes without paying an outrageous fee. One friend who lives in San Francisco said, "you know it is good that this happened since now we can a house." Meaning they were on the sidelines until now. This information re-affirms my thinking that it is the rich and leveraged that are having lots of problems.
The second issue and it ties into the first is that the creative financing of the past is done for. People will need to save and live within their means. Though this is less of a problem outside of North America, then inside North America.
I am a bullish on the future! Of course I am not buying caviar, and salmon. I am still buying my hotdog’s on special with sauerkraut.
Friday, Aug. 22, 2008
by Christian
Oil is up over 5 dollars, and why is that? It’s Russia! It’s Fay and its potential to hit something! Oh it’s the rebels in Nigeria that are being rebellious!
WHATEVER!!!
Want to know why oil is up? It’s because Goldman said the following:
LONDON, Aug 20 (Reuters) - Goldman Sachs (GS.N: Quote, Profile, Research, Stock Buzz) reiterated on Wednesday its year-end price forecast of $149 a barrel for U.S. crude oil, and said strong fundamentals were a more important factor than a strengthening dollar.
And what do the lemming fund managers do? Oh they buy oil, because Goldman said it would go up. But of course a fund manager can’t say that. They have to say, "hey it is the rebelious rebels of Nigeria that are the problems."
Lemmings! That’s right, all of you fund managers are lemmings! Folks I have become completely disgusted with these overpaid fund managers. Heck you can get these returns by just investing in ETF’s and waiting for some comments from Goldman or what have you.
But this oil spike will be short lived because there is real demand destruction. People have changed habits and they will use less oil. EVEN in China!
Thursday, Aug. 21, 2008
by Christian
