Scientists of the subprime

‘Science of the subprime’ is currently available from BBC iplayer.

Overview

Mathematicians and scientists were complicit in the crash. Financiers were ‘in thrall to mathematics’, with people like Stiglitz and Soros ‘lone voices in the wilderness’. The ‘low point’ were derivatives, which were ‘fiendishly complicated’, yet ‘mathematical models’ convinced people to trade in them.

The problem was that liberalisation led to an increase in connectedness, which was thought to be a good thing, but that this went to far and led to a decrease in diversity, which made the whole system very fragile, eventually crashing. This was presented by Lord May from an ecological perspective.

Perhaps the most interesting part was that Lord May had tackled his lunching partner Mervyn King before the crash, and that in 2003 Andrew Haldane had independently come up with a ‘toy model’ that he felt compelling, but which failed to gain traction.

After the crash, none of the mainstream mathematical models gave any insight into what had gone wrong. The problem was that the models concerned single-point failures, not systemic failures [my words]. Since then Haldane and May have published a paper in Nature showing that structure matters.

The new activities are to generate financial maps, much like weather maps and transport maps.

One problem is diversity: the solution is

  • To ensure that banks suffer the consequences of their actions [no ‘moral hazard’].
  • To ’tilt the playing field’ against large players [the opposite of what is done now].

Another problem is the expectation of certainty: it must be recognized that sensible models can give insights but not reliable predictions.

In summary, the main story is that physics-based mathematics led decision-makers astray, and they wouldn’t be persuaded by Lord May or their own experts. There were also some comments on why this might be:-

Gillian Tett (FT) commented that decision makers needed predictions and the illusion of certainty from their models. A decision-maker commented on the tension between containing long-term risk and making a living in the short-run [but this was not developed]. Moreover, policy makers tend to search for data, models or theories to support their views: the problems are not due to the science as such, but the application of science

Comments

  • This broadly reflects and amplifies the Turner review, but I found it less appealing than Lord Turner’s recent INET interview.
  • Gordon Brown ‘at the top of the shop’ shared these concerns, but seems unable to intervene until his immediate post-crash speech. This seems to raise some interesting issues, especially if the key point was about financial diversity.
  • The underlying problem seems to be that the policy-makers and decision-makers are pragmatic, in a particular sense.
  • Even if the complexity explanation for the crash is correct, it is not clear that this is the only way that crashes can happen, so that pragmatic regulation based on ‘carry on but fix the hole’ may not be effective.
  • The explanations and observations are reminiscent of Keynes, Stiglitz, Soros and Brown have all commended Keynes pre crash, and many have recognized the significance of Keynes post-crash. Yet he is not mentioned. Before the 1929 crash he thought the sustained performance of the stock market remarkable, rather than taking it for granted. His theory was that it would remain stable just so long as everyone was able to trade and expected everyone else to be able to trade, and the central role of confidence has been recognized ever since. The programme ignored this, which seems odd as the behaviourist are also quite fashionable.
  • Keynes underpinning theory of probability [not mentioned] is linked to his tutor’s, Whitehead’s, process logic, which underpins much of modern science, including ecology. This makes the problem quite clear: if mathematicians and scientists are employed by banks and banks are run as ordinary commercial organisations then  they will be focussing on the short-term. The long-term is simply not their responsibility. That is what governments are for (at least according to Locke).  But the central machinery doesn’t seem to be up to it. We shouldn’t blame anyone not in government, academia or similar supposedly ‘for the common good’ organisations.
  •  There were plenty of mathematicians, scientists and economists (not just Lord May) who understood the issues and were trying hard to get the message across, many of them civil servants etc. If we don’t understand how they failed we may find ourselves in the same position again. I think that in the 90s and 00s everything became more ‘commercial’ and hence short-term. Or can we just kick out the Physicists and bring on the Ecologists?

See Also

General approach

Dave Marsay

Advertisements

About Dave Marsay
Mathematician with an interest in 'good' reasoning.

5 Responses to Scientists of the subprime

  1. Pingback: Pragmatism and mathematics | djmarsay

  2. sfnhltb says:

    I guess there is one particular problem that politicians face – if they detect a bubble has formed early on then they can do something about it. Once it is large enough, even if they can see what is happening, anything they do to try and deflate the bubble can easily lead to a crash which they will then be blamed for as it is easy to trace the cause and effect. Of course the hypothetical world in which they let the bubble keep growing bigger lending to a much more massive crash is no consolation when they get kicked out. It is easy to imagine the bubble that popped in 2007/08 lasting a couple more years and then if Obama had still been elected how the entire blame would be laid at his door just due to the time the bubble burst.

    • djmarsay says:

      Almost entirely agree. But a politician who comes to realise that he is responsible for bubble may feel that he is doomed if he admits it, but has a chance of pinning the blame elsewhere if he carries on.

  3. Pingback: Systemism: the alternative to individualism and holism | djmarsay

  4. Pingback: Haldane’s Tails of the Unexpected « djmarsay

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: