6 ms·

Remember the Gall-Mann amnesia effect: expert believing news articles on topics outside of their field of expertise even after acknowledging that articles writt

by bko 8y ago

Remember the Gall-Mann amnesia effect: expert believing news articles on topics outside of their field of expertise even after acknowledging that articles written in the same publication that are within the expert's field of expertise are error-ridden and full of misunderstanding While the article mentions the 2008 financial crisis, it does not mention that CLOs existed prior to the crisis and performed well during that time, much better than other securitized products. > The CLO asset class has performed strongly, according to a recent report from S&P (“Twenty Years Strong: A Look Back At U.S. CLO Ratings Performance From 1994 Through 2013”), with few negative rating actions on senior notes due to underlying collateral deterioration, few defaults, and minimal loss rates since the agency started rating the asset class in the mid-1990s... Looking at the default statistics, of the over 6,100 ratings issued by S&P on over 1,100 U.S. CLO transactions, only 25 tranches have defaulted and had their rating lowered to D as a result. Based on this, S&P calculated a 0.41% default rate, or just over four tranches for every 1,000 it has rated. The reason is that the collateral is higher in the capital structure than debt so defaults are much less likely and recoveries in case of default are higher. I don't like how pop-financial articles talk about risk and debt. Companies aren't "risky" like a crappy car is risky. It's not that they cut corners and put lives at risk. Leverage and debt are normally conscious decisions made by the company. There is some optimal debt level that they strive for. The higher the debt, the higher the cost, but the greater return you can make. So like anything it's a trade off. I also resent the fact that any company with a non-investment grade debt rating is written off as unworthy of credit. [0] http://www.leveragedloan.com/sp-report-clos-show-strong-historic-performance-with-few-defaults/ http://www.leveragedloan.com/sp-report-clos-show-strong-hist...

gvhst 8y ago
Thank you for saying this. In all honesty, the leverage loan (and thereby CLO) issues we are seeing now aren't really an issue of complexity. It's really an issue of how underwriting standards are deteriorating as more and more parties compete for these leverage loan deals to put into their CLOs. Companies can also fall into the trap of, "well I'm able to raise debt at these terms so I should be able to afford it." I will admit that complex securitization structures can obfuscate this risk, but the underlying financial risk comes from the cyclical properties of the collateral asset class (i.e. the credit cycle), not from the structure itself.
- whatok 8y ago
  Underwriting standards are definitely deteriorating and debt covenants are just crazy in some cases so in all likelihood, recoveries should be lower during this credit cycle. That said, a capital structure is a capital structure and loans are still up there.
ratel 8y ago
A financial product that is said to be a strong and will never fail according to some commercial analysts. Although other experts seem to disagree. (Deja vu) Trading CLO's has been expanding. One could argue far beyond a point where there is enough safe companies to lend to. That must mean the risk for CLO's is growing (Deja vu again) Continues low interest rates make people look for better returns on their investments and people selling products to fill that need. They may forget to make sure their clients understand that there are no save investments in the market at current Fed rates. (Can we say deja vu) CLO's now cover leveraged loans, meaning loans with no collateral other than future profit. Like people taking out mortgages on for-rent properties. (Deja vu, deja vu)
- gpsx 8y ago
  Back in the 2008 financial crisis I read articles about what went wrong, but I am not sure I understood exactly what was going on so well. I filled in details mysefl by guessing. Maybe someone can clarify this? When they combine a number of risky assets into a single asset, they factor in an assumption that a number of these will fail. Others will not and given the payoff of those, the net investment pays off. I don't know much about finance and how they do these calculations, so I'm going to say something dumb here, and maybe someone can tell me if they are being this dumb (or dishonest) when the calculate these things. Forgive the "explain it like I am 5" description. There is a naive way of combining these probabilities which high school students probably know. However, this assumes the outcomes in question are not correlated. For example if you flip two coins, the probability of each coming up heads is .5 and they are not correlated, so the probability of getting two heads on two coin tosses is .25. Of course, if the events are correlated, then that formula doesn't work any more. For example, if there is a new Quantum Coin Toss Manipulator (because we all know it would have to be quantum) that makes all coins flips near it come up the same, then the probability of getting 2 heads when you do two coin tosses is no longer .25 but instead it is .5. And, if you do 100 coin tosses, the probability is still .5 of getting all heads. Back to the CDOs or CLOs. The chance of individual components failing is clearly not completely independent. Economic conditions such as a big recession presumably will have similar effects on the different components. So the naive formula does not apply. Hopefully they are not being that naive or dishonest, but it seems like it would be pretty tricky to estimate the correlation and correspondingly difficult to estimate the true risk. Is it that case that they are just not good at estimating the correlation in the risks of these different assets?
paulsutter 8y ago
A 20 year history doesn't invalidate the facts at hand. The CDOs in the 2008 crisis were designed for uncorrelated risks, but in a real estate bubble driven by too-lax lending standards, the risks were all too correlated. Before the downturn this was stated by the New York Times, numerous finance blogs, and this golden quote: "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing." Chuck Prince, July 10th, 2007 (then Citigroup CEO)
- pmart123 8y ago
  Another component to this is that the marketing materials in CLO products always highlight zero default history, even through 2008, but what if the government didn’t backstop AIG, the banks, GE, etc? Safer tranches were saved from default as a product of action by Paulson and the fed before there were more defaults rather than the perceived risk control imo.
dragontamer 8y ago
> Remember the Gall-Mann amnesia effect: expert believing news articles on topics outside of their field of expertise even after acknowledging that articles written in the same publication that are within the expert's field of expertise are error-ridden and full of misunderstanding This trope is tired and very annoying each time I see it come up. I'm an expert in Programming Computers (at least, that's my job, so I assume I'm an expert). So I laugh at WashPo or New York Times, or Bloomberg whenever they make simple computer-related errors in their article. But guess what? I'm not paying Wash Po for my computer news. I'm paying ACM or IEEE actually for computer news. But ACM / IEEE have no news on financial markets. (Bloomberg is an expert newspaper in the realm of finance). ACM / IEEE don't have many articles on politics. Washington Post is far better at describing the daily political issues in the capital. Al Jazeera gets American news incredibly wrong sometimes. But I'll trust Al Jazeera on middle-eastern news over almost any American-based paper (aside from Wash. Po, which has a solid foreign politics / world politics section). Throw in a few "Conservative" newspapers for the conservative slant on issues, and you can get a decent balance of news from a variety of sources. I don't expect general Newspapers to be an expert in my field. I read newspapers to learn about things OUTSIDE of my realm of expertise. Believe it or not, newspapers have "specialties", and they're quite good if you read them based on what they're actually an expert in. ------- Honestly, I don't read too much NY Times, so I dunno what they're an expert in. Financial news is definitely a Bloomberg thing IMO.
- pmart123 8y ago
  Bloomberg, FT, institutional investor, CFA, abnormalreturns.com does a decent job of aggregating. Sometimes Barron’s is ok. Blogs and podcasts can be better. It’s always good in finance to think “does this guy have an agenda or bias to push?” when a famous investor is being interviewed.
  - dragontamer 8y ago
    Individual blogs are good if you know the individual author and trust them well. Basically, a blog is great to follow a specific person you trust. But individuals still only have expertise in a narrow field. I'm not going to be reading Herb Sutter's blog for Java-programming news, or "The Old New Thing" (Windows-blog) for even Linux-ARM news. I read Herb Sutter for C++, Old New Thing for Windows-specific stuff. To get more information from a wider variety of sources, you end up reading Newspapers. You learn to trust the editor, a non-expert but someone who tries to promise quality of their writers follows a certain code. Even within a newspaper, different editors handle different sections (the OpEd section of WashPo is less factual than other sections) As long as you understand the trust model of various sites or newspapers, things are good. Some amateurs on "Seeking Alpha" or "Medium" are pretty darn good with their analysis, you just gotta learn their names and follow them specifically.

by bko 8y ago

gvhst 8y ago

Thank you for saying this. In all honesty, the leverage loan (and thereby CLO) issues we are seeing now aren't really an issue of complexity. It's really an issue of how underwriting standards are deteriorating as more and more parties compete for these leverage loan deals to put into their CLOs. Companies can also fall into the trap of, "well I'm able to raise debt at these terms so I should be able to afford it." I will admit that complex securitization structures can obfuscate this risk, but the underlying financial risk comes from the cyclical properties of the collateral asset class (i.e. the credit cycle), not from the structure itself.

whatok 8y ago
Underwriting standards are definitely deteriorating and debt covenants are just crazy in some cases so in all likelihood, recoveries should be lower during this credit cycle. That said, a capital structure is a capital structure and loans are still up there.

ratel 8y ago

A financial product that is said to be a strong and will never fail according to some commercial analysts. Although other experts seem to disagree. (Deja vu) Trading CLO's has been expanding. One could argue far beyond a point where there is enough safe companies to lend to. That must mean the risk for CLO's is growing (Deja vu again) Continues low interest rates make people look for better returns on their investments and people selling products to fill that need. They may forget to make sure their clients understand that there are no save investments in the market at current Fed rates. (Can we say deja vu) CLO's now cover leveraged loans, meaning loans with no collateral other than future profit. Like people taking out mortgages on for-rent properties. (Deja vu, deja vu)

gpsx 8y ago
Back in the 2008 financial crisis I read articles about what went wrong, but I am not sure I understood exactly what was going on so well. I filled in details mysefl by guessing. Maybe someone can clarify this? When they combine a number of risky assets into a single asset, they factor in an assumption that a number of these will fail. Others will not and given the payoff of those, the net investment pays off. I don't know much about finance and how they do these calculations, so I'm going to say something dumb here, and maybe someone can tell me if they are being this dumb (or dishonest) when the calculate these things. Forgive the "explain it like I am 5" description. There is a naive way of combining these probabilities which high school students probably know. However, this assumes the outcomes in question are not correlated. For example if you flip two coins, the probability of each coming up heads is .5 and they are not correlated, so the probability of getting two heads on two coin tosses is .25. Of course, if the events are correlated, then that formula doesn't work any more. For example, if there is a new Quantum Coin Toss Manipulator (because we all know it would have to be quantum) that makes all coins flips near it come up the same, then the probability of getting 2 heads when you do two coin tosses is no longer .25 but instead it is .5. And, if you do 100 coin tosses, the probability is still .5 of getting all heads. Back to the CDOs or CLOs. The chance of individual components failing is clearly not completely independent. Economic conditions such as a big recession presumably will have similar effects on the different components. So the naive formula does not apply. Hopefully they are not being that naive or dishonest, but it seems like it would be pretty tricky to estimate the correlation and correspondingly difficult to estimate the true risk. Is it that case that they are just not good at estimating the correlation in the risks of these different assets?

paulsutter 8y ago

A 20 year history doesn't invalidate the facts at hand. The CDOs in the 2008 crisis were designed for uncorrelated risks, but in a real estate bubble driven by too-lax lending standards, the risks were all too correlated. Before the downturn this was stated by the New York Times, numerous finance blogs, and this golden quote: "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing." Chuck Prince, July 10th, 2007 (then Citigroup CEO)

pmart123 8y ago
Another component to this is that the marketing materials in CLO products always highlight zero default history, even through 2008, but what if the government didn’t backstop AIG, the banks, GE, etc? Safer tranches were saved from default as a product of action by Paulson and the fed before there were more defaults rather than the perceived risk control imo.

dragontamer 8y ago

> Remember the Gall-Mann amnesia effect: expert believing news articles on topics outside of their field of expertise even after acknowledging that articles written in the same publication that are within the expert's field of expertise are error-ridden and full of misunderstanding This trope is tired and very annoying each time I see it come up. I'm an expert in Programming Computers (at least, that's my job, so I assume I'm an expert). So I laugh at WashPo or New York Times, or Bloomberg whenever they make simple computer-related errors in their article. But guess what? I'm not paying Wash Po for my computer news. I'm paying ACM or IEEE actually for computer news. But ACM / IEEE have no news on financial markets. (Bloomberg is an expert newspaper in the realm of finance). ACM / IEEE don't have many articles on politics. Washington Post is far better at describing the daily political issues in the capital. Al Jazeera gets American news incredibly wrong sometimes. But I'll trust Al Jazeera on middle-eastern news over almost any American-based paper (aside from Wash. Po, which has a solid foreign politics / world politics section). Throw in a few "Conservative" newspapers for the conservative slant on issues, and you can get a decent balance of news from a variety of sources. I don't expect general Newspapers to be an expert in my field. I read newspapers to learn about things OUTSIDE of my realm of expertise. Believe it or not, newspapers have "specialties", and they're quite good if you read them based on what they're actually an expert in. ------- Honestly, I don't read too much NY Times, so I dunno what they're an expert in. Financial news is definitely a Bloomberg thing IMO.

pmart123 8y ago
Bloomberg, FT, institutional investor, CFA, abnormalreturns.com does a decent job of aggregating. Sometimes Barron’s is ok. Blogs and podcasts can be better. It’s always good in finance to think “does this guy have an agenda or bias to push?” when a famous investor is being interviewed.
- dragontamer 8y ago
  Individual blogs are good if you know the individual author and trust them well. Basically, a blog is great to follow a specific person you trust. But individuals still only have expertise in a narrow field. I'm not going to be reading Herb Sutter's blog for Java-programming news, or "The Old New Thing" (Windows-blog) for even Linux-ARM news. I read Herb Sutter for C++, Old New Thing for Windows-specific stuff. To get more information from a wider variety of sources, you end up reading Newspapers. You learn to trust the editor, a non-expert but someone who tries to promise quality of their writers follows a certain code. Even within a newspaper, different editors handle different sections (the OpEd section of WashPo is less factual than other sections) As long as you understand the trust model of various sites or newspapers, things are good. Some amateurs on "Seeking Alpha" or "Medium" are pretty darn good with their analysis, you just gotta learn their names and follow them specifically.