10 ms·

How would you connect the two events?

RichardCA 3y ago
I don't know what the mathematical underpinnings of those mortgage-backed derivatives were, but I know someone somewhere looked at all that math and decided the risk burden was acceptable. No one said hey, wait, the model is only as good as the assumptions you feed into it. The movie The Big Short got at this, but it was just a movie with Steve Carell standing in for that shocked person who doesn't seem to have really existed until after the assumptions failed and the collapse was inevitable. My point is you can't plead 20-20 hindsight.
- andruby 3y ago
  Housing prices hadn’t really gone down in the 20 or so years before 2008. So the “risk” of decreasing prices was just under-appreciated. When the firms started making tons of money, it’s probably easy to ignore the risk department. Margin call is another great movie. Doesn’t really explain the details of what went wrong, but I think it shows how a financial institution unravels when they accept that the risk is real and it is going to come down.
- RandomLensman 3y ago
  I'd say the maths wasn't that central compared to beliefs about the housing market or regulations focused on ratings.
- seanhunter 3y ago
  LTCM wasn't caused by anything like mortgage-backed securites. LTCM was doing ultra-leveraged short-term trades of various kinds. When they started these were arbitrages of various kinds so they had low risk and a solid edge but as more capital flowed into their fund, the capacity of those trades was exhausted and they put money into riskier other trades. Some of their counterparties were big banks who parked overnight funds in LTCM and then when they got spooked by some losses and yanked those funds, LTCM lost a staggering amount of money very quickly as a result and went bust. If you want an excellent book about LTCM, "When Genius Failed" is one of the best books ever written about the history of financial markets. The origins of the subprime mortgage crisis were a lot more complicated than most people give credit for and in particular I really wouldn't take "the big short" as any kind of reliable guide. For a good critical view of the crisis written by someone who actually knows what they are talking about I would recommend "Fools Gold" by Gillian Tett. Financial crises and crashes have happened since the dawn of human history and will probably continue to happen. Suffice to say that the 2008 crisis had nothing to do with thing things that caused LTCM to fail, and neither of them have anything to do with the insight behind the Black/Scholes/Merton model other than the fact that Scholes and Merton were I think on the board of LTCM.[1] [1] Fun fact, the other one of the three, Fischer Black was a quant at Goldman Sachs. So there's your 2008 crisis connection[2] [2] Or not. Fischer Black died in 1995.
dboreham 3y ago
The idea that you can somehow predict unpredictable things, if you wrap it in fancy math.

I don't know what the mathematical underpinnings of those mortgage-backed derivatives were, but I know someone somewhere looked at all that math and decided the risk burden was acceptable. No one said hey, wait, the model is only as good as the assumptions you feed into it. The movie The Big Short got at this, but it was just a movie with Steve Carell standing in for that shocked person who doesn't seem to have really existed until after the assumptions failed and the collapse was inevitable. My point is you can't plead 20-20 hindsight.

andruby 3y ago
Housing prices hadn’t really gone down in the 20 or so years before 2008. So the “risk” of decreasing prices was just under-appreciated. When the firms started making tons of money, it’s probably easy to ignore the risk department. Margin call is another great movie. Doesn’t really explain the details of what went wrong, but I think it shows how a financial institution unravels when they accept that the risk is real and it is going to come down.
RandomLensman 3y ago
I'd say the maths wasn't that central compared to beliefs about the housing market or regulations focused on ratings.
seanhunter 3y ago
LTCM wasn't caused by anything like mortgage-backed securites. LTCM was doing ultra-leveraged short-term trades of various kinds. When they started these were arbitrages of various kinds so they had low risk and a solid edge but as more capital flowed into their fund, the capacity of those trades was exhausted and they put money into riskier other trades. Some of their counterparties were big banks who parked overnight funds in LTCM and then when they got spooked by some losses and yanked those funds, LTCM lost a staggering amount of money very quickly as a result and went bust. If you want an excellent book about LTCM, "When Genius Failed" is one of the best books ever written about the history of financial markets. The origins of the subprime mortgage crisis were a lot more complicated than most people give credit for and in particular I really wouldn't take "the big short" as any kind of reliable guide. For a good critical view of the crisis written by someone who actually knows what they are talking about I would recommend "Fools Gold" by Gillian Tett. Financial crises and crashes have happened since the dawn of human history and will probably continue to happen. Suffice to say that the 2008 crisis had nothing to do with thing things that caused LTCM to fail, and neither of them have anything to do with the insight behind the Black/Scholes/Merton model other than the fact that Scholes and Merton were I think on the board of LTCM.[1] [1] Fun fact, the other one of the three, Fischer Black was a quant at Goldman Sachs. So there's your 2008 crisis connection[2] [2] Or not. Fischer Black died in 1995.

dboreham 3y ago

The idea that you can somehow predict unpredictable things, if you wrap it in fancy math.