6 ms·

The bad models were a consequence of a fraudulent system. So by definition, the models weren't the cause of the financial crisis. Therefore the bad models were

The bad models were a consequence of a fraudulent system. So by definition, the models weren't the cause of the financial crisis. Therefore the bad models were an effect, in the same way the financial crisis was an effect. If this is true, then the author's claim (mix-up of cause and effect) must be correct.

deleted 14y ago
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Alex3917 14y ago
The easiest way to understand this is that even if the models were accurate, the financial crisis would still have occurred. So blaming the models would be confusing cause and effect regardless of whether you think the models were wrong intentionally or unintentionally. That said, I didn't read the book so I have nothing to say about whether or not Nate Silver actually does this.
- cube13 14y ago
  In order for this to be true, she needed to make the argument that it is. She's not saying anything to that effect at all.
  - sillysaurus 14y ago
    If her point wasn't "corruption caused the financial meltdown," then why did she write this piece? The simplest explanation is that she was, in fact, arguing that corruption caused the financial crisis.
- mbucc 14y ago
  The models certainly contributed. (Note: I have read this far in the book.) The modeling error in question was independence; that is, if you have five mortgages, each with a 5% change of default, then these can be packaged up as an AAA security as follows: you only lose your money if all five default. A bit riskier package is that you lose if 4/5 default. And so on, each with different returns. If they are independent, the p(default) = 1/20^5. If they are dependent, it is 1/20. Now multiple mortgage pool size by a 100 or 1,000 or 10,000 (?) and see how far off the estimated risk is. :) Now combine this with a 30-to-1 leverage when buying these "AAA" securities. (This was quite a good problem to work through with my daughter to see what that little "independence" assumption means. :) His main point here was that modeling failures are typically due to out-of-sample conditions; when the housing bubble broke, the markets were might more tightly coupled across the country than the modelers assumed. While they could have seen this kind of dependence if they looked to Japan, there was no such precedence in the US in recent history.
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  - jeltz 14y ago
    This is a beginner mistake which I have a hard time believing the entire mortgage market failed to spot. My personal belief is that they knew of the flaw of the models but did not care since their personal incentives were more profitable if the model was not fixed.
    - hindsightbias 14y ago
      As Michael Lewis found in the Big Short. His Liar's Poker (from the 80's) explains the mentality. As he says in the former, he thought the latter would be the be-all end-all. But the kids in Business School would constantly write him and ask him for new ways to rig the game.
cube13 14y ago
But it's not. She states: >Rather, the entire industry crucially depended on the false models. Indeed they changed the data to conform with the models, which is to say it was an intentional combination of using flawed models and using irrelevant historical data (see points 64-69 here for more). So C(corruption) directly leads to B(bad model). She does not argue that A(everything falling apart)<-C anywhere in the piece. Silver is claiming that A<-B. He is not commenting about C. So while Silver's claim may not identify the absolute root cause, the author does not actually prove that his cause and effect analysis is flawed. If anything, she has shown that it may be incomplete.
- sillysaurus 14y ago
  But it's not [true]. What, specifically, isn't true? So C(corruption) directly leads to B(bad model). She does not argue that A(everything falling apart)<-C anywhere in the piece. The point of the piece is that the financial meltdown stemmed from corruption, not from models. If this wasn't her point, then why else would she have written this piece?
  - cube13 14y ago
    She does not prove that claim, though. She argues that corruption causes bad models. For Silver's cause and effect analysis to be incorrect, she needed to prove that the inaccurate models had absolutely nothing to do with the financial meltdown.
    - deleted 14y ago
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    - btilly 14y ago
      The models can be part of the meltdown without really being a cause. If I choose to shoot you with a gun, and have a variety of appropriate guns, it is not the fault of the specific gun chosen that it was used to kill you. I had motive, opportunity, and alternate means available.
chc 14y ago
You're imposing a cause/effect dichotomy that doesn't actually exist. Most causes are effects of something else. When we talk about mixing up cause and effect, we mean that A is said to have caused B when in actuality A was caused by B. Showing that A was caused by C does not mean that we've mixed up cause and effect, because nobody said A caused C.
hsitz 14y ago
"The bad models were a consequence of a fraudulent system. So by definition, the models weren't the cause of the financial crisis. Therefore the bad models were an effect, in the same way the financial crisis was an effect." This is faulty reasoning. A pool ball may go into a pocket because it was hit by a cue ball. In this case the cue ball hitting the other ball is the cause of the other ball falling into the pocket. Yes, you can look back into the chain of causes to find one further back, e.g., the fact that a person used a pool cue to hit the cue ball into the other ball. This doesn't mean that the first cause you found was not a cause, and certainly doesn't mean that "by definition". If a corrupt and fraudulent system could have brought about the financial crisis by some means other than causing bad models (which I assume is true), then you can say that the bad models were not a necessary part of the causal chain. But you can't say that they weren't part of the causal chain at all. As a matter of fact (at least according to assumptions everyone is making in this topic's thread) they were.
- tomkarlo 14y ago
  I'm not sure you can get to the financial crisis without faulty models. Risk models, especially on packaged securities, are crucial to setting ratings as a proxy for risk. Those ratings are key to determining pricing, maximum leverage, and which portfolios can buy them. If the models had been more accurate - for example, if they had more properly reflected the way that the value of a bundle of mortgages will suddenly lose value as housing prices decline - banks would not have been able to pile up such huge risks and high leverage. You can only justify things like 30X leverage if you believe the securities in question have essentially no risk - because at that leverage, a 3% loss in value means you're wiped out.
  - pdonis 14y ago
    I'm not sure you can get to the financial crisis without faulty models. Sure you can. The root cause of the crisis was people gaming the system. There are many ways to game the system; faulty models are only one of them.
    - tomkarlo 14y ago

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Alex3917 14y ago

The easiest way to understand this is that even if the models were accurate, the financial crisis would still have occurred. So blaming the models would be confusing cause and effect regardless of whether you think the models were wrong intentionally or unintentionally. That said, I didn't read the book so I have nothing to say about whether or not Nate Silver actually does this.

cube13 14y ago
In order for this to be true, she needed to make the argument that it is. She's not saying anything to that effect at all.
- sillysaurus 14y ago
  If her point wasn't "corruption caused the financial meltdown," then why did she write this piece? The simplest explanation is that she was, in fact, arguing that corruption caused the financial crisis.
mbucc 14y ago
The models certainly contributed. (Note: I have read this far in the book.) The modeling error in question was independence; that is, if you have five mortgages, each with a 5% change of default, then these can be packaged up as an AAA security as follows: you only lose your money if all five default. A bit riskier package is that you lose if 4/5 default. And so on, each with different returns. If they are independent, the p(default) = 1/20^5. If they are dependent, it is 1/20. Now multiple mortgage pool size by a 100 or 1,000 or 10,000 (?) and see how far off the estimated risk is. :) Now combine this with a 30-to-1 leverage when buying these "AAA" securities. (This was quite a good problem to work through with my daughter to see what that little "independence" assumption means. :) His main point here was that modeling failures are typically due to out-of-sample conditions; when the housing bubble broke, the markets were might more tightly coupled across the country than the modelers assumed. While they could have seen this kind of dependence if they looked to Japan, there was no such precedence in the US in recent history.
- deleted 14y ago
  [deleted]
- jeltz 14y ago
  This is a beginner mistake which I have a hard time believing the entire mortgage market failed to spot. My personal belief is that they knew of the flaw of the models but did not care since their personal incentives were more profitable if the model was not fixed.
  - hindsightbias 14y ago
    As Michael Lewis found in the Big Short. His Liar's Poker (from the 80's) explains the mentality. As he says in the former, he thought the latter would be the be-all end-all. But the kids in Business School would constantly write him and ask him for new ways to rig the game.

cube13 14y ago

But it's not. She states: >Rather, the entire industry crucially depended on the false models. Indeed they changed the data to conform with the models, which is to say it was an intentional combination of using flawed models and using irrelevant historical data (see points 64-69 here for more). So C(corruption) directly leads to B(bad model). She does not argue that A(everything falling apart)<-C anywhere in the piece. Silver is claiming that A<-B. He is not commenting about C. So while Silver's claim may not identify the absolute root cause, the author does not actually prove that his cause and effect analysis is flawed. If anything, she has shown that it may be incomplete.

sillysaurus 14y ago
But it's not [true]. What, specifically, isn't true? So C(corruption) directly leads to B(bad model). She does not argue that A(everything falling apart)<-C anywhere in the piece. The point of the piece is that the financial meltdown stemmed from corruption, not from models. If this wasn't her point, then why else would she have written this piece?
- cube13 14y ago
  She does not prove that claim, though. She argues that corruption causes bad models. For Silver's cause and effect analysis to be incorrect, she needed to prove that the inaccurate models had absolutely nothing to do with the financial meltdown.
  - deleted 14y ago
    [deleted]
  - btilly 14y ago
    The models can be part of the meltdown without really being a cause. If I choose to shoot you with a gun, and have a variety of appropriate guns, it is not the fault of the specific gun chosen that it was used to kill you. I had motive, opportunity, and alternate means available.

chc 14y ago

You're imposing a cause/effect dichotomy that doesn't actually exist. Most causes are effects of something else. When we talk about mixing up cause and effect, we mean that A is said to have caused B when in actuality A was caused by B. Showing that A was caused by C does not mean that we've mixed up cause and effect, because nobody said A caused C.

hsitz 14y ago

"The bad models were a consequence of a fraudulent system. So by definition, the models weren't the cause of the financial crisis. Therefore the bad models were an effect, in the same way the financial crisis was an effect." This is faulty reasoning. A pool ball may go into a pocket because it was hit by a cue ball. In this case the cue ball hitting the other ball is the cause of the other ball falling into the pocket. Yes, you can look back into the chain of causes to find one further back, e.g., the fact that a person used a pool cue to hit the cue ball into the other ball. This doesn't mean that the first cause you found was not a cause, and certainly doesn't mean that "by definition". If a corrupt and fraudulent system could have brought about the financial crisis by some means other than causing bad models (which I assume is true), then you can say that the bad models were not a necessary part of the causal chain. But you can't say that they weren't part of the causal chain at all. As a matter of fact (at least according to assumptions everyone is making in this topic's thread) they were.

tomkarlo 14y ago
I'm not sure you can get to the financial crisis without faulty models. Risk models, especially on packaged securities, are crucial to setting ratings as a proxy for risk. Those ratings are key to determining pricing, maximum leverage, and which portfolios can buy them. If the models had been more accurate - for example, if they had more properly reflected the way that the value of a bundle of mortgages will suddenly lose value as housing prices decline - banks would not have been able to pile up such huge risks and high leverage. You can only justify things like 30X leverage if you believe the securities in question have essentially no risk - because at that leverage, a 3% loss in value means you're wiped out.
- pdonis 14y ago
  I'm not sure you can get to the financial crisis without faulty models. Sure you can. The root cause of the crisis was people gaming the system. There are many ways to game the system; faulty models are only one of them.
  - tomkarlo 14y ago