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"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
by 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 agoI'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 agoI'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 agoOkay, but all routes to that gaming - at least at the institutional level - ran through being able to do it without it impacting credit ratings. Credit ratings and security pricing are very dependent on statistical models for risk, in particular correlation and downside outcomes.
- pdonis 14y agoall routes to that gaming All routes to that particular method of gaming. There are other methods.