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Algos didn't cause the '08 crash. The '08 crash was caused by a lot of bad bets on the housing market. 100% of those bets were made by humans chatting on Bloo

Algos didn't cause the '08 crash. The '08 crash was caused by a lot of bad bets on the housing market. 100% of those bets were made by humans chatting on Bloomberg or over the telephone. Edit: No, child posts, you cannot make the leap that trend following algos are the same thing as modeling MBS risk (which isn't an algo...).

Retric 12y ago
Garbage in Garbage out. Algos directly caused the '08 crash (lot's of things where indirectly responsible though). Software Algorithms designed to model risks did not take into account a down economy which systemically undervalued risks leading to lots of over leveraged institutions to fail. Arguably, many of the people writing the software where instructed to 'tweak' their models to the point of uselessness. One of the major failing of modern statistics instruction is 6+ sigma events don't look like 1-5 sigma events. Case in point global death totals per second probably fit a very well defined curve, but Hiroshima and Nagasaki where well outside that curve.
- rainhacker 12y ago
  I believe, the underlying cause of '08 crash was short term profit mentality. Some large financial institutions knew that the financial instruments built on the top of sub-prime/very risky mortgages were bound to fail. So much, that some of them bet against the very instruments they sold off to investors. And there were other ones too, which predicted this successfully and made a lot of money.
- karmacondon 12y ago
  This is a misattribution. It's like saying "The nails caused the building to collapse". The people using the tools are to blame, not the tools themselves. The ratings agencies gave incorrect ratings to mortgage backed securities, humans made assumptions based on greed and individual home buyers made poor purchasing decisions. The flash crash was the result of bad algorithms, the tools acting on their own without significant human guidance or erroneous input. But that was a relatively minor event that temporarily affected professional market makers. Something like that could happen again, with a much larger impact. But the 2008 crash was not it, and wasn't related or even similar. It is difficult to predict 6+ sigma events, but humans as a whole are no better at it than algorithms are. There were plenty of people who saw things that others didn't and made big short bets against the housing market. The problem there is that everyone else didn't listen to them. Eventually we can improve statistics to catch more outliers. Good luck improving human nature to get people to listen to predictions that go against the herd.
  - busterarm 12y ago
    Full-on agreement with what you're saying here. And if someone really wants to place blame, it's pretty tough to ignore the regulatory and interest rate changes that created the environment that allowed it all to happen. But again, like you said, good luck improving human nature. Banks have shown themselves to be pretty irresponsible with (practically) free credit though. That's a mistake we shouldn't repeat again.
  - Retric 12y ago
    Edit: Direct Cause (businessdictionary.com) Alternative term for proximate cause. http://en.wikipedia.org/wiki/Proximate_and_ultimate_causation http://en.wikipedia.org/wiki/Proximate_and_ultimate_causatio... A proximate cause is an event which is closest to, or immediately responsible for causing, some observed result. This exists in contrast to a higher-level ultimate cause (or distal cause) which is usually thought of as the "real" reason something occurred. Often bad nails are the direct cause of a collapse. As in someone used 3 inch nails when they should have used 6 inch nails, or they were not rust resistant etc. In the end Root cause analysis is about looking past the direct cause to keep from repeating the same mistakes you need to look at both the direct case and dig further. In this case you look at algorithms misclassifying a lot of bad debt and then pealing back the layers. In the nails example it might be someone incompetent designed a foot bridge or someone tried to skim money by using 3 vs 6 inch nails or whatever. In the bridge example replacing the crooked supplier is all well and good, but you also need to fix all the other bridges made with 3 inch nails. PS: Where to place blame and the direct cause are far from the same thing.
- walru 12y ago
  Algos were stewards of the '08 crash, not the reason. It's dangerously naive to believe overexerted housing values and propped up fundamentals weren't to blame. Not to mention how institutional trust went out the window once it was discovered how poorly loans were written/packaged. Why wouldn't trend following be the winning strategy when the market stayed on a steady climb? Anyone who hasn't continued with that strategy, attempting to call a top to this current market, has probably taken a beating many times over. If anything, Algos helped to correct the market more quickly as those who chose poorly were washed away with greater speed.
bsdpython 12y ago
See my other answer here but basically I see all of these things as the same: find a trend, abstract it with algorithms/risk models, exploit that trend and then walk away when the trend inevitably breaks.

Retric 12y ago

Garbage in Garbage out. Algos directly caused the '08 crash (lot's of things where indirectly responsible though). Software Algorithms designed to model risks did not take into account a down economy which systemically undervalued risks leading to lots of over leveraged institutions to fail. Arguably, many of the people writing the software where instructed to 'tweak' their models to the point of uselessness. One of the major failing of modern statistics instruction is 6+ sigma events don't look like 1-5 sigma events. Case in point global death totals per second probably fit a very well defined curve, but Hiroshima and Nagasaki where well outside that curve.

rainhacker 12y ago
I believe, the underlying cause of '08 crash was short term profit mentality. Some large financial institutions knew that the financial instruments built on the top of sub-prime/very risky mortgages were bound to fail. So much, that some of them bet against the very instruments they sold off to investors. And there were other ones too, which predicted this successfully and made a lot of money.
karmacondon 12y ago
This is a misattribution. It's like saying "The nails caused the building to collapse". The people using the tools are to blame, not the tools themselves. The ratings agencies gave incorrect ratings to mortgage backed securities, humans made assumptions based on greed and individual home buyers made poor purchasing decisions. The flash crash was the result of bad algorithms, the tools acting on their own without significant human guidance or erroneous input. But that was a relatively minor event that temporarily affected professional market makers. Something like that could happen again, with a much larger impact. But the 2008 crash was not it, and wasn't related or even similar. It is difficult to predict 6+ sigma events, but humans as a whole are no better at it than algorithms are. There were plenty of people who saw things that others didn't and made big short bets against the housing market. The problem there is that everyone else didn't listen to them. Eventually we can improve statistics to catch more outliers. Good luck improving human nature to get people to listen to predictions that go against the herd.
- busterarm 12y ago
  Full-on agreement with what you're saying here. And if someone really wants to place blame, it's pretty tough to ignore the regulatory and interest rate changes that created the environment that allowed it all to happen. But again, like you said, good luck improving human nature. Banks have shown themselves to be pretty irresponsible with (practically) free credit though. That's a mistake we shouldn't repeat again.
- Retric 12y ago
  Edit: Direct Cause (businessdictionary.com) Alternative term for proximate cause. http://en.wikipedia.org/wiki/Proximate_and_ultimate_causation http://en.wikipedia.org/wiki/Proximate_and_ultimate_causatio... A proximate cause is an event which is closest to, or immediately responsible for causing, some observed result. This exists in contrast to a higher-level ultimate cause (or distal cause) which is usually thought of as the "real" reason something occurred. Often bad nails are the direct cause of a collapse. As in someone used 3 inch nails when they should have used 6 inch nails, or they were not rust resistant etc. In the end Root cause analysis is about looking past the direct cause to keep from repeating the same mistakes you need to look at both the direct case and dig further. In this case you look at algorithms misclassifying a lot of bad debt and then pealing back the layers. In the nails example it might be someone incompetent designed a foot bridge or someone tried to skim money by using 3 vs 6 inch nails or whatever. In the bridge example replacing the crooked supplier is all well and good, but you also need to fix all the other bridges made with 3 inch nails. PS: Where to place blame and the direct cause are far from the same thing.
walru 12y ago
Algos were stewards of the '08 crash, not the reason. It's dangerously naive to believe overexerted housing values and propped up fundamentals weren't to blame. Not to mention how institutional trust went out the window once it was discovered how poorly loans were written/packaged. Why wouldn't trend following be the winning strategy when the market stayed on a steady climb? Anyone who hasn't continued with that strategy, attempting to call a top to this current market, has probably taken a beating many times over. If anything, Algos helped to correct the market more quickly as those who chose poorly were washed away with greater speed.

bsdpython 12y ago

See my other answer here but basically I see all of these things as the same: find a trend, abstract it with algorithms/risk models, exploit that trend and then walk away when the trend inevitably breaks.