Sunday, 12 February 2012

Inside Job

Finally saw Inside Job the other day, and it did pretty well in explaining what seemed to have happened. I felt that more could have been put at the door of the ratings agencies - private companies whose function is written into law, lets not forget. For example look at the graph in this Reuters blog post by Felix Salmon - is shows the world issue of AAA bonds since the 1990s. They went from non-existent to being about half of all issued bonds by 2006. As Felix says:
That’s possibly the most horrifying bit of all: it simply defies credulity for anybody to be asked to believe that more than half the bonds issued in any given year are essentially free of any credit risk.
An article in today's Guardian about the Black-Scholes equation is also pretty interesting. Ian Stewart (Professor of Maths at Warwick) points out that the financial industry has repeatedly used equations beyond their stated limits and then got us all into a mess. His paragraph at the end caught my eye:
Despite its supposed expertise, the financial sector performs no better than random guesswork. The stock market has spent 20 years going nowhere. The system is too complex to be run on error-strewn hunches and gut feelings, but current mathematical models don't represent reality adequately. The entire system is poorly understood and dangerously unstable.
This ties into my earlier blue-screen metaphor for the crash, but also his statements that the stock market has spent 20 years going nowhere gave me a jolt. Having grown up in the 80s I guess I'd internalised the conventional wisdom that over the longer term the stock market is always a good bet. But if you look at the recent era, the era of super fast transactions and derivatives, it certainly no longer seems to be the case. Since the mid 90's the FTSE 100 has just been bouncing from about 3500 to about 6500 and back again. If you look for an inflation adjusted FTSE 100 it looks even bleaker. But in the meantime, the trend has been for people to base more and more of their savings and mortgages on stock-market products. Hmmmm.

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