Osinski’s “Man­hat­tan Project”

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There’s an inter­est­ing story in the New York Mag­a­zine by Michael Osin­ski–the author of the main soft­ware pack­age used to cre­ate the CMOs and CDOs that have helped crip­ple the finan­cial sys­tem.

Osinski’s story is worth a read in its own right. But what I found curi­ous about it was that he appears unaware of a flaw that existed in those prod­ucts from the outset–the pre­sump­tion that the stan­dard math­e­mat­ics of risk and return could be applied to finan­cial assets. He doesn’t even men­tion this topic, but state­ments like the fol­low­ing imply that his soft­ware used a stan­dard prob­a­bil­ity dis­tri­b­u­tion to cal­cu­late risk and return for a given bond:

Work­ing with another pro­gram­mer, I wrote a new mort­gage-backed sys­tem that enabled investors to choose the spe­cific com­bi­na­tions of yield and risk that they wanted by slic­ing and dic­ing bonds to cre­ate new bonds. It was end­lessly ver­sa­tile and flex­i­ble. It was the prover­bial money tree…”

Though these dis­tri­b­u­tions don’t have to be “Gaussian”–the “Nor­mal Dis­tri­b­u­tion” that lies behind the ubiq­ui­tous “Bell Curve”–all these dis­tri­b­u­tions “tend” towards that one, and they cer­tainly share one fea­ture: they have finite vari­ances around the mean out­come.

Sorry for some of the sta­tis­ti­cal jar­gon so far: the basic point is that, if some process–like rolling dice at a casino–follows one of these dis­tri­b­u­tions, then you can cal­cu­late both the aver­age score (which for a roll of two dice is 7) and the odds of a par­tic­u­lar score (say 12, the odds of which are one in 36) com­ing up. You can also cal­cu­late that some out­comes are so rare as to be effec­tively impossible–such as rolling 12 twelve times in a row (such an out­come would occur only once in every 5 mil­lion tril­lion attempts).

The prob­lem is that mort­gage defaults aren’t like dice rolls. Which face on one dice turns up on the top doesn’t affect what the other dice do: a 6 on one dice has absolutely no impact on the like­li­hood of another dice also turn­ing up 6. But if your neigh­bour defaults on a hous­ing loan, you are more likely to do so too–because her mort­gagee sale will depress the likely price for your house, and her dis­ap­pear­ance from the neigh­bour­hood will decrease incomes there, indi­rectly affect­ing yours, and so on.

Cru­cially, price rises in an asset mar­ket are also cor­re­lated: a ris­ing asset mar­ket leads to the ris­ing expec­ta­tions that Minsky’s “Finan­cial Insta­bil­ity Hypoth­e­sis” describes so well, and a falling one puts the process in reverse.

In this sense, asset price move­ments have more in com­mon with earth­quakes than with dice rolls. The best stylised model of an earth­quake was built by a physi­cist called Per Bak–he called it “the sand­pile model”.

Con­sider a child build­ing a mound of sand at a beach by smoothly pour­ing dry sand out of a bucket. Ini­tially, the sand spreads wide, then it gets to the point where side­ways move­ment requires more force than each sand grain can impart, so the mound begins to rise up. It gets steeper–approaching a pyra­mid shape–and as it gets steeper, the struc­ture gets pre­car­i­ous. Then another grain is added, and the whole struc­ture sud­denly col­lapses in an avalanche. The avalanche then stops, the pyra­mid is much less steep, the sand pile broader. The child con­tin­ues adding sand, it pyra­mid rebuilds, then col­lapses at some trig­ger point, and so on.

The process build­ing the sand pile doesn’t change–it’s always more sand grains drop­ping out of the bucket–but at some­what unpre­dictable moments, the behav­iour of the aggre­gate sand pile changes, from build­ing upwards to col­laps­ing, and then rebuild­ing again.

The pat­tern repli­cates what we see with earth­quakes: move­ments in the earth’s tec­tonic plate occur all the time, and most of the time, each move­ment just adds to the exist­ing level of ten­sion between those plates. But every now and then, one addi­tional move­ment occurs, the whole mass shifts, and a major earth­quake results. As Per Bak put it, “a big earth­quake is a small one that doesn’t stop”.

The pat­tern of move­ments you get from such a process can look super­fi­cially like a Nor­mal distribution–the famous Bell Curve–but it dif­fers from it in two fun­da­men­tal ways. Firstly, there are many more move­ments near the aver­age; sec­ondly, there are also many more move­ments way, way away from the average–so many more that, in what is known as a pure “Power Law” dis­tri­b­u­tion, the stan­dard devi­a­tion is infi­nite: any scale event can occur, and will occur given enough time.

What does that mean for CDOs and CMOs? Since they pre­sumed a “Nor­mal” dis­tri­b­u­tion (or at best one drawn from the class of sta­tis­ti­cal dis­tri­b­u­tions where stan­dard devi­a­tions are finite), they cat­e­gor­i­cally ruled out the pos­si­bil­ity of “large events”–such as, for exam­ple, house prices falling 10% in a year.

There is no exam­ple of the num­bers Osinski’s  pro­grams may have used, but for exam­ple if a bond had assumed that house prices move up at 5% a year with a stan­dard devi­a­tion of 2% around that trend, then a 5% fall in house prices would only occur once every 3.5 mil­lion years. A 10% fall would only occur once every 31 tril­lion years–it sim­ply couldn’t hap­pen.

Yeah, right.

In fact, in a Power Law process, move­ments of that scale will occur, and far more fre­quently than pre­dicted by these stan­dard prob­a­bil­ity func­tions.  Osin­ski shows no aware­ness of this:

It hurts when peo­ple say I caused this mess. I was and am quite proud of the work I did. My soft­ware was a del­i­cate, intri­cate web of logic. They don’t under­stand, I tell myself. Per­haps it was too com­pli­cated. But we live in a world largely of our own device. How to adjust and con­trol these com­plex­i­ties, with­out sti­fling inno­va­tion, is the prob­lem.

He couldn’t be proud of what he has done, had he known that he had used a fun­da­men­tally inap­pro­pri­ate model as the foun­da­tion of how risk and return were cal­cu­lated. As usual, igno­rance rules in this folly.

I’ll return to this topic in more detail in next month’s Debt­watch.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • amishthrasher

    Two final thoughts to share as far as social demo­graph­ics and eco­nomic mod­el­ing goes: age, and ide­ol­ogy.

    The age of peo­ple in a pop­u­la­tion is impor­tant, not only in that it is a fac­tor that (obvi­ously) changes over time, and the forms of eco­nomic activ­ity peo­ple par­take in, but also because it shapes how they — and soci­ety — view the world.

    Con­sider a child born after 1998 or 1999. It is quite pos­si­ble that a mid­dle class child born after 1998 or 1999 has never lived in a home with­out the world wide web, pay TV, or a mobile phone. They may not, in many cases, remem­ber a world with­out broad­band inter­net, Face­book, MySpace, and YouTube. They may have been too young to remem­ber the dot-com bub­ble and its burst­ing, or an Amer­i­can Pres­i­dent before George W. Bush. They were not alive for any Prime Min­is­ter before John Howard, and may not remem­ber a ‘Pre-9/11’ world. A host of what older peo­ple con­sider ‘recent devel­op­ments’ have defined their world, as they know it. And their knowl­edge of the world as it existed before these ‘recent devel­op­ments’ is entirely drawn on sec­ond-hand accounts.

    The old­est among them are already about 10 or 11. In the next cou­ple of years, they’ll enter high school. In the next decade, there’ll be Uni lec­ture halls full of kids who have never known life before Face­book and Myspace; a few years later, they’ll start tak­ing up mort­guages, homes, and full time work.

    On the other end of the age spec­trum, 10 years ago, an 80 year old was born around 1919. Now it’s 1929. In 10 years time, 1939, and 10 years after that, 1949. And, with life expectancy in the devel­oped world hov­er­ing around 80 or so, that year becomes sig­nif­i­cant because it marks the end of what can real­is­ti­cally be con­sid­ered liv­ing mem­ory. Any events before that is ‘his­tory,’ based on the rec­ol­lec­tions of peo­ple who most likely have passed on. 

    What would be inter­est­ing to con­sider, and to model, is a chart break­ing down the per­cent­age of the pop­u­la­tion born in — say — a given year, spread out over time, and char­tered against key his­tor­i­cal events. It would, if you will, lit­er­ally be a chart of how things dwin­dle from liv­ing mem­ory — and life­time expe­ri­ence — over time. 

    In a man­ner sim­i­lar to life­time expe­ri­ence, ide­ol­ogy (or per­haps ‘world view’) should be a very impor­tant fac­tor in mod­el­ing or sim­u­lat­ing eco­nomic behav­ior.

    Osinski’s model was bunk. But that — for the best part of a decade — many quants believed it wasn’t. And they inter­preted the world accord­ingly, and acted accord­ingly.

    Given this, there is per­haps some merit in:
    a) Mod­el­ing the rise and fall of polit­i­cal, social, and eco­nomic ide­olo­gies over time.
    b) Mod­el­ing how these shifts in ide­ol­ogy impacted how peo­ple under­stood the world, and
    c) Mod­el­ing how shifts in how the world was under­stood impacted on how peo­ple acted in turn.

  • Frank


    It reminds me of the debate between free-mar­ket or strong gov­ern­ment inter­ven­tion. This is anal­o­gous to the reli­gious idea of nat­ural and unnat­ural.

    In my opin­ion every­thing is nat­ural, by the mere fact it exists. An atomic pow­er­sta­tion is as nat­ural as a flower. The thing evolved into being and no one per­son or thing was respon­si­ble for it. It is a mis­take to think that ‘we’ as humans are some inde­pen­dent agent with mas­tery over and abil­ity to deter­mine our­selves and the envi­ron­ment. The notion is a relic, a meme, an idea still float­ing around from the days of Chris­tian­ity, where ‘we’ were supe­rior to ani­mals, by god-given right, and had nature as our play­thing.

    The anal­ogy with free mar­kets is that every­thing is a free mar­ket, and states and state inter­ven­tion emerges from it — states and state inter­ven­tions are emer­gent and their emer­gence is entirely depen­dent on the type of peo­ple and cul­ture in the soci­ety.

    Mod­els should be able to pre­dict the emer­gence of states (for exam­ple), not pre­scribe whether or not their should be states.

  • JamesC

    This mat­ter of dis­tri­b­u­tions is actu­ally a very com­plex area and can be counter intu­itive, I stum­bled across this once look­ing at ratios of pho­to­mul­ti­plier counts (please read on this is actu­ally inter­est­ing!). For instance if you had a ‘pre­dic­tive mea­sure’ that was formed by the divi­sion of one Gauss­ian vari­able by another Gauss­ian vari­able, the result­ing dis­tri­b­u­tion would be log-nor­mal, nor­mal or inverse log-nor­mal depend­ing on the rel­a­tive sizes of the stan­dard error in the two vari­ables. This can result in very weird com­pos­ite mea­sures that behave as if they are log nor­mal one minute (and thus never go neg­a­tive), then Gauss­ian the next with neg­a­tive val­ues, seem­ingly impos­si­ble in the pre­vi­ous sce­nario. This type of dis­tri­b­u­tion is known as a ratio pop­u­la­tion, it has no defin­able mean or stan­dard devi­a­tion, the Cauchy dis­tri­b­u­tion is an exam­ple of this prob­lem. It is a com­mon mis­take even in fields asso­ci­ated with physics to not spot this ratio mea­sure prob­lem. Finally, what hap­pens if your mea­sure is con­structed from a ratio of log-nor­mal or non-Gauss­ian vari­ables?, I imag­ine the splice and dice heads down these paths, do you think it might have an even big­ger tail?

  • mahaish

    sorry steve sailor,

    if the course of human endeav­ours were that unpre­dictable the book­ies and crim­i­nal pro­fil­ers of this world would be all out of busi­ness.

    i am bet­ting that if the book­ies had framed a mar­ket for the fight, the cuban would have been the favourite, and they would have been right. they usu­ally are.

    entirely pre­dictable

    in some cir­cles it would have been con­sid­ered a lay down mis­ere

    same goes for hitler. he might have been deluded by his own inter­pre­ta­tion of the so called data that invad­ing rus­sia and fight­ing a war on 2 fronts was a good idea. clearly many of his gen­er­als didnt think so, because their inter­pre­ta­tion of the data led them to beleive they were going to be toast.

    the book­ies would have rightly had hitler at long oods to achieve his altru­is­tic goal of re uni­fy­ing europe just like napolean tried to. again entirely pre­dictable.

    i tend to think that the geo polit­i­cal forces that under lie the coarse of human his­tory and the human actors involved are very much pre­dictable and cycli­cal.

    that goes for sport­ing events as well.

    actu­ally the vast major­ity of human behav­ior can be encap­su­lated in a david atten­bor­ough doco on baboons in the serenghetti

    per­haps i’m being too unkind

    obvi­ously human his­tory doesnt fol­low the math­e­mat­i­cal pre­ci­sion of an ele­gant equa­tion.
    we can set sail in a par­tic­u­lar direc­tion but some­times the des­ti­na­tion may sur­prise
    there’s no 100% money back gau­ran­tee,
    so in that sense there is unpre­dictabil­ity.

    his­tory rhymes rather than repeats

    how­ever the laws of karma or cause and effect are always in play

    in fact many of our older cul­tures have ded­i­cated many a trea­tise on the rules of the game by which the coarse of human endeav­ours should fol­low, less you make a miss step.

    these rules were cre­ated to pre­vent mr sur­prise from knock knock­ing at ones door.

    quite often the only peo­ple who are sur­prised by the way things turn out, are those deluded indi­vid­u­als such as hitler, and some econ­o­mists who never let the facts get in the way of a good argue­ment

  • mahaish

    hi aac

    the prob­lem with use­ing the entropy anal­ogy when it comes any aspect of human endeav­our, is that we may or may not have entropy depend­ing on what the sys­tem bound­aries are.

    it is entirely pos­si­ble that entropy can actu­ally decrease depend­ing on the para­maters used and the sys­tem bound­aries that are defined.

    we can go from less order to more order depend­ing on our frame of ref­er­ence.

  • jamesb

    I think agent-based mod­els are def­i­nitely an inter­est­ing way to go. There’s a guy at Bran­deis Uni­ver­sity named Blake LeBaron who makes agent-based mod­els of finan­cial mar­kets with pretty inter­est­ing results. Last I saw, they were just toy models–nothing you could apply to any sort of real-world question–but they dis­played pretty inter­est­ing non-equi­lib­rium dynam­ics.

  • rie­mannzeta


    What’s the alter­na­tive? I’m still try­ing to fig­ure that out, because the same prob­lems apply in mod­el­ing the eco­log­i­cal and cou­pled human-envi­ron­men­tal sys­tems I work on.

    I don’t dis­agree with your obser­va­tion here, but I don’t think that it is fair then to con­clude that no math­e­mat­i­cal mod­els are help­ful. Physi­cists have mod­els for sys­tems that are far from equi­lib­rium, and some of them work pretty well at cap­tur­ing what oth­er­wise seem like ran­dom pat­terns.

    For exam­ple, the dynam­ics of atoms or mol­e­cules in a laser cav­ity can be mod­eled as an ensem­ble of cou­pled para­met­ric osil­la­tors. The mod­els can’t be solved exactly, but they give quite a bit of insight into how the mol­e­c­u­lar-level dynam­ics pro­duce the macro­scop­i­cally observ­able effects of coher­ence, &c. See here.

  • Frank


    Thanks for that. I’ll take a look. 

    I wish I had more time to work on my own stuff. In fact I wish I’d taken some kind of aca­d­e­mic career path. Prob­lem is most peo­ple I think don’t realise they have acad­e­mia in their blood until some spouse and/or employer has got them nailed down for good.

  • jimbo

    From the arti­cle, it looks like this Osin­ski guy was just a soft­ware mechanic — he took other people’s for­mu­las and did the grunt work of putting them in an appli­ca­tion that was usable by traders. He prob­a­bly never really thought through any of the the­o­ret­i­cal impli­ca­tions of gauss­ian curves and power laws, instead think­ing about “Should that but­ton be blue or pur­ple?”

  • I agree with you here Frank. One of my prob­lems with Aus­trian thinkers–and this was noted by my friend Chris Sciabarra’s excel­lent book Marx, Hayek and Utopia–is that Aus­tri­ans treat the state as some­thing that was sim­ply imposed on an oth­er­wise evo­lu­tion­ary sys­tem. Of course, as you observe, the state’s role evolved out of soci­ety, as did the market’s.

  • Bull­turned­bear

    I have a few thoughts that may war­rant fur­ther dis­cus­sion. Maybe we have already had the dis­cus­sions under another guise. I will present the two ideas as two sep­a­rate posts.

    Paul Keat­ing keeps com­ing to my mind. While Mr Keat­ing was far from per­fect, he is remem­bered by me as a straight shooter. Some­times to straight. His famous line “The reces­sion we had to have”. Is very inter­est­ing. I claim that gov­ern­ment deci­sions are lead by the herd and that gov­ern­ments want to please the herd to avoid being kicked out of office. Whilst the 1991 reces­sion was very painful. It was a nec­es­sary cir­cuit breaker. If a few more politi­cians had back­bone and vision, this cur­rent bub­ble may have been no where near as large as it is. 

    But then I guess the herd got what they wanted. They just were not aware of the con­se­quences.

  • Bull­turned­bear

    The sec­ond dis­cus­sion relates to the sol­vency of the large US banks and how “they are the prob­lem that needs to be fixed”.

    I keep hear­ing two oppos­ing argu­ments:
    1. The US Admin­is­tra­tion says — The large banks are too big to fail. We must pump in as much money as pos­si­ble to save them or our sys­tem will crum­ble. This new money will also re-cap­i­talise the banks so they can start the credit flow again, which will allow growth to restart. Yeh!!!
    2. The oppos­ing view — The 5 large US banks are the prob­lem. We must nation­alise, liq­ui­date and start again. If we do this, the banks will be clean and we can start lend­ing again. Thus get credit flow­ing again. Yeh!!!

    Both argu­ments are based on a false premise. That con­sumers and busi­nesses have an appetite and abil­ity to ser­vice new credit. And fur­ther that there is any real soci­etal ben­e­fit from new spec­u­la­tive credit any­way. Both argu­ments are treat­ing the symp­tom and not the cause. That is, too much debt.

    While ever the focus remains on only two solu­tions the sys­tem grows weaker and weaker by the day.

    I don’t under­stand why the politi­cians can’t focus on the cause. Some say because of con­spir­a­to­r­ial greed, some say bad eco­nomic the­ory, some say polit­i­cal sur­vival and some say plain old igno­rance.

    What­ever the cause. We are all head­ing for a total sys­tem­atic col­lapse because every­body (and I mean every­body) is look­ing in the wrong place at the wrong time. Get ready for the biggest crash, sys­tem­atic change and soci­etal break­down in 100 years. Why, because no-one truly believes it is com­ing, every­one believes that some exist­ing ace or new ace in the hole will fix the bro­ken sys­tem. Every­one is liv­ing in hope. Hope that is based on igno­rance.



    I began get­ting inter­ested in the US eco­nomic sit­u­a­tion in 2006. I was com­ing towards mak­ing some major deci­sions with my super and decided I bet­ter get myself up to speed, rather than just accept the Finan­cial Plan­ner type pap. I am so glad I did. Even back then it was clear to me what was com­ing.

    After hav­ing fol­lowed all these devel­op­ments since that time, I believe that that essen­tially the US Admin­is­tra­tion is entirely cor­rupted by the influ­ence of the Big Banks- pri­mar­ily GS. There are many many instances sup­port­ing this belief but the events of this year with AIG really is the smok­ing gun. If GM was a coun­ter­party to GS for bil­lions in deriv­a­tive swaps, it would never be allowed to go under. No way. The rela­tion­ships that GS has within the Fed , US Banks , US reg­u­la­tors and all US Admin­is­tra­tions since the early 90’s in Clinton’s Pres­i­dency is insid­i­ous and extremely pow­er­ful. GS has infil­trated and I believe has now a con­trol­ling inter­est through­out the US finan­cial sys­tem and US polit­i­cal sys­tem. The US has taken extra­or­di­nary steps to amend com­mon sense mark to mar­ket account­ing rules (FAS157) in order to con­tinue play­ing in their make-believe world of dodgy Ponzi finance. 

    One sim­ple logic which I am unable to dis­miss is that if the Banks are too big to fail, then why are they allowed to be so big ? The US Govt has bro­ken up empires before because of this very issue of being too big. Yet they allow this mon­ster which has caused immea­sur­able human suf­fer­ing to con­tinue, and in fact sup­port it.

    So, don’t expect the Fed or Trea­sury to change their ways on prop­ping up US banks.

    Inci­den­tally, I agree that we are head­ing for a sys­temic col­lapse but I am now think­ing it will be in slow motion and show up much worse in some places than oth­ers. Eg, south­ern Europe and the UK are finan­cial bas­ket cases- Africa will fall into real chaos quickly. The Asian export eco­nomic model is over- to be replaced by what? Finan­cial sys­tems and insti­tu­tions will crum­ble and atro­phy over time as finan­cial and social chaos grows. The Mex­ico sit­u­a­tion bears watch­ing as it could eas­ily be a “model” of the future for many coun­tries.

    That slow decline sce­nario will be to the advan­tage of the elites because it allows them to main­tain their power and abil­ity to con­tinue milking/gaming the tax­payer and the econ­omy. This will make any invest­ment strat­egy a sig­nif­i­cant chal­lenge going for­ward.


    By the way.….….

    One main rea­son why I believe the finan­cial sys­tem col­lapse will not be a sud­den event is that Govt’s world­wide intend to squeeze every drop of wealth (now and future) they can from their cit­i­zens, by spend­ing theirs tax dol­lars friv­o­lously, in order to keep this debt based econ­omy game going. While that is a dead ended plan, it will take time to reach it’s ulti­mate death, and keep the masses suf­fi­ciently docile in the mean­time.

    It is all (only?) about play­ing for time now.

  • Bull­turned­bear

    Hi Macca,

    I agree the fall out is tak­ing a lot longer to sur­face than I expected. I dis­agree about the slow process though.

    When the point of real­i­sa­tion is reached. The mar­kets will already be 1/2 way to being destroyed. That final half will hap­pen very very quickly. 

    Dur­ing this mas­sive sell-off phase (I expect this to hap­pen later this year) the pol­icy announce­ments and gov­ern­ment direc­tional changes will be unprece­dented and unpre­dictable.

    I pre­dict that the “change” will occur so fast that any­one who is not ready (that’s all of us) will be both caught by sur­prise and major finan­cial loss at the same time.

  • The Out­back Ora­cle

    Just think­ing out loud.….

    I believe the end game will be quick. Whether it will be soon is a moot point.
    Later this year…maybe June…the Govt, find­ing they don’t actu­ally have unlim­ited money and far less than they now have, will have to choose between say…the First home Buy­ers grant and pen­sions, or health care etc
    If they drop the FHBG it’s game over…property falls…Banks are bank­rupt… end of story.
    If they get past June, it will be some other month or some other cause like a cri­sis in the exter­nal account which busts fund­ing. This econ­omy is built on the false per­cep­tion that every­thing is fun­da­men­tally strong. The prick­ing of that per­cep­tion, which must hap­pen sooner or later, will result in a dete­ri­o­ra­tion at a speed even those of us here can’t really visu­alise.


    Hi BTB and Out­back Ora­cle;

    Thanks and very good points all. What you out­line is no doubt very plau­si­ble. Those were my thoughts as well, up until I saw the way in which Gei­th­ner out­flanked the US leg­isla­tive process with his lat­est PPIP scam and his setup of the AIG money laun­der­ing oper­a­tion. Those were game chang­ers for me in terms of delay­ing tac­tics, with the clear intent of exer­cis­ing unas­sail­able power to ben­e­fit the cho­sen few. 

    I think also BTB you have more con­fi­dence than I that the pub­lic will “get it”. Cer­tainly, in Aus­tralia it will take a good deal more pain for peo­ple here to really ask the truly search­ing ques­tions of their insti­tu­tions, them­selves and their belief sys­tems. It will take a very long time for the pub­lic to accept and under­stand that things will not be going back to the way they were any­time soon for the lucky coun­try.

    Whilst I may not entirely agree with your view on tim­ing for the moment, I have prepa­ra­tions for either sce­nario. The end is the same and no dis­agree­ment on that.

  • Jim

    Hi Bull­turned­bear,
    Very good post! To answer your ques­tion the cause is falling prop­erty prices trig­gered by excess debt. The author­i­ties have turned into cri­sis man­agers, who put out fires one fire at a time start­ing with biggest fire. That’s why they are focus­ing on the banks. I was really impressed when the Obama admin­is­tra­tion started giv­ing some atten­tion to fore­clo­sures in their lat­est stim­u­lus pack­age. The penny must have finally dropped! After the announce­ment, Mort­gage rates actu­ally dropped a lit­tle, which will help home own­ers. This is not an all out res­cue, but at least it is reas­sur­ing to know they are now mov­ing in the right direc­tion. Hav­ing stated all the above it is prob­a­bly too lit­tle too late! Just look at the lat­est house price data just released:-


  • oni­mod

    I’m not sure that the final crash will happen…this time.
    I know we deserve it, but I expect full scale obfus­ca­tion and sta­tis­ti­cal manip­u­la­tion (as if it hasn’t been going on for quite some time) to really move into hyper­drive.
    Change of this scale is essen­tially gen­er­a­tional, and until the cur­rent rul­ing gen­er­a­tion (and prob­a­bly their under­lings too) has been removed, both phys­i­cally and intel­lec­tu­ally, I can’t see rad­i­cal change com­ing from the top down.
    I think you have to be pretty informed, even in these times of unlim­ited infor­ma­tion, to be actu­ally intel­lec­tu­ally out­raged. Sure, there’s plenty of envy out­rage at present in the masses, but it doesn’t even scratch the sur­face as far as under­stand­ing of the under­ly­ing cause(s).
    I think all of that tends to sug­gest that most peo­ple will con­tinue to take the spin they are being fed.
    Long term I can’t see how things won’t unwind, but then I see a lot of things that defy my (twisted?) logic every­day. Aus­tralian prop­erty prices would be close to the top of that list.
    I’ve seen in the last few days more spruik­ing from the RBA sug­gest­ing that our prop­erty won’t slump like the rest of the world. I haven’t heard a sin­gle per­son (pub­licly) ask whether that is in fact a good thing for our future.
    Also,why on earth is the RBA get­ting in to the busi­ness of pre­dict­ing the future? How many mis­taken pre­dic­tions does it take to evap­o­rate your cred­i­bil­ity?

  • Zulu

    I think there is a very good chance there will be a crash this year. 

    I remem­ber read­ing some­where that WD Gann pre­dicted the big col­lapse (end of the super cycle) in 2014 (I think it was), though I can’t say I believe in his the­o­ries exactly. Now, assum­ing he’s right, have the gov­ern­ments past inter­fer­ence (& lack of reg­u­la­tion) brought this for­ward or will their new stim­u­lus pack­ages etc actu­ally mean we sur­vive until then .…

  • Tel

    You can argue over the details of the prob­a­bil­ity (and FWIW I agree with the cen­tral point that by ignor­ing cor­re­la­tion, Osin­ski was guar­an­teed to get utterly bogus results) but there’s a big­ger fish lurk­ing a lit­tle deeper that Osin­ski remains happy to ignore.

    Why didn’t any­one spend a lit­tle time with a com­puter model check­ing those results? Why not run them against some arbi­trary his­toric data? Was there not a sin­gle man or woman in these large finan­cial organ­i­sa­tions who could not have put up a hand and asked whether cor­re­la­tion had been con­sid­ered?

    Of course, the answer is that it is unthink­able that they really believed they were turn­ing lead into gold. But they were gam­bling with some­one else’s money so it didn’t really mat­ter. There was absolutely no incen­tive to cre­ate a work­ing model for the CDO cal­cu­la­tor, and that is the real rea­son why their bell curve was con­sid­ered good enough. Good enough to fool the fools and cre­ate a haze of con­fu­sion around fraud.

    I’m excited by the intel­lec­tual exer­cise of under­stand­ing cor­re­la­tion in a mar­ket econ­omy, but to fix the bank­ing indus­try the only answer is to ensure that the peo­ple mak­ing the bets are bet­ting strictly with their own money, and they are the ones who lose when the prob­lem strikes. Any other sit­u­a­tion and the result will be loot­ing just like hap­pened this time, and many times before.

  • het­ero­dox


    actu­ally many of the banks inter­nal mod­els, whether they be specif­i­cally pric­ing CDOs, broader VaR or wider yet Eco­nomic Cap­i­tal mod­els are often based on his­toric cal­i­bra­tion. But there in lies the problem.….and sur­prise, sur­prise, past price behav­ior does not nec­es­sar­ily reflect future price move­ments.

    So although say in the case of CDOs, his­toric volatil­ity and cor­re­la­tion assump­tions may be used.….this does not nec­es­sar­ily pro­vide any mean­ing­ful risk sig­nals about what may occur.

    But there are two impor­tant points that can be drawn from this in the case of real estate mod­el­ling ;
    (1) His­toric price behav­ior — US post w/war II period, at least prior to 2007, nom­i­nal prop­erty prices did not see any period of sys­tem­atic nation­wide falls. Of course there were localised exam­ples (eg- Cal­i­for­nia etc), but not nation­wide at the same time. Per­haps a broader view of his­tory may have helped, as Shiller has demon­strated with the Dutch exam­ple going back to 17th cen­tury. Any­way “main­stream think­ing” only observed the post WWII expe­ri­ence, hence a mis­taken belief that prop­erty prices cant fall, which was then reflected in the mod­els…

    (2) Sys­temic feed­back loops — Most pric­ing mod­els do not take account of how like­minded think­ing (ie- pric­ing of these prod­ucts) can in fact change the sys­tem. Soros refers to this as reflex­iv­ity. So although his­toric prices did not dis­play mate­r­ial price falls, the wide­spread adop­tion of orig­i­nate and dis­trib­ute busi­ness model changed the inher­ent sys­temic risk — and there­fore cre­ated the pos­si­bil­ity that prop­erty prices can fall.….and fall mate­ri­ally, since prices were able to be bid up to unre­al­is­tic / unsus­tain­able lev­els.

    I guess in a con­vo­luted way i agree with you — but the sim­ple truth is that look­ing at his­tory is not always suf­fi­cient either. As Steve might say “Sta­bil­ity is desta­bil­is­ing” and the com­fort taken from 50years or so of a lack of falls in real estate val­ues, has proven to be desta­bil­is­ing.…

    That said — What is