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----- Original message -----
Sent: 2008/11/10 16:02:15
Subject: Fw:Re: Re: Re: [OPE] The micro dimension of the Financial Crisis.
Alejandro writes:
"The role of these idealized economic models is clear here. To support a financial policy that allegedly would satisfactory deal with the risks involved in loans unreliable enough in themselves. The invention of “credit default swaps” was the only thing needed to legitimize the business.
"
To which MJW responds:
Abstract economic models (neoclassical, austrian, etc.) passed off as actual truth are indeed ideological - i.e. systematically partial.
They offer no support to the misselling of mortgages that neglects toinvestigate the feasibility of re-payment. Such misselling involves sharp practice and no doubt some criminality. Nor do they offer support to the securitisation of such dodgy mortgages and their onward misselling to those assured by the ratings agencies of their AAA status. More sharp practice and criminality. The models certainly did not predict that the system would work if their was widespread criminality and incompetence
CDS's provide in principle legitimate hedging opportunites, i.e. insurance. They failed to pay out because the sellers (viz the major Investment banks) failed to maintain capital adequacy, which the regulators failed to notice for a variety of reasons including a favourable view of the hope of offering mortgages to excluded would be home owners, the absence of 'insurance' in the names of thes products (as you point out), etc. - i.e. incompetence and no doubt some criminality.
AA again:
"What I suspect we have here are models built upon unrealistic assumptions that have been exceeded by reality, i.e. the usual unrealistic assumptions (listed before) of what Leonid Hurwicz calls “classical environments” that make possible axiomatization.
"
MJW says
Axiomatizable models are an abstraction. (Marx says somewhere something to the effect that 'to think is to abstract'.) They are, of course, subject to critique; but that critique cannot simply be the assertion that they miss out some aspects of actuality - ' cos that is what an abstract model does! Similarly, they are deliberately unrealistic in their very nature.
What you would have to do is first to establish that option pricing modles are nested within the neo-classical paradigm (which Paul C. has queried) - I guess you could investigate their grounding in the efficient markets hypothesis? Then to investigate exactly which aspects of reality they miss out that explains their putative role in the credit crunch. (I have already indicated some of these, and argued that they are pheneomena that must be used in concretising the basic abstract model.)
Alejandro's comments about the data and informational problems of concretising mathematical models to deal with decomposability are relevant to their use as policy alogorithms. I see prescriptive models differently. A simple illustration: what should the apparatchiki on the putative socialist cloud 9 assume about how citizens will respond to some implemented policy change? In the absence of other reliable evidence, I would suggest they assume that the folks will behave rationally, and construct their predictive models accordingly. As they gather information on mass behaviour, including from comparing the actual responses to what they expected, they can tweak policy to achieve it's ends. NB this may or may not involve concretising the mathematical model, depending on the feasibilty of so doing.
michael
----- Original message -----
Sent: 2008/11/10 15:52:41
Subject: Re: Re: Re: [OPE] The micro dimension of the Financial Crisis.
The financial crisis has two main pillars:
1) Unreliable loans that marketed in the way mathematical models prescribed, would allegedly reconstitute them “…in ways that it is supposed to eliminate most of the risks” (60 minutes).
2) Risk saving devises like “credit default swaps” that insured the investors in the case of the financial instrument failure. But these swaps by virtue of their name were not subjected to the regulations applicable to common insurances. Therefore, those who sold swamps (well known financial institutions) were not required to have capital reserve to face the trigger of the insurance.
The role of these idealized economic models is clear here. To support a financial policy that allegedly would satisfactory deal with the risks involved in loans unreliable enough in themselves. The invention of “credit default swaps” was the only thing needed to legitimize the business.
So, I disagree with
Michael W. when he says that
“The deletrious effects that generate crises come not from models per se, but from their inapproriate use.” We are not speaking here of bad applications of good models. What I suspect we have here are models built upon unrealistic assumptions that have been exceeded by reality, i.e. the usual unrealistic assumptions (listed before) of what Leonid Hurwicz calls “classical environments” that make possible axiomatization.
Paul C.: “That sounds too much like neo-classical economics to be plausible for the maths used to price derivatives and bundles of debt. I had assumed that what they did was based much more soundly on classical probability theory with little reference to factors of production, returns to scale etc.”
Essays in Positive Economics (1953) of Milton Friedman is basically a development of probability theory within the framework of Neoclassical Economics. The development of Neoclassical Economics during the last 60 years has followed this route. The mixture of axiomatic economics and free market ideology sounds too much as Friedman.
Michael W.: “It is simply not true that externalities, local preference saturation, factor indivisibility, convex production functions, etc. cannot be modelled. All of these phenomena can be mathematically expressed.”
When in 1973 Hurwicz faced the question of the possibility of designing mathematically processes for nondecomposable environments (environments with externalities), he concluded:
“It seems that one would have to say ‘no’, but this has not as yet been rigorously established. It can be shown that informational requirements increase when nondecomposability (externalities) enters.” (pp.20) Hurwicz, Leonid. “The Design of Mechanisms for Resource Allocation”,
The American Economic Review, Vol. 63, Nº 2, 1973.
The question is if this economic theory has evolved to be able today to deal with “nonclassical environments” or nondecomposable environments. The Sweden's central bank price awarded to Hurwicz and his colleges on 2007 was not because of these advancements.
Regards,
A. Agafonow
De: Michael Williams <michael.williams.j@googlemail.com>
Para: alejandro_agafonow@yahoo.es
Enviado: domingo, 9 de noviembre, 2008 12:04:29
Asunto: Re: Re: [OPE] The micro dimension of the Financial Crisis.
Alejandrow A writes:
----- Original message -----
Sent: 2008/11/09 10:09:52
Subject: Re: Re: [OPE] The micro dimension of the Financial Crisis.
...
"3) PRESCRIPTIVE/MANDATORY MODELS: this is the nature of the models behind the “derivatives” that caused the financial crisis. Why they failed? Because mathematics only can deal with classical environments characterized by: A) absence of externalities, B) absence of local saturation of preferences, C) total divisibility of factors of production, D) convexity or absence of increasing returns to scale, and E) temporal homogeneity.
"
I have yet to see even the outline of an argument that it is either derivitives or models that caused the crisis. The relevant derivitives, primarily Credit Default Swaps, in this context are simply forms of hedging, i.e. insurance. (The players avoid calling them this in order to avoid concomitant regulation of the market.)
It is simply not true that externalities, local preference saturation, factor indivisibility, convex production functions, etc. cannot be modelled. All of these phenomena can be mathematically expressed. The deletrious affects that generate crises come not from models per se, but from their inapproriate use. In particular from the ignorance of the need for concretisation of abstract models to incorporate abstractly contingent phenomena as relevant in particular domains of application. For example, both the 1998 and the 2008 failures in derivitives markets were driven by lack of appreciation of the possibility of rapid onset of liquidity famines. I have already indicated that behavioural mistakes based on hubris, greed, criminality, incompetence and loss of bottle (one might add) by players who shouldn't have been able to enter the game, can explain liquidity crises. Further explanation of those behavioural traits, of course, needs reference to biological and social determinants of behaviour to concretise the abstract assumption of rationality.
michael
Regards,
A. Agafonow
De: GERALD LEVY <gerald_a_levy@msn.com>
Para: Outline on Political Economy mailing list <ope@lists.csuchico.edu>
Enviado: domingo, 9 de noviembre, 2008 1:10:37
Asunto: RE: [OPE] The micro dimension of the Financial Crisis.
> Just as Dickinson described the situation several decades ago: > “The most efficient statistical service in the world will not make it possible to predict,
> without a large margin of uncertainty, whether spots will be more popular than stripes
> next season.
Hi Alejandro:
That shouldn't be a problem since it shouldn't take a year to change the design of
clothing from spots to stripes. There asre relevant technological advances which
can speed the process both of production and ordering.
On the production side, there are integrated CAD/CAM technologies employed
throughout manufacturing. Furthermore, more efficient 'lean production' systems
decrease the need for excessive inventory and allow for faster changes in batch
composition. The consequence is that the 'lead time' required for such minor
changes in output composition has been drastically reduced.
On the ordering side, advances in communications technologies (including
the Internet and the cell phone) allow for consumers to make their preferences
known on a 'just in time' basis (this dovetails nicely with the just in time advances
in production technologies). Most people wouldn't at all find it difficult to
decide this week whether they prefer a shirt with spots or stripes next week.
Hence, Dickinson's claim is being made irrelevant by technological
advances.
> How a new film or musical play will go, what will be the reception of a
> novel, a gramophone record, or a mechanical ‘Mickey Mouse’.”
People can be asked in advance to make reservations and output composition
decisions can then be based on their clearly stated preferences.
One of the positive developments in the USSR was that concerts, musicals,
films, etc. were often made freely available to workers. Indeed, performances
were often in the factories themselves.
In any event, you should consider - once again - how technological advances
affect this process. For example, books and records can be replaced with
digital books and digital recordings. This drastically lowers the production
- and, especially, the reproduction - costs (not to mention the shipping costs).
If someone wants a book or a recording, then all they will have to do is
download it.
We need to think of socialism as it is now possible in the 21st
Century and not be limited in our vision to what was experience in the
20th Century. It is a new world, Alejandro. A new world that Dickinson
did not live to see.
In solidarity, Jerry
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Received on Mon Nov 10 15:07:48 2008