How bankers took mathematics and misused it
Within the world that we (most readers of this blog) live in, the words "’financial innovation’ means new online banking services or adding pfm capability to banking services online. Its all about online.
The major lesson for me from the credit/banking crisis is what financial innovation actually means to the financial community. Gillian deals with it in this excellent piece. Financial innovation to the rest of the world means creation of derivatives.
Mathematicians must get out of their ivory towers | ft.com Gillian Tett
No longer. In the three years since the financial crisis exploded, financial mathematics has come in the line of fire, with “quants” and models blamed for fuelling the banking woes. Hence Dr Johnson now has his work cut out, as he tries to defend the world of maths. Or as he told a conference this week: “There [is] a sense of bewilderment amongst mathematicians [about] the view that mathematics was responsible for the crisis.”
While it is a narrow view there is not doubt it is a significant view in terms of the impact on the banking industry. She goes on to point out the philosophical differences that are arising as the debate evolves amongst the mathematicians, economists and sociologists.
The good news is that if these types of endeavours swell, it could potentially change how financial economics and mathematics is done. The bad news, however, is that it is still unclear whether this will occur. The level of debate between the mathematicians, economists and sociologists remains pretty low. And while many intellectuals and regulators in Europe now seem open to a radical new debate, the intellectual climate in America appears far more constrained. So much so, in fact, that when Mr Soros held the inaugural conference for his institute, he deliberately did this in the UK – and not the US, where (he claims) the sense of intellectual conformity remains too strong.
Then the clincher. The admission that math is not a perfect science and in fact is used by mathematicians as something to explore. Yet bankers used it based on assumption of precision and perfection.
Moreover, rewriting the rules of financial mathematics – or economics – risks challenging many vested interests. After all, it is far easier for a Wall Street bank to make profits by plugging numbers into a crude model, than to admit that money could be a cultural or relativist construct.
Nevertheless, now, at least, there is a chance to reshape the debate. What really damaged the financial system in recent years was not so much “maths” or “economics”; instead the crucial problem was bad maths (and economics) that was used and abused. Now, more than ever, mathematicians need to get out of their ivory towers or back offices and state that loudly, not just for their sake, but for economists. And, of course, those bankers.
Bluecap enters with a novel financing model for Canadian small business
I have long predicted that innovation within financial services will come from one or two innovative banks but more likely from new entrants. This morning a note in linkedin from a friend, Scott Wilson, highlighted his new Canadian company with a model that caught my attention.
The typical small business is time starved, suffers cash flow peaks and valleys, and is at the mercy of the larger economy and business cycles. Bank lending for small business is identical to lending for large businesses, just on a smaller scale. The rigidity of payment plans in bank products plus the paperwork to get it done is not a comfortable fit for many.
Bluecap deals with that mismatch by providing Canadian small business financing that has repayment tied directly to the cash flow. the real novelty is using debt and credit transaction revenue thus providing some measure of risk management to Bluecap, while allowing the small business to repay their loans from available cash flow.
An interesting model and one to watch.
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- Bluecap pays you a fixed dollar amount now for a fixed percentage of your future credit card and debit sales until your contract obligation is fulfilled.
- Because repayments are dependent on your Visa, MasterCard, Amex and Interac receivables, Bluecap doesn’t get paid unless you get paid, which helps you manage your cash flow during slow periods.
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Bank of America launches text banking | Netbanker
Jim at Netbanker notes BofA have quietly launched text banking, and it is rolling out in waves. As Jim points out there is so much more banks can do with mobile. Everyone has a mobile device in their pocket, enjoy using it and like to interact with it. Why not take advantage of it, and not just to shift activity to the channel. that work is largely done. Mobile offers the potential to build loyalty through spending and budget assistance type apps. Ron recently noted his bullishness on PFM’s and I believe the connection of PFM to mobile will be a powerful one.
Netbanker has more on mobile in their latest Online Banking Report.
The signup process required the entry of a mobile number and a YES response from that mobile device (see screenshots below). While, that’s not much to ask, it did seem unnecessary since I was already signed up for mobile banking through that number.
After responding yes from my mobile, I received a welcome text from the bank.
Nationwide are eliminating cash withdrawals for cash cards only.
On this blog I have mused for some time about the future of branches and the ascendance of online banking in their place. I have been proven wrong so far as rumours of the branch demise are proving false. However there continue to be be periodic clues and hints of a different future.
Nationwide are eliminating cash withdrawals for cash cards only.
Nationwide to restrict small cash counter withdrawals | BBC
Nationwide Building Society is to stop some customers taking out less than £100 over the counter at its branches.
From 7 June customers with cash cards who want smaller amounts will have to use a cash machine.
The change will not apply to people with debit cards, or those who still use a passbook.
Nationwide said the change was needed to reduce queues in its branches and that there were alternatives for those affected.
Risk assessment of banks’ continues to be harder than it needs to be
From the “we haven’t really learned anything” department, banks continue to work within the rules they are given and make month end adjustments to their balance sheets with considerable impact to the real risk level, by understating debt in reports.
Wall Street banks accused of window dressing debt | The Times
Leading Wall Street investment banks have been accused of understating debt levels used to finance security trades by an average of 42 per cent at the end of each financial quarter for the past five quarters.
…
While the practice of “window dressing”, or using cosmetic devices to make published accounts look more attractive, is not necessarily illegal or uncommon, the findings have led some to question how much the banks have learnt from the crisis.
…
The practice of reducing quarter-end borrowings has occurred periodically for years, according to the data, which go back to 2001, but never as consistently as in 2009, the Journal said.
The New York Fed said that although it collected the data, the activities highlighted in the report were regulated by the Securities and Exchange Commission. After the Lehman revelations, the SEC is now seeking detailed information from nearly two dozen large financial institutions about accounting techniques that could hide a firm’s risk-taking.
“The world of privatizing the gains and socializing the risks must become a thing of the past” | Mauldin
I look forward to John Mauldin’s weekly emails. He is pragmatic and fact based in his analysis. This particular quote today caught my attention as one that summarises the Obama/ Brown (US/ UK) fixation with new debt that addresses an immediate problem yet creates a future one that is much larger.
The world of privatizing the gains and socializing the risks must become a thing of the past.
And This Thing About Leverage
The problem of too big to fail is ultimately one of leverage. If a small bank fails, no one really notices. If a giant bank fails and puts the system at risk, it costs us a lot. I have a simple proposal to mitigate the problem.Why not reduce the allowable leverage the larger a bank gets? This would clearly reduce their risk and encourage them to only make prudent bets (otherwise known as loans), as their risk capital would be limited. If they wanted to make more loans, then they could raise more capital or retain more earnings. Would that hurt earnings and shareholders and limit share prices? Yes. And I don’t care. If I’m not getting the dividends, then I don’t want to be made to pick up the tab if there is a crisis. The world of privatizing the gains and socializing the risks must become a thing of the past.
There is a larger message in the title quote.
What Happens If We Do Nothing?
What happens when we have the next credit crisis, when a major sovereign government defaults, as I think will happen? It will be a body blow to many banks, especially in Europe. Once again, we could have banks worried about lending to each other or taking letters of credit, which would be a disaster for world trade and the recovery we are now in.That we (and Europe and Britain) have taken so long to enact real reform has the potential to really put the world at risk. In the next crisis, we will not have the tools available to stem the tide that we did the last time. Rates are already low. Do you think we could pass another TARP? The Fed’s balance sheet is already bloated.
Incredibly … Citibank was ‘surprised’ by credit problems
I read, listen and watch as much as anyone, yet the credit crisis caught me off guard, and not until Aug 2007 did I write about it here. In fact even I was looking at this from a far too narrow perspective in retrospect.
Back to basics and the promise of social lending | bankwatch
Social Lending by definition carries the promise of at least eliminating the problem that the financial markets experienced this week. A promise of a simpler financial process, one that is easily understood and explainable. It won’t replace the worlds capital markets, but if it can provide at least a small alternative to those who choose, then mission accomplished.
However when I read this following story today, I can only express incredulity. As poorly prepared as this poor blogger was, it turns out I was still a month ahead of the chair and a director of Citibank.
They are either lying or stupid. There is no in-between – take your pick.
Citi’s ex-grandees strain to keep cool | ft
However, the two men’s assertion that the first time they knew Citi had billions of dollars of CDOs on its books was in September 2007 – when they began a series of nightly calls that became known as “defcon calls” – came under scrutiny.
Mr Angelides pointed to internal documents that appeared to contradict Citi’s assertion – in an analysts’ call in October 2007 – that its exposure to CDOs was $13bn.
If anyone remains in doubt, then check the stats in this bankwatch post. This was public information by the time I got it.
This post was September 2007. Note that month 1 on this chart is Jan 2007 so it highlighted the problem to be precipitated between the peak period SubPrime ARM resets of September 2007 through May 2008 (grey bars). This nails the problem to September 2008 quite precisely.
Bank shareholders need to ask better questions of their Chairman and boards methinks. Do not get overwhelmed by those excessive dividend payouts. They know and if they do not they are asking the wrong questions.
Review of the US economy – Federal Reserve Bank of San Francisco
The shifts that must be made before recovery is accepted are nicely summarised here including the required reduction in debt. Interestingly this comes after a few introductory cheerleading paragraphs suggesting recovery is already here.
At the Federal Reserve Bank of San Francisco Community Leaders Luncheon, San Francisco, California
As I have been emphasizing, the transition to full employment and the emergence of this new configuration of spending and production, and borrowing and saving, will take time. This rebalancing involves repairs to balance sheets, the movement of capital and labor across sectors of the economy, and shifts in the global pattern of production and consumption–adjustments that are likely to be gradual under any conditions. Moreover, the re-equilibration may be slower than might otherwise be the case because tight credit will limit the ability of some households and firms to make the necessary adjustments.
Then some additional remarks about the economy in general.
Government policies will be essential to supporting the smooth transition to more-sustainable economic growth with greater investment and exports. We must ensure that changes in taxation and regulation do not blunt incentives for business investment. In addition, although fiscal policy has provided important support for the economic recovery, it will need to be put on a more sustainable path in the medium term. Failure to do so risks a market reaction that could increase longer-term interest rates; economic growth would be hindered if government borrowing boosts the cost of capital and diverts resources away from private investment.
Reducing the deficit and avoiding a continuing buildup in government debt relative to income will be essential for bringing national production and spending into better balance. That balance, in turn, is necessary so that we are no longer so reliant on borrowing from other nations. Heavy dependence on foreign borrowing by the United States is not a solid foundation for long-term economic growth either here or in those countries extending us credit. The actions of U.S. authorities and private parties to bring about a better balance of saving and investment must be matched by action overseas in chronic surplus countries. While we reduce demand relative to our productive potential, the surplus countries must increase their domestic demand if the global economy is to thrive.
Finally, as has been so painfully demonstrated over the past few years, sustained growth requires a financial system that is much more resilient and thus better equipped to continue to supply funds to creditworthy borrowers when the unexpected happens. To this end, banks and other lenders must hold capital and liquidity to cover more of the risks they are taking, and they must have the capability to know what those risks are and to manage them effectively. Critically, the financial regulatory structure needs to be modernized to bring oversight and market discipline to bear much more effectively on our rapidly evolving financial system and to give regulators more tools to deal with problems as they arise. At the Federal Reserve, we are improving our supervision and regulation to incorporate a broader view of emerging risks in the financial system and to become more effective at translating identified risks to supervisory oversight and, if required, remedial actions by the banks.
Change to your Windows 7 set up that will make your life easier/ safer
Small but important change (imho) to your own laptop that will eliminate lots of potential problems from viruses.
90 percent of Windows 7 flaws fixed by removing admin rights
After tabulating all the vulnerabilities published in Microsoft’s 2009 Security Bulletins, it turns out 90 percent of the vulnerabilities can be mitigated by configuring users to operate without administrator rights, according to a report by BeyondTrust. As for the published Windows 7 vulnerabilities through March 2010, 57 percent are no longer applicable after removing administrator rights. By comparison, Windows 2000 is at 53 percent, Windows XP is at 62 percent, Windows Server 2003 is at 55 percent, Windows Vista is at 54 percent, and Windows Server 2008 is at 53 percent. The two biggest exploited Microsoft applications also fare well: 100 percent of Microsoft Office flaws and 94 percent of Internet Explorer flaws (and 100 percent of IE8 flaws) no longer work
Steps to follow:
- add new user (your super user – call it ‘admin’ or whatever you wish) with admin rights
- go to old user in control panel/users and remove admin rights – make it a standard user
- reboot.
- log in as old user
Now when you try to install anything it will launch a password screen for the admin user. (Just like linux)
The Impact of the Internet on Institutions in the Future | PEW
There is lots of wishful thinking contained in this PEW report which is not one of their better ones imho. The people interviewed are by PEW’s admission skewed and several silicon valley names are included. However the views follow the predictable linear thought process, such as, we have social networks therefore tomorrow everything will be social. Clearly there are themes and directional indicators, but there are competing themes such as organisational inertia, shareholder needs, economic crises and last but not least, human nature.
Some extracts.
The Impact of the Internet on Institutions in the Future | PEW
Some 26% agreed with the opposite statement, which posited:
- ”By 2020, governments, businesses, non-profits and other mainstream institutions will primarily retain familiar 20th century models for conduct of relationships with citizens and consumers online and offline.”
Once past the headline, the sense of change remains, but some doubt expressed about the 2020 date and that it might be too early for consequential change.
While their overall assessment anticipates that humans’ use of the internet will prompt institutional change, many elaborated with written explanations that expressed significant concerns over organization’s resistance to change. They cited fears that bureaucracies of all stripes – especially government agencies – can resist outside encouragement to evolve. Some wrote that the level of change will affect different kinds of institutions at different times. The consensus among them was that businesses will transform themselves much more quickly than public and non-profit agencies.
Many selected the “change” option, but said they were not sure drastic change will occur in organizations by the 2020 time frame. They said the most significant impact of the internet on institutions will occur after that. Some noted this change will cause tension and disruption.
And this final pessimistic note from Andy Oram is one that I can see being true.
The positives and negatives of technological change do battle. Will the result be a triumph of networking or more-concentrated, centralized control?
“I’m sure the survey designers picked this question knowing that its breadth makes it hard to answer, but in consequence it’s something of a joy to explore. The widespread sharing of information and ideas will definitely change the relative power relationships of institutions and the masses, but they could move in two very different directions. In one scenario offered by many commentators, the ease of whistle-blowing and of promulgating news about institutions will combine with the ability of individuals to associate over social networking to create movements for change that hold institutions more accountable and make them more responsive to the public. In the other scenario, large institutions exploit high-speed communications and large data stores to enforce even greater centralized control, and use surveillance to crush opposition. I don’t know which way things will go. Experts continually urge governments and businesses to open up and accept public input, and those institutions resist doing so despite all the benefits. So I have to admit that in this area I tend toward pessimism.” – Andy Oram, editor and blogger, O’Reilly Media.
Thoughts? What will organisations look like in 2050 say? Will the enterprise be open and participative with looking more like todays Google, or todays Bank of America?
