Monday, November 15, 2010

Quant insuff.

John Lanchester's Whoops! Why Everyone Owes Everyone and No One Can Pay, is an entertaining account of the economic crash that uses farce as its narrative model and, for the economically-illiterate (most of us), unriddles those mysterious instruments (CDOs, CDSs, SPVs, junk bonds, sub-prime mortgages) used by finance industry's Masters of the Universe to create what appeared to be a casino filled with fruit machines that spewed a jackpot at every tug of the handle. I don't buy into his theory that it all started with the collapse of communism, which freed the West of the need to emulate communism's cradle-to-grave care and let loose unbridled libertarian capitalism, but it's an interesting thesis that would make a good SF story (Gardens of the Sun is a somewhat similar story of triumphalist hubris trashed by nemesis, but required the unity of a despotic government to work). But his dissection of the root cause of the crash is masterly. Briefly, it was caused by underestimation of risk, because of overreliance on equations devised by the clever maths PhDs (quants) hired by the banks. The quants devised nice, tidy equations which they applied without taking into account of the real world's messiness, and the inability of most people to make rational assessments of risk:
Most of this exemplifies what I would argue is the most common mistake of very smart people: the assumption that other people's minds work in the same way theirs do. To non-exonomists, the mathematically based models and assumptions of rational conduct which permeate the field often have the appearance at best of toys, entertaining but by definition of limited utility; at worst, they can seem wilful delusions, determinedly ignoring reality.
Gosh, Lanchester could be talking about science fiction - the Analog school of storytelling that irritates the hell out of me with its childish just-so logic; the armchair critics who complain that characters don't behave logically or consistently while failing to notice, all around them, the blooming, buzzing confusion of ordinary life.

3 Comments:

Blogger Ken Houghton said...

"[Lanchester argues] that it all started with the collapse of communism, which freed the West of the need to emulate communism's cradle-to-grave care and let loose unbridled libertarian capitalism"

I'm inclined to argue he got the source almost right (I would point to excessive privileging of capital over labor in the U.S. tax system as the source, and the concomittant willingness to run high government debt--real "free money"--that was the result of both Thatcherite and Reaganite policies.)

What happened post-1989 in broad terms is that you have an influx of labor into "the market" without a parallel supply of capital. (The Soviet Union didn't "break up" because of its excellent balance sheet, but rather because of its suboptimal allocations--20% of GDP on "defence" is truly unsustainable, since its multiplier effect is at best one.) Combine that with tax privileging (that came out of a bollixed economic theory that still pervades today [Chamley, 1986]), and you encourage people to overuse the scarce resource and underutilize the available one. (Charlie Stross said something similar, in English, a few weeks ago when he was looking at the returns to U.K. public [U.S. definition] education.)

The rest is that capital accumulates to those who already have it, innovation declines at the margin, and the process feeds on itself until you end up looking as if you've "let loose unbridled libertarian capitalism."

In reality, the fall of the USSR (and its subsequent "oligarchy"/mob rule) is necessary but not sufficient to exacerbate—not cause—the effects of policies that led to their own destruction.

(As an aside, it's not difficult to justify a few of those products--junk bonds solved a true market failure, while CDSes are a fine interbank product to make the system less volatile. A similar argument to the junk bond one can be made about "sub-prime" mortgages--which caused rather none of the crisis, since the excessive building in the US, Eire, Spain, etc. was not of housing that received those mortgages. But that's a side discussion that uses those economic models and reality and tries to match the two instead of fiating that the model is the territory.)

Short version: Krugman is correct; it started ca. 1981 with Reagan/Thatcher sowing the seeds and the collapse of communism merely adding kindling to a bonfire that was barely controlled as it was.

November 15, 2010 8:47 PM  
Blogger Adam Roberts said...

I wholeheartedly second that (your last paragraph, I mean). You've put your finger on something important about SF more generally, I think -- practice and theory.

November 18, 2010 5:33 PM  
Blogger Paul McAuley said...

Ken - you most definitely know more about this than me: thanks for yr post, expecially mapping of locus and cause. Started with Thatcher & Reagan most certainly, and both Clinton and Blair let it run when they should have reined it in. Deregulation is always quoted as the fuse for what happened later, but your point about the idea that capital was privileged over labour (ie making things) is perhaps equally important. Though globalisation of labour (moving the manufacturing base to countries where labour is cheap and non-unionised) is part of the whole picture too, I think. Now, in the form of China, that strategy is coming back to bite us hard. You're right, too, that some of those instruments where actually useful - Lanchester is good, I think, in explaining how the idealism of some bankers was exploited or undermined by others.

Adam - most of the theory v. practice problem in SF I learned from Mike Harrison. Shorter version: 'Suicide Coast'. Longer version: 'Light'. Once you start looking, it's everywhere.

November 18, 2010 6:05 PM  

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