Have we become too reliant on computer modeling?
Nothing can replace the human touch
By Melvin J. Howard
The modern world of high technology could not have come about without the invention of the computer. Computers are used throughout society for the storage and handling of data—from secret governmental files to banking transactions to private household accounts. Computers have opened up a new era in manufacturing through the techniques of AUTOMATION, Computers come in a wide range of sizes. Supercomputers analyze massive, complexly interrelated sets of data. For example, they solve problems in aerodynamic design of supersonic aircraft, predict the weather, and come up with new designs for disease-specific drugs. Mainframe computers and their smaller cousins, minicomputers, are the workhorses of commerce and industry. These centralized machines maintain records, calculate payrolls, and analyze statistics, among many other jobs. But there is a down side with all this technology we have come to rely on it as fact instead of a tool.
The familiar PERSONAL COMPUTER, also known as a PC, desktop computer, or microcomputer, is used for word processing, accounting, and record keeping in businesses and homes. In business and industry, employees use PCs for their everyday work and to access other computers, larger or more specialized, for work of greater complexity.
Slightly larger than PCs, but considerably more powerful, workstations are used in such diverse tasks as designing machines, electronic circuits, and structures; creating advertisements, brochures, and magazines using DESKTOP PUBLISHING software; and training doctors in surgical techniques. Now rivalling desktop computers in computer power, but considerably smaller in size, laptop and notebook computers have become a favorite tool of business people. Travelers carry these light, battery-powered computers into trains, planes, and hotel rooms to do their work much as if they were in the office. Through small modules called docking stations, these users can link their laptops to a variety of external services such as printers and communication networks.
“Embedded” computers are hidden in equipment. They perform such simple tasks as preventing a car’s brakes from locking or such complex ones as instructing a machine tool to perform a task or stabilizing a jumbo jet. Did you know that everything a computer does is based on ones and zeroes? It's hard to imagine, because you hear people talking about the absolutely gargantuan (huge) numbers that computers "crunch". But all those huge numbers - they're just made up of ones and zeros. It's kind of like the computer is made up of a bunch of lightswitches, and each lightswitch controls just one lightbulb. On or Off. One or Zero. But if you took all of those lightbulbs together, and said "Let's make each sequence of On-and-Off represent a different number!" Well then, you could get some pretty large numbers. For instance this binary code says Melvin J. Howard Principal of the Howard Group :01001101 01100101 01101100 01110110 01101001 01101110 00100000 01001010 00101110 00100000 01001000 01101111 01110111 01100001 01110010 01100100 00100000 01010000 01110010 01101001 01101110 01100011 01101001 01110000 01100001 01101100 00100000 01101111 01100110 00100000 01110100 01101000 01100101 00100000 01001000 01101111 01110111 01100001 01110010 01100100 00100000 01000111 01110010 01101111 01110101 01110000. Another part of the financial industry that relies heavily on numbers is credit scoring.
Credit scoring was invented by the Fair Isaac Corporation in 1958 to provide a quick, data-driven method for determining the credit worthiness of an individual or corporation. This innovation was only possible with the development of the computer and modern communications technology. As the technology and business model has advanced, credit scoring has become integral to the proper functioning of the consumer economy. Credit scoring was developed as a method for predicting consumer behavior based on sophisticated statistical models. In short, it compares one credit user's behavior to statistical averages in order to predict whether they will be a good candidate for an extension of credit. These statistical models only improve in overall accuracy as more people enter the system. This was difficult to accomplish in the early period of the history of credit scoring. The FICO score, last overhauled in 1989, is based on a complex formula using many variables—and yet it can be manipulated fairly easily by ordinary people. In the past few years a group of "credit doctors" and mortgage brokers began devising tricks, some illegal, to help borrowers juice their FICO scores to qualify for credit cards and mortgages on homes they couldn't afford. At the same time new, exotic mortgages were bursting onto the scene and Fair Isaac was slow to keep up with the changes. By the end of the housing boom in 2006, FICO's accuracy in predicting the likelihood of a borrower's repaying a debt had slipped. Yet this model is flawed the more heavily lenders and bankers relied on credit scores, the more mistakes were made," says Anthony B. Sanders, a finance professor at Arizona State University and former head of asset-backed research at Deutsche Bank in New York. FICO was not created to predict risk; it was created to make money think about it? Ever got some info on your credit score that was not right. Or worst yet someone is using your identity it happen to me several times try to get that erased. You have a better chance of getting a seat on the next space shuttle. There are better ways to predict consumer risk what’s the use of having a high credit score but only have a week’s salary in the bank?
Smart people aren't supposed to get into this kind of a mess. With two Nobel prize winners among its partners, Long-Term Capital Management L.P. was considered too clever to get caught in a market downdraft. The Greenwich (Conn.) hedge fund nearly tripled the money of its wealthy investors between its inception in March, 1994, and the end of 1997. Its sophisticated arbitrage strategy was avowedly ''market-neutral''--designed to make money whether prices were rising or falling. Then came the guns of the month of August or I like to call it vodka and caviar . Long-Term Capital's rocket science exploded on the launchpad. Its portfolio's value fell 44%, giving it a year-to-date decline of 52%. That's a loss of almost $2 billion. ''August has been very painful for all of us,'' Chief Executive John W. Meriwether, a legendary bond trader, said in a letter to investors. (Long-Term's executives declined to speak on the record.)
Long-Term Capital and its Nobel laureates in economics, Robert H. Merton and Myron S. Scholes, weren't the only ones who got creamed. Locating the losses is hard because Wall Street and the hedge-fund world don't disclose them. According to Andrew W. Lo, a finance professor at Massachusetts Institute of Technology who advises several so-called quant funds, as much as 20% of hedge funds, which control some $295 billion, are quantitatively oriented. The reputation of quantitative investing itself has been dealt long-term damage. Merton and Scholes, after all, are two of the most esteemed figures in finance--co-inventors with the late Fischer Black of the options-pricing model that underpins much of rocket science ( “ quant funds “ ).
1994: Long-Term Capital Management is founded by John Meriwether and accepts investments from 80 investors who put up a minimum of $10 million each. The initial equity capitalisation of the firm is $1.3 billion. (The Washington Post, 27 September 1998) End of 1997: After two years of returns running close to 40%, the fund has some $7 billion under management and is achieving only a 27% return — comparable with the return on US equities that year. Meriwether returns about $2.7 billion of the fund's capital back to investors because "investment opportunities were not large and attractive enough" (The Washington Post, 27 September 1998). Early 1998: The portfolio under LTCM's control amounts to well over $100 billion, while net asset value stands at some $4 billion; its swaps position is valued at some $1.25 trillion notional, equal to 5% of the entire global market. It had become a major supplier of index volatility to investment banks, was active in mortgage-backed securities and was dabbling in emerging markets such as Russia (Risk, October 1998) 17 August 1998: Russia devalues the rouble and declares a moratorium on 281 billion roubles ($13.5 billion) of its Treasury debt. The result is a massive "flight to quality", with investors flooding out of any remotely risky market and into the most secure instruments within the already "risk-free" government bond market. Ultimately, this results in a liquidity crisis of enormous proportions, dealing a severe blow to LTCM's portfolio. 1 September 1998: LTCM's equity has dropped to $2.3 billion. John Meriwether circulates a letter which discloses the massive loss and offers the chance to invest in the fund "on special terms". Existing investors are told that they will not be allowed to withdraw more than 12% of their investment, and not until December. 2 September 1998: LTCM's equity has dropped to $600 million. The portfolio has not shrunk significantly, and so its leverage is even higher. Banks begin to doubt the fund's ability to meet its margin calls but cannot move to liquidate for fear that it will precipitate a crisis that will cause huge losses among the fund's counterparties and potentially lead to a systemic crisis. 3 September 98: Goldman Sachs, AIG and Warren Buffett offer to buy out LTCM's partners for $250 million, to inject $4 billion into the ailing fund and run it as part of Goldman's proprietary trading operation. The offer is not accepted. That afternoon, the Federal Reserve Bank of New York, acting to prevent a potential systemic meltdown, organises a rescue package under which a consortium of leading investment and commercial banks, including LTCM's major creditors, inject $3.5-billion into the fund and take over its management, in exchange for 90% of LTCM's equity. Fourth quarter 1998: The damage from LTCM's near-demise was widespread. Many banks take a substantial write-off as a result of losses on their investments. UBS takes a third-quarter charge of $700 million, Dresdner Bank AG a $145 million charge, and Credit Suisse $55 million. Additionally, UBS chairman Mathis Cabiallavetta and three top executives resign in the wake of the bank's losses (The Wall Street Journal Europe, 5 October 1998). Merrill Lynch's global head of risk and credit management likewise leaves the firm. April 1999: President Clinton publishes a study of the LTCM crisis and its implications for systemic risk in financial markets, entitled the President's Working Group on Financial Markets (Governance and Risk Control-Regulatory guidelines-president's working group) As this case demonstrate, the lenders are the first to get nervous when an external shock hits. At that point, they begin to ask the fund manager for market valuations, not models-based fair valuations. This starts the fund along the downward spiral: illiquid securities are marked-to-market; margin calls are made; the illiquid securities must be sold; more margin calls are made, and so on. In general, shareholders may provide patient capital; but debt-holders do not. |
LTC prided itself on hiring PhDs and other brilliant talent to add to the mystique of the group. And the hedge fund performed spectacularly. It used proprietary computer driven models (think algorithms) to find miniscule misprincings in markets and would use leverage and derivatives to exploit those mispricings. At one point in time, $5b of equity was levered up to a $130b of total assets or bets outstanding well you know what happened.
The role played by the big credit rating agencies - such as Standard & Poor's and Fitch - in the unfolding financial crisis is now well-known. By giving complex, opaque and ultimately toxic mortgage-backed securities high ratings and therefore, their own ringing stamp of approval, the credit agencies enabled banks to market these destructive securities around the world. We are now all paying the price. Now, to prevent this very same crisis from turning into a full-blown catastrophe 1930's-style, governments around the world - from President Obama to Brown to Merkel and beyond - are planning major fiscal spending operations to place a floor on the terrifying downward economic spiral and to begin to turn the world economy toward recovery. Even the austerity-loving IMF is strongly supporting these initiatives.
Yet now, Standard & Poor's and Fitch are sending "credit warnings" to other governments, threatening to downgrade their sovereign debt ratings if they "allow" their fiscal deficits to increase too much. Standard & Poor's downgraded Greece's sovereign credit rating. Explaining the downgrade, Marko Mrsnik, S&P analyst, said: "The global financial and economic crisis has, in our opinion, exacerbated an underlying loss of competitiveness in the Greek economy." (Financial Times, January 14, 2009). And in recent days, three other eurozone countries - Portugal, Ireland and Spain - have been warned by Standard & Poor's to "fix" their public finances or face downgrades. Under the current system, such downgrades would increase the cost of raising funds and be taken as a signal to investors to shy away from these investments. Most significantly, these public warnings fire a shot across the bow of larger countries - such as Germany, the UK and France - that they had better not go too far down the road of fiscal expansion, or they might face a similar fate. This is flawed thinking the only way, then, to improve countries' ability and willingness to service debt in the medium term is to engage in massive fiscal expansions in the short term. But the credit rating agency models do not reflect this truth. This is true on a country by country case. What is most insidious about the credit agency warnings is the "fallacy of composition" follies it provokes. If collectively countries and investors follow their advice and governments - especially in the largest countries - fail to engage in large enough fiscal expansions - then the prospects for widespread payment problems of sovereign debt surely will occur. A widespread heeding of Standard & Poor's information will almost certainly lead to massive losses for investors.
A fully computerized global finance system means currency traders can move millions of dollars around the world with a few taps on the computer keyboard. Investors instantly profit from minute fluctuations in the price of currencies, short selling etc. There is a downfall with all this capital can flood in and out of a country with a push of the finger leaving a country in ruins remember South East Asia? Was John Maynard Keynes right about global bubbles hate to say it but right now it sure looks like it.
The Human Genome Project (HGP) was one of the great feats of exploration in history - an inward voyage of discovery rather than an outward exploration of the planet or the cosmos; an international research effort to sequence and map all of the genes - together known as the genome - of members of our species, Homo sapiens. Completed in April 2003, the HGP gave us the ability to, for the first time, to read nature's complete genetic blueprint for building a human being.
At the gene level, people are much more the same than they are different. In fact, individual humans vary between each other much less than do individuals of almost any other species. All of this argues that we came from a small group of common ancestors in the recent past.
None of this means that there are no distinguishing marks on our genes that can tell us where our ancestors are from. Anyone looking at Will Smith, Uma Thurman, and Jackie Chan would conclude they are different. Since these superficial differences happen at the genetic level, there must be genetic markers that are shared between people of the same "race." It is important to note, however, that these differences are incredibly minor. By and large, we are all very similar at the genetic level. As an example, a tall white man and a tall black man probably have more in common genetically than do a tall and a short black man. This is because many more genes are probably involved in height than are in observable racial differences. Yes we are different but that difference comprises of only 0.001 or one-tenth of 1 percent of our genes. These are the kind of numbers that astonishes me yet it does not make the news. That tells me we are more alike then different. Yet we have over 10,000 different religions and sects that war with each other. Different ethnic groups that think there are better then any other ethnic group. If people were adept to educate themselves instead of carrying misinformed information from generation to generation we all be a lot better off. We have put some much currency in computer modeling and number crunching this will always lead to disaster. As quantum theory has taught us. You cannot replace the observer i.e. us humans in interactions of the universe. It will always change on you there is one universal law that will not change. That is there will always be change and that is what you can always rely on change.
