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Short Term Memory – Roger Lowenstein

In Money on September 7, 2008 at 22:27

Roger Lowenstein has written a nice simple take on the present housing mortgage crisis.

  • Models are not built on complete evidence; they do not know how to model unseen events.
  • Events become more correlated during stressful times.
    • LTCM assumed independent spreads which become correlated after the Russia default.
    • The present crisis resulted from a bad assumption that the housing markets among states (e.g., CA and FL) are independent. So the odds of subprime defaults in both states were assumed to be exponentially lower than in either of them.
    • (But these new investment vehicles (subprime, Alt-A, etc.) themselves were inherently bad products. I do not know what kind of default processes were assumed.)
  • However, modelers are not alone to blame. Regulators knew what can happen with unregulated growth after LTCM. However, follow-up was not done. Greenspan was strongly convinced (and still is :)) that investment banks are the best self-regulators. (He has also mentioned in some FT.com articles that he himself does not know what is the best method of regulation).
  • “The United States had never suffered a nationwide contraction in housing prices” – is this true??
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