Tuesday, May 01, 2012

Are You "Listening" Part 3... ? - Efficient Market Theorists!

Magicians...with pointy hats!
"The reputation of economists, never high, has been a casualty of the global crisis.  Ever since the world's financial system teetered on the abyss ... critics have posed one uncomfortable but highly pertinent question:  "Are economists of any use at all"?"    (First five paragraphs excerpted from the Financial Times: "A Realm Dismal In Its Rituals Of Rigour" - 8/26/2011) 

"Economists complain that the critics do not understand what they really do.  But, if the critics did understand what economists really do, public criticism might be more severe yet."

Entirely "empirical"....!!
"The study of financial markets revolves around the "efficient market hypothesis" - that all available information is incorporated into market prices, so that these prices at all times reflect the best possible estimate of the underlying value of assets - and the "capital asset pricing model".  This latter notion asserts that what we see is the outcome of decisions made by a marketplace of rational players acting on the belief in efficient markets."

"The serious criticism of modern economics is not that its practitioners failed to anticipate the crisis, but that they failed to understand the mechanisms that had put the global economy at grave risk.  Economic systems are typically dynamic and non-linear.  This means that outcomes are likely to be very sensitive to small changes in the parameters that determine their evolution.  These systems are also reflexive, in the sense that beliefs about what will happen influence what does happen."

....a "proven record" of foresight!
"The belief that models are more than just useful tools and instead are capable of yielding comprehensive and universal descriptions of the world blinded proponents to realities that had been staring them in the face."

Credit unions are currently confronted by a regulatory regime which still believes in this "economic model theocracy" - so thoroughly, painfully and expensively discredited by recent events at the Corporates.  

And, our regulatory "cultists" - in the best tradition of Jim Jones, Kool-Aid drinking "true believers" - persist and compound their errors with new irrationality on interest rate risk, ALM model madness, concentration risk presumptuousness, participation pontifications, and a whole range of concocted, simplistic, and hallucinatory-verging "best practices."  

Pretty clear what our "Let Them Eat Cake " regulatory "listeners" are baking up for CUs in the future; another very costly serving of...

...are you listening?


Anonymous said...

“In economics, for instance, we have very large models of risk calculations sitting on very rickety assumptions (actually, not rickety but plain wrong). They smoke us with math, but everything else is wrong. Getting the right assumptions may matter more than having a sophisticated model.

An interesting problem is the “value at risk” issue where people imagine that they have a way to understand the risk using “complicated mathematics” and running predictions on rare events—thinking that they were able from past data to observe the probability distributions. The most interesting behavioral aspect is that those who advocate it do not seem to have tested their past predicting record.”

--Nassim Taleb – Fooled by Randomness

It is interesting that regulators push instantaneous parallel rate shocks as some measure of interest rate risk. When in history has every market rate (loans and deposits) increased immediately by 3%? In the real world, interest rates move more slowly and in a proportional manner, not parallel. Therefore, a 3% instantaneous parallel rate event has a less than remote chance of occurring and is beyond a “worst case” scenario. Why would a credit union CEO manage a balance sheet or plan to such a scenario? Again, Mr. Taleb points out the idiocy of such a practice in his comment above. Why do credit unions let people (regulators) who have never run a balance sheet in their life dictate the structure of their balance sheet?

Jim Blaine said...

If you have never encountered Mr. Taleb before, Google "black swan"...its a great story about the arrogant self-assurance of those who always "know they are right"....

Little is certain in life.... less each day.... it's called experience... or wisdom!