Career in finance

Mute

It doesn't surprise me that people would use Ising models in finance contexts, although I would expect that most economic systems are not necessarily in equilibrium and so dynamical models would have to be used to model the financial situation properly. The first reference approaches the problem using equilibrium statistical mechanics. Perhaps that's good enough for the particular problem they are looking at, but I would expect that for looking for signals of approaching crashes a non-equilibrium kind of model would be necessary. Then again, that's the sort of thing I've done in other contexts, so perhaps I'm biased in my approach (although I would still be skeptical about using equilibrium stat mech unless someone can provide good reasons as to why the system has equilibrated).

twofish-quant

The **end** of a depression is pretty much the best time to start a company. Also the oil crisis lasted for only a two years, and to large part it was self-inflicted. The basic problem wasn't so much lack of oil as price controls.

Someone has got to win the lottery.....

But it seems to me unwise to base your financial planning on it. Also, it seems even more unwise to base your economy on it.

The other thing is that the stereotype of entrepreneurs as risk takers is one of those fun stereotypes that are questionable. Malcolm Gladwell has written a few articles (that fit my personal observations of entrepreneurs) which argue that entrepreneurs are actually quite *risk-averse*. They often *seem* like they are taking big risks when in fact they aren't. (see http://www.newyorker.com/reporting/2..._fact_gladwell)

And they all end up begging from money from some bank or venture capitalist.

twofish-quant

They can. But they don't necessarily do. Also the groups that have the power to lobby Congress tend to be professional societies, and they have interests that can be quite at odds with newly graduated physics Ph.D.'s. For example, one very strong thing that could be done is to unionize graduate students and post-docs, but if you do that you will be fighting tooth and nail against AAUP and the professional societies which are dominated by established folks.

The other thing is that lobbying requires money and political skill. This gets you back to finance. One of the things that I like about my job is that I got to see the process of political lobbying first hand so I've learned some tricks that may be useful to me later.

If they can find a venture capital willing to fund them. This all boils back to money.

Not true. I know of several physics Ph.D.'s at the managing director level, and a few who are government regulators.

No I don't agree with this. Even at my level a great deal of my time involves what would be considered politics. I'm not a manager, but I do have to negotiate access to resources from other groups at a day to day basis.

Your odds of getting screwed over are much less if you are on the committee that does the screwing.

Or industry. There are several theory physics Ph.D.'s that have made it to the top (the head of Renaissance Technology for one).

twofish-quant

No you aren't. It would be a bad thing that physics Ph.D.'s going into finance were doing work that was actively socially destructive, but I don't we are. Of course, I'm not unbiased at this. Having someone give you large sums of money changes your view of them.

Also, I really don't care if you have negative connotations about me. If I'm doing the "right thing" and you have negative opinions of that, then I don't care. I'm not running for public office, and because I'm not, I have a bit more freedom to say what I think even if those things are unpopular.

Conversely, if you have a positive opinion of me, it's not going help me to pay my rent, and if you have positive opinions of me and we both are wrong, that's bad.

1) Because everyone knows that.
2) Because *I* quite intentionally didn't work on those products.

Because of 2) there was a "negative Darwin" effect that happened before 2008. People with half a brain and some moral sense ended up not working for firms and in areas were stupid stuff was going on, which made those firms even more stupid and amoral. I know of some people that worked for bad firms that tried to change things from the inside, got disgusted and quit.

You can ask why people didn't alert the media or the government. Simple, before 2008, people didn't care, and it would have gotten you in a lot of trouble and done no good. Things are *very* different since 2008. There are government regulators monitoring things and they have put in management changes, and those bad firms killed themselves in the end. Too bad they took down the rest of the world.

The other thing is that it's often not obvious what the "right thing" is. If you put yourself in 2005, there was a prevailing opinion of "markets good/government bad", and most of the people that believed that were quite sincere and well-meaning, just like most Communists that I've met are nice well-meaning people, notwithstanding that it lead to things like Stalin and Mao. One thing that I makes me nervous is that I *think* that I'm doing socially positive things, but it will be up to historians to judge.

twofish-quant

And even having physicists cash out is not necessarily a bad thing. I'm hoping that a decade from now I'll have a fat bank account, and be using it to fund my own research in supernova and high performance computing. I'll also have a ton of experience in things like management, finance, and politics which I'll be able to use to do astrophysical things. Right now, "I want a moon base" is idle talk. When I have money and political connections, then I can effectively lobby for moon bases.

Ultimately, the reason I went into finance was that I want to study astrophysics. If someone has a better plan than make a ton of money from Wall Street and then cash out, I'm open to alternatives........

Now a critical part of this strategy involves not blowing up the world......

I can hope for stuff. I can pray for winning the lottery, or I can actually do something that gets me what and where I want.

Which is pretty relevant for someone looking to get into the business now. Now what the world looks like in 2017, I really don't know. I subscribe to the "pinball model" of history and finance. If you want to know what the world looks like tomorrow, then it's going to look a lot like what it looks like today. If you are trying to model the motion of a pinball, you can use the same principle until it hits a bumper at which point it's going to fly off in some random direction. (I did some work in chaotic billard systems.)

As time passes the odds of something happening that causes the "straight-line" approximation to fail increases until it hits one. You can deal with this sort of system using Lypanov exponents and timescales, so the time scale for "history hitting a bumper" is roughly two to three years.

Also it matters when you hit the bumper. For example, right now there really isn't that much point in talking about financial regulation, because all of the big decisions were made two years ago, and no one wants to revisit them and undo the deals that were being made.

twofish-quant

What ends up being useful is multiple-scale analysis....

http://en.wikipedia.org/wiki/Multiple-scale_analysis

What happens with complex dynamical systems is that you often have things happening at vastly different time scales, so what you do is to calculate a local equilibrium at one time scale and then using that as your order zero scenario to do perturbation analysis at a different scale.

So in stars, you have things happening on hydrodynamic scales (i.e. seconds) and nuclear time scales (millions of years) and then you separate those two problems.

This happens a lot in finance. The time scale for stock prices equilibrium is seconds. The time scale for macroeconomic impact is months. The time scale for institutional changes can be years or sometimes decades. So you assume local equilibrium at one level and use that as the base case for another level.

Very dramatic things can happen if something goes wildly out of local equilibrium at one level since it takes down all the levels above it. You end up with supernova and financial crashes.

One other nice thing about Ising spin models and monte carlo methods is that they are dead simple to explain to someone without any technical background. If you write a bunch of greek symbols, this will not do for a regulator or senior manager.

But it's easy to come up with an explanation of an Ising model. I have a bank, which is either alive or dead. If a bank dies then it has a probability X of causing neighboring banks to die. I run a computer simulation with these assumptions and see what happens. It turns out that if a few banks die then nothing bad happens, but I go over a threshold then suddenly all of the banks die.

And that you put that into a powerpoint and draw some pictures....

You can use local equilibrium some times. If we are talking about timescales of an hour, then stock prices are in local equilibrium. Also very interesting things happen when you get into very non-equilbrium situations because quantities that assume equilibrium become hard to define. If you look at a single electron, you really can't talk about it's entropy or temperature.

Similarly when you are looking at timescales of seconds or lower, it's difficult to define a "stock price." To have a defined "price" you have to have an equilibrium between supply and demand. If something is wildly out of equilibrium, then the concept of "price" no longer exists. This does happen with stocks at seconds. It also happens with everything else during a financial crash (or bubble), which is very bad because markets depend on the concept of "price" to make decisions.

Keile

Yeah but saying that they're doing something useful to the economy is pulling at straws. Finance existed before quants. We had a growing, profitable and stable financial center before quants. Then the quants came in and contributed to one of the sector's worst collapses. I've heard arguments from bankers regarding the social utility of their work and their argument is much the same nebulous nonsense as yours. They increase efficiency in the system, they say, and we should be glad Harvard graduates are doing this because the financial system is so gosh darn important. Yada yada.

We don't need some of the smartest people alive fiddling with numbers for an MBA's personal enrichment, we want them in our labs innovating and making new new scientific discoveries.

So you don't reject the notion quants had a part to play in the crash? Great. Let's get to solving the big problems in America, not creating more of them as a result of shameless self-interest and greed.

twofish-quant

And you also had financial crises before quants.

Baby and bathwaters.

Money and the internet creates a lot of problems. This doesn't mean that we should ban it.

Fine. Are you willing to put your money were your mouth is? It all boils down to this money thing. I'll take a 50% pay cut to work on astrophysics. Heck, maybe I'll consider an 80% job cut. Do you have a job offer in hand? Do you have any ideas for me to get a job?

Now my plan is to make a ton of money and learn as much as I can about finance and politics. At some point I hope to cash out. I'll probably do astrophysics research. I'll have enough experience with this money thing and enough contacts to do things like lobby for moon bases. Heck, if I know enough rich people, I might to able to convince them to build one themselves.

Of course I don't.

This is silly and empty politician talk. It sounds good, but it's totally meaningless. Let's "solve problems!!!!" YEAH!!!! Can you give me some clue as to which problems you propose to solve and how you propose to solve them?

The big problem right now is how do you avoid another finance disaster. Do you have any *specific* ideas for how to do that? More regulation? Cool. What specifically do you want to regulated? Who do you want to regulated it? How do you want it regulated?

Also, we can argue whether greed is good, but I think it's pretty irrelevant to argue this. Human are greedy. If you have a social system that *depends* on people being altrustic to people they don't know, then it's not going to work.

Also, why focus on America? This is a global system.

chiro

We did but that's always due to the way the system is structured from the start: the quants just make it worse especially when it comes to raw speculation as opposed to real hedging which is what the point of these so called "miracle math products" were meant to be about.

This is what it boils down to: the idea of "I'll do it as long as I have to". When you get the majority thinking that way then it causes problems and it's a form of delusional personal brainwashing.

I agree with the sentiment of your response, but I can give you one solid thing to stop a lot of problems and it has to do with liquidity.

The amount of liquidity in the system is ridiculous. It used to be that when major purchases were made the liquidity was very low in that buying a house took a long time and even getting a loan for said house or a small business.

Today money is exchanged ridiculously quickly and more importantly, money is also exchanged in very large amounts very quickly. This is very very dangerous.

When you have this kind of environment with regards to liquidity it means that all the stuff like the panics and the runs will be a lot more chaotic.

So what's one solution, get rid of instant liquidity. With respect to hedging, proper hedging does not require a lot of liquidity: when an airline takes out an option for fuel, they pay for it, it gets delivered and they use it. They don't trade it around like a one dollar bill.

If you want to speculate, you should bear the risk of having to hold on to that particular thing for a little while. The people that do real hedging won't be affected but the speculators will think twice.

It also means that the system is harder to rig when you have proper liquidity constraints. When there are requirements about how frequently exchange can occur, it means that all these absolute pointless activities like algorithmic trading will become useless and they are useless to society.

The other thing: raise interest rates. You want capital for capitalism, then encourage people to save. When rates are at zero you discourage saving and encourage borrowing. It's irresponsible and it's just down right stupid.

Lots of people are pointing out things like this all the time including fund managers and owners, professional investors, economists and journalists who have been in the system before.

This idea of trying to eliminate and move risk is ridiculous: you just make it worse when you mix this risk-management scheme with infinite liquidity.

The thing is that when you have infinite liquidity, things are going to blow up a hell of a lot quicker and it's just a ticking time-bomb.

The truth is though that infinite liquidity and speculation is profitable for the people that do it even when it blows up other parts of the world and they don't want to stop doing it because it's easy money.

There is no reason for wash trades and many of these ridiculous insurance products for betting on outcomes like interest rates. We just found out that LIBOR was rigged. I wonder how "beneficial" this is for holders of insurance contracts on interest rates.

As I said above, the biggest thing is liquidity: there is too much of it and it's destroying things.

In terms of option contracts, you have liquidity issues regarding the frequency of exchange. We already have this for mortgages (although even this has gotten worse) so at least quants have some reference point to build on in their research as well as regulators that wanted to consider how such an approach would be executed.

General rule though is that the liquidity should be such that it discourages un-necessary speculation.

So you basically tie the frequency constraints of liquidity to the nature of asset/product, how it impacts the rest of the system. If people want to have more liquidity, then they can pay a tax that is relevant to the asset/product they are trading, the market they are in, and the value of that asset.

Humans are greedy and this means you need to design systems that are pessimistic in the way that they don't just protect us from others but ourselves from ourselves.

The best thing we can do is to come up with something that everybody agrees on or to the best approximation thereof.

I know you challenged this statement before in another thread saying "that couldn't happen", but the point of the derivatives was to do exactly that: it was to use mathematics as a way of drawing up contracts because mathematicians and lawyers on both sides would tell their clients that everything was A-OK.

The problem is that these contracts and products only focus on two parties and you have an entire system of things go on that impacts everything.

The other thing is that a lot of the people that are affected don't really have any part in terms of a physical action in the creation and execution of these contracts which basically affects their own form of arbitrage (i.e. they have none) while the financial institutions have all the arbitrage at their disposal.

So ultimately the solution is to implement principles where all people have the same advantage and this means being really pessismistic.

The answer is going to be something that everyone hates because they can't game the system for themselves and will be politically un-palatable for everyone and this is the biggest thing that sets it back from even being considered because as you pointed out, people are greedy.

So ironically, IMO, the solution will be something that absolutely everybody hates at first, but eventually one that everybody appreciates a lot later and I only see it happening when everything goes to hell and as a consequence there is very serious discussion about what to do about it.

Until the world literally goes to hell, I can't see it happening any time soon but it has to affect the entire world so that everybody is affected in some way and although I'd rather it did not happen, I can't see any other way for it happening.

When it happens to a few people, the rest can deny it: when it happens to everyone, no one can deny it.

Mute

I seem to remember that a much worse economic collapse occurred way back in 1929, well before quantitative finance became a field. I'm sure at the time people also claimed the financial centers were growing, profitable and "stable", too. Assigning all of the blame for the recent collapse to quants and the like is at best simplistic and at worst disastrous, because if you assume that the problem was the entirely the quants, then you become blind to the other causes that might well have caused a similar collapse (better or worse) even if quants didn't exist. Your primary advantage in this argument is that it appears that the use of a financial model beyond its applicability was one of the important contributing factors to this collapse, but it doesn't prove that no collapse would have occurred without quants.

Furthermore, one of the reasons we haven't had such a disastrous collapse since the great depression is that people spent a lot of time thinking about what went wrong and instituted measures to prevent similar problems from happening again. The same sorts of things are going to happen and are happening now, and unless people can demonstrate that the financial system is going to work better without a deeper understanding of it, banks aren't going to stop hiring quants.

How does one measure social utility? I don't know if quants actually increase efficiency in the system. I'm just putting forward the notion that maybe, just maybe, some quants are doing something that is useful, and we just don't hear about it because it doesn't impact us as obviously as the economic downturn did.

What's the social utility of a string theorist?


Most of those "smartest people alive" also want to be in labs innovating and making new scientific discoveries, but there just aren't enough well-paying jobs to absorb them all. Why should those "smartest people alive" subject themselves to years of postdocs in which they make low salaries, have to move around the country/continent/world, in hopes of landing a permanent job at a university or lab, with limited their ability to support a family when they could go into field and have actual financial and geographical stability on a much shorter time-scale? If they can't find a decent job in the field they want or have to postpone stability in their lives for years to do it, exactly what incentive is there for the "smartest people alive" not to go into finance?

Experimentalists perhaps have an easier time finding jobs in industry. What about theorists who want to be able to keep using the skills they've learned but no longer want to be in academia? Would you prefer they all got jobs modelling for the gas and oil industry? Is that a morally higher ground than finance? Who's willing to hire theoretical physicists to do theoretical physics? If you have a serious answer to that question, I'd certainly like to hear it! I'm 100% serious! I'd certainly love to keep doing science my whole life, but if it's going to take me another 3-6 or more years to get a tenure-track position and actually start settling down, and then another five years on top of that to get tenure, then yes, I am going to look at other options, and those options are going to include finance. (And I'd like to think that I would be one of the people trying very hard to not let the system collapse!)

I also don't reject the notion that physicists had a part to play in developing the nuclear bomb, which brought the world to the brink of destruction during the Cold War (and still threatens to do so, although tensions are seemingly not quite as high as back then). Do you think you would have suggested at the time that people should stop doing physics just because some physicists had made such a destructive weapon?

I don't see why quantitative scientists should stop doing finance just because some quants made a model that was used beyond its realm of application and played a role in the recent economic collapse. It doesn't mean all quants are going to screw up the system, and it certainly doesn't mean it's not possible for a quant to do something that will help prevent economic collapse rather than cause one.

So, Keile, what exactly is your expertise on the subject, and how have you come to the conclusion that no quants are able to do anything useful in finance? (This is not a rhetorical question)

As for my expertise, to save you the trouble of asking, I am not an expert on financial systems themselves, but much of my graduate research has been studying models of other systems which exhibit kinds of catastrophic failures and trying to devise signals or methods of predicting those collapses. This has obvious connections to the concept of trying to predict economic collapses in financial models and systems, hence my interest in the current discussion.

twofish-quant

You also had major economic messes in 1973, 1980, 1985, 1989, 1997, and 2001. Now, 2007 was unusually because it was global, but I would argue that the cause of that is the internet. You can move money and ideas across the world in milliseconds. That's mostly a good thing, but it does have drawbacks.

There's a very fine line between "accepting responsibility" and "being a scapegoat." As part of the financial system, physics Ph.D.'s do have some blame for what happened, but I don't think that physicists were the sole or even the most important piece of the problem.

There's one particular equation that blew up the world. The Gaussian coupla model for collaterialized default obligations. The problem was that that model and cheap computers made lots of people very wealthy, so by the time the physics geeks were starting to warn people about the limits of that equation, they were brushed aside in a lot of places.

The basic problem is that in 2004, if you were a physics Ph.D. that was in a badly run firm, then people would just not listen to you. You're only choice was to move to a firm where your opinions were respected. Now from a "personal morality" point of view, that was a good thing. From a social system point of view it led to a "reverse Darwin" effect. Clueless firms became more clueless, until the system blew up at its weakest links.

Now people have tried to fix the problem. Today, if you come up with a model, then dozens of people are going to look over it before it makes it anywhere near real money, and there are lots of places where people can veto moving the model to production. That means that banking is extremely bureaucratic with a ton of procedures. But that also means lots of jobs for people that can understand high level mathematics.

There have been a lot of important decisions made, and the people have more or less agreed on the regulatory framework. The big thing that is going on right now is implementation of the Basel III standards.

http://en.wikipedia.org/wiki/Basel_III

There are a *lot* of interesting physics-type problems here.

And then there is the social utility of keeping physicists doing hard math. I spend most of my days solving very hard math and computer problems. It keeps my brain going. If aliens suddenly invaded and the world needed scientists to design laser cannon flying saucers, I'm ready, because I've been doing enough math so that I can switch to something else.

Now if I was working at a non-math job, there would be nothing to keep my skills from rotting. So even at the level of "storing brain power", Wall Street is performing a useful service.

I'd personally be glad if there were other types of jobs available for theory Ph.D.'s. But nothing is stopping people from talking about other types of jobs here.

And the cool thing is that I am innovating. One thing about academia is that people care about credit. I don't care about credit as long as I can get cash. We use several open source packages where I work, and we've been very, very active at pushing our improvements back into the software community.

And then what happens when your lottery tickets don't pay off?

Done that too. :-) :-) Not a bad job, and I'd still be happily employed in an oil company had we not gotten an idiot CEO that decided to fire everyone.

And that's the third major employer of astrophysicists. Building hydrogen bombs. I know people that do that. I respect them. It's not a good job for me. My problem is that I talk too much. That's a mildly negative thing when you work in finance. Talking too much can get you in jail if you build H-bombs. The worst thing my current employer can do to me is to fire me, and if they do, they aren't going to be following me for the rest of my life. Once you get hired building nuclear weapons, people *WILL* be tracking you for the rest of your life.

The big three employers of astrophysicists are oil gas, finance, and nuclear bombs. You might wonder why astrophysicists get hired studying things that could wreck the planet. Not a coincidence. Once thing that you quickly figure out when you do astrophysics is how puny and fragile the earth is in comparison to the rest of the universe. Once you start studying planet-destroying energies, it's not a surprise when you get hired in areas that could blow up the planet.

I'm not an expert in financial systems either. I've been working in finance for five years. Even if I spend the next thirty years working on this, I won't be an expert.

twofish-quant

Fine, how do you propose to uninvent the internet? Money today consists of electronic pulses that can travel at pretty close to the speed of light. You have instant liquidity because you can money electrons very, very quickly.

Ever hear of Las Vegas? Las Vegas gets it's wealth because casino gambling is prohibited in most of the United States. So the one place where it isn't makes tons of money. This is a very common theme. There are several small islands in the Caribbean that have entire economies devoted to circumventing regulations.

If you institute draconian regulations everyone except the South Pole, someone will set up a financial center in the South Pole and thanks to the internet, you can do all your transactions there.

Exactly. So how do you propose to uninvent the internet?

At which point people will just move their money to places without that tax and do the deal there. Press a button. My money just went to the British Virgin Islands. Press another button. We just did the trade there. This internet thing makes things annoying.

StatGuy2000

Here are some questions for you, twofish-quant.

(1) You had stated above that back in 2004 if you were a physics PhD (or math, statistics, or operations research PhD) working as a quant in a badly run firm, people would not listen to you. How many of the major financial firms operating in the world today are well-run now, in the sense that those with the expertise are listened to?

I ask this because the math/physics/stats PhDs have been made to be the scapegoats in the financial crash of 2007, but I personally feel that the poor use or misuse of mathematical models in financial instruments is as much, if not more, of a result of poor decision-making on the part of upper management who had no understanding or appreciation of the limitations of those models and either foolishly trusted the models or refused to listen to those who questioned them.

(2) Do you feel that the full implementation of Basel III standards is sufficient in mitigating or greatly reducing the risks of the banking crashes and the contagion effects that we've seen occur in 2007? If not, what else do you feel needs to be done?

(3) On a related note to point (2), you had stated earlier that if we build too draconian a system of regulations, then financial firms will have incentives to simply move to another part of the globe where such regulations are lax. This would just as likely put efforts at Basel III to nought as well. After all, Basel III are a voluntary set of standards; the Feds can mandate enforcement within the US or with dealings with US institutions, but they cannot enforce it on firms with key operations out of the US. Ditto for other firms. Not to mention that there are still questions on how Basel III can be implemented with insurance or hedge funds.

chiro

The internet is a general device for communication and while I agree that it facilitates all the exchanges that are made, it doesn't control them.

There are already bodies that are meant to regulate the exchange and are in charge of their own portion of regulations and these are the banks and the regulators themselves.

Credit for a start is a regulated entity and these so called Caribbean islands don't create a lot of credit. The main problem is not moving around non-credit forms of digital "wealth" like savings, but stuff that has more to do with speculation and that is centred on credit.

When deposits are moved around at the speed of light, then everybody who does that should have the right to do so. The deposits came largely from both labour and existing credit and that's not the problem.

The problem comes in at the point where credit is created, and credit comes from the top to the bottom: from the central banks down to the consumer/business lending banks and they can and should have regulated liquidity constraints.

When people speculate, a lot of the time they are doing it with credit and not with deposits or savings. If someone goes to Los Vegas and blows their weekly wage then that's OK. When someone however blows 50,000 of money of which they only have 500 (i.e. a leveraged bet of 1:100) then that creates a systemic problem for the casino, the person and a whole chain of other people. Again, the point has to do with credit.

If you are speculating and the speculation is based on credit, the creditor can enforce the regulations at the point of credit creation. If the speculator is using their own deposits that are not bound to credit, then the liquidity should be infinite as they are only affecting themselves: it's their money and there are no chances for cascading effects like defaults and the like.

Credit creators have always done this: you get a business loan for a bank, they might stipulate conditions for you to get the credit.

So to summarize, you enforce at the point of credit creation and it's use in regard to what the credit is used for. We already do this kind of thing in some ways, but the practices and policies need to be updated for all these new uses for derivative products and the like.

Again, the main issue has to do with credit creation: this is the entry point for liquidity and it's only logical that this is the point where you start with the new regulation.

Carribean islands aren't major creditors and most of the large creditor nations are ones with large economies that include high productive capacities and not just ones that are largely tax havens and tourist economies, and that's for a very good reason.

It's not so much the transaction aspect, again it's the credit creation.

The issue of credit vs capital is the big thing and they are very different even though some people see them as the same: they're not.

When one creditor gets a bad reputation, people stop going to that creditor and they end up going to another. Creditors have every reason to keep their reputation at the highest standard, and doing something like this would encourage investment in an economy because it demonstrates sound policies for aiding an economy over destroying it.

The problem is not the internet, it's the aspect of credit creation and how this credit creation indirectly facilitates these problems of instant liquidity in the context of speculation.

Exactly. So how do you propose to uninvent the internet?



At which point people will just move their money to places without that tax and do the deal there. Press a button. My money just went to the British Virgin Islands. Press another button. We just did the trade there. This internet thing makes things annoying.[/QUOTE]

twofish-quant

"Well run" as in that sense, I think that all of the major banks are. The thing is that the regulations have changed so that you cannot ignore quantitative views, and the major governments have forced the larger banks to make changes so that you have to go through risk controls to do anything. There's also been a major cultural shift. Before 2007, it was the traders that ran the company because they were closer to the money. Now, it's the risk managers, because they are closer to the regulators.

Now, this may not prevent another crash. Financial systems being as complex as they are it's possible that something that no one in the industry is seeing will lead to another blow up, but if the system blows up, it will be for reasons which are not obvious now.

1) This is why people with mathematical skills get into relatively senior management positions in finance.

2) It's not so much of understanding than psychology. If an equation is making you personally wealthy then you are not going to be intentionally looking for flaws in that equation. If you think that there *may be* a flaw, you aren't going to be spending that much effort to make sure.

I don't know. Part of the question right now is that Basel III is more of a *process* than a set of firm standards, and part of the process involves some basic mathematical research. For example, Basel III contains standards on liquidity. Well how do you measure liquidity? What is a price? Mark-to-market? Which market?

Just from general principles, I can't say that something bad won't happen. Also I can say pretty confidently, that we won't see something exactly like 2007, because history just doesn't repeat. But as far as getting us into a situation where we end up doing something that causes worse problems, I don't know. Not knowing is fine. Thinking that you know when you don't is dangerous.

One of the reason this is a real problem is that there are reasons to think that Basel II actually made the financial crisis worse. The idea was behind Basel II was that you could use as bank reserves products that hedged your positions, which meant that European banks bought tons of derivatives to hedge their losses, so that in a crisis they would be protected against losses by their derivatives...... Oooopppppsssssss......

So it's very possible that we are doing something right now that will dig the hole deeper. Or not.

If people really knew what was going on, they wouldn't need to hire researchers.

It makes life much more difficult, but all of the governments think that "blowing up the world" is a bad thing. There's a minimal set of things that the all of the major powers agree on, and that's enough to limit regulatory arbitrage. Again Basel III is a process, so that when people do disagree over some things, people can scream at each other and come up some agreement rather than to just let things collapse.

The idea of "blowing up the world is a bad thing" is something that we can get agreement on. The idea that "gambling and speculation is a moral sin that ought to be banned" is something that you can't. People in the UK just don't believe this, and that impacts the financial system. It is *extremely* difficult to buy and sell retail derivatives in the US. Trivially easy in the UK. The idea that "banks shouldn't run companies" is something that Americans believe, but not the French or the Germans.

One other thing which I think is a real problem but it's a reality is that the people that go to the meetings in Basel share a pretty common world view. They all know each other, and their kids all go to Harvard or Yale. The richer and more powerful you are, the more global you are, and there is something of a new "planetary elite." It's something that I find a little disturbing.

Basel III is "voluntary" in the same sense that filling out your income taxes in the US are "voluntary."

Feds mandate enforcement in the US. FSA for UK. CBRC for China. All the regulators talk to each other, so if the Fed tells you to do something at a meeting, it's very likely that the FSA will tell you to do the same thing at the next meeting. If the Fed and the FSA disagree about something, it's likely they'll work it out before they talk to you.

People figured out a regulatory system for hedge funds after LTCM, and that worked pretty well in 2007. The thing is that you don't regulate hedge funds. You regulate the banks lending money to hedge funds. Hedge funds blow up all the time. Since LTCM, that hasn't caused a domino effect because what happens is that the bank killed the hedge fund before it has a chance to be de-stabilizing.

twofish-quant

And those bodies proved ineffective in 2007 which is one reason that the crash happened. One big problem was that government bureaucracies move very slowly, and they were outrun by technology.

And they do. The trouble is that with the internet you can work around the liquidity constraints. Let's talk about interest rates. If you go to a US commercial bank you'll find that their interest rates for saving are lower than a money market account you can get through a broker.

Why is that? Well, US commercial banks are required to hold reserves. Money market funds are not. MM therefore can offer much better rates than banks. This didn't matter in 1950, but now with the magic of the internet, I can log into my online broker and they have a nice web page listing all of the various funds with their interest rates.

If you pick up an economics text book that talks about the banking system, it's likely very, very wrong. There's this thing called the "shadow banking" system. What people don't realize is that the "shadow banking" system *is* the banking system.

Everything is credit. What's a savings account? It's credit that you are providing to the bank. One big problem in explaining money is that people think of money as a "thing" like a pile of gold. When you have a "deposit" in a bank, it's not that the bank has a pile of gold. It's not that there is *anything physical at all*. When you deposit something into a bank, you have just provided the bank with a callable loan.

So to summarize, you enforce at the point of credit creation and it's use in regard to what the credit is used for. We already do this kind of thing in some ways, but the practices and policies need to be updated for all these new uses for derivative products and the like.

There is no such point.

I take my paycheck and deposit it into the bank. I am now a creditor to the bank who is now a debtor to me. The bank doesn't care what my credit rating is.

I feel as feel as if I'm trying to explain the big bang to a young earth creationist. The basic problem with your view is that

1) you *cannot* have a hedger without a speculator, and
2) you *cannot* have a creditor without a debtor

When I deposit money into a bank, I'm creating credit. I'm the creditor and the bank is a debtor. When the bank loans out the money (and sometimes they'll loan it back to me) the arrow is reversed.

The thing about banks is that they *are not* net creditors. Banks just transmit credit from the depositors to loaners while taking a bit of transaction fee on the side.

chiro

There was a lot of stuff that proceeded this like the removal of Glass Steagal that was introduced after the great depression happened and it was introduced for a reason.

The issue is the regulation of credit creatioh policies system-wide and this is not about competition for people's deposits.

Credit creation is the same in principle whether a central bank does it or whether a small lending facility does it.

Again, the point is not about a particular entity, but rather a general approach to credit creation.

There already are regulations for general credit creation, but unforunately they are not uniform. Uniformity as a general regulation policy is the best policy because its simple and because it's a lot easier to understand than having a bunch of exceptions and new bills having to be passed to "patch things up".

The other thing with beauracracy is that they have so many pieces of law that they have to follow: the amount of things signed into law is absolutely ridiculous and one of the reasons why these administrators are so slow is because they are occupied with the ridiculous amount of new legislation that keeps coming in.

The idea of just "patching things up" continually in an admistrative sense is creating the very thing that it tried to prevent by having a ridiculous amount of legislation which means that it becomes a lot harder to enforce said legislation if someone ever actually wants to enforce it.

This is one primary argument for keeping things simple in a legal sense and not just a financial sense.

I am aware of this system and it's very concerning that we have "two systems".

Not everything is credit: you have for example collateral and you have credit.

Collateral is something that the owner possesses without any kind of contractual obligation to any other party.

If you own a factory out-right that is collateral. If you own a few gold bars outright that is collateral.

Credit (real credit) is anything whereby a contractual obligation exists between two parties creating obligations with regards to the ownership and the issues of how this ownership is mitigated between the two parties.

These are very distinct things and they are not the same.

In the case of a deposit, I agree that you become a creditor with the actual bank since a dependency is created, but this need not be created and something can be classed as a non-credit item in the case that wealth is stored electronically without any kind of contractual obligation regarding issues of ownership between two distinct parties under distinct rules for the creditor and the debtor.

Credit can be separated legally from non-credit.

This is the main point I am trying to make yes.

The point regarding liquidity is that you treat the liquidity of credit products differently to those of non-credit products.

This would mean offering an option to people with deposits to not enter into an actual creditor contract with their lending facility. I know there are banks that do this where it really is just "administrative handling of money" without having interest rates and so on, but the holder does have to pay transaction and a small management fee for the service.

If people do not wish to enter into such a situation and want the interest (as well as what comes with being a creditor) than that is their business, but the option should be made available for people to have.

Treating the liquidity of non-credit vs credit would have a huge impact on the infrastructure and the confidence of the system overall, and the main thing about the system that everybody wants is some kind of real trust.

They should: haven't we already learned our lesson here with the GFC? A credit agreement is a two process and not a unidirectional one.

Maybe my terminology was wrong but what I'm talking about relates more or less to a futures contract in opposition to an exotic derivative. Hopefully that clears things up.

Again, the issue is of resolving what credit is and what non-credit is. Collateral is not credit: there is a very clear distinction.

There needs to be a real distinction between the two and the public needs to be able to differentiate between the two as well.

The thing is however that all money in circulation is credit, but collateral does actually exist and hopefully I have pointed a few examples.

If people want to use instruments of credit, enter into credit agreements, and so on then that's OK: just regulate it differently to ones of non-credit.

Yes I know this, and they are allowed to loan out a lot more than they have on the books through fractional reserve banking and the capital requirements issued by things like the Basel committee and other relevant regulatory frameworks.

Most people are not aware that non-credit instruments exist: they do exist but not in the form of conventional currencies whether digital or on paper.

I'm not saying to remove credit: if people want to go into credit arrangements then that is their business. If people just want to use non-credit instruments though that are not bound to distributed ownership in the form of a credit agreement that is legally binding, then they should have that option as well.

They won't earn interest and they will have to pay for the privilege for someone to administer their account and handle the transactions and all the rest, but they will have completely different liquidity constraints (i.e. they won't have any) in comparison and contrast to those bound up in crediting agreements.