Saturday, October 25, 2008

Global Economic Meltdown – Don’t Blame it on Bad Data, Blame it on Common Sense

Alan Greenspan, the former chairman of US Federal Reserve yesterday on a hearing by the US House Committee on Oversight and Government blamed the current economic meltdown on bad data that was used to develop various computer models. According to him the data fed into developing various financial models were often “garbage-in, garbage-out”. 

Why blame it on bad data now? If you have something called “common sense” you would have predicted this. The main cause for this economic downfall is the crash of US housing market. What was happening in the housing market for the last few years before the crash? House prices were increasing exponentially; the banks were giving loans to any tom, dick and harry who applied for a loan without seeing if he/she is capable of paying it back. Everything worked on the assumption that housing price is going to rise exponentially but if you use your “common sense’ you can easily understand that this cannot go on increasing like this. Somewhere in the future, increase has to flatten out and a market built just on the assumption that housing market will never go down, is going to crash like a bundle of cards. This is exactly what we have seen. The key here was every time in the history of US the housing prices were rising but was never rising exponentially and when something rises exponentially you can always expect a fall. 

History is full of examples and we don’t even learn from history. There was a dot com boom in late nineties. Start-ups were mushrooming like anything, stock market was booming and again every other man you meet in the street either wanted to work in a dot com company or wanted to own one. The growth flattened after some point of time and lot of them lost their job and so much of their money. 

Similarly another boom that is going on – it may have already started the negative journey – construction industry in Middle East. My friends working in Middle East tell me that construction industry is booming there, thanks to the record oil prices. It is no-brainer to predict that it can end anytime now with the oil prices in the downward spiral. No system can absorb an unprecedented growth and even if the oil prices don’t go down some other factors will come up and correct this growth. 

Take the case of IT industry in India. For a few years now, India is going through an IT boom. Half way through your college, you get placed through campus recruitment. The salaries of IT employees are increasing at an unprecedented rate. Students, irrespective of their area of specialization want to join as a software engineer.  They think this boom will go on for ever and they will be getting these salary hikes for ever. When this exponential growth in IT goes the other way (I fear it’s already started) lot of people are going to loose their job and they won’t have a clue what to do next. The big mistake people and institutions make is – assumption that this growth will go one for ever which has never been true. 

It is good to “Make Hay while Sun Shines” but is better to know that Sun never shines always and a period of darkness will also come in between. You need just your common sense to understand that, you need to have a plan B to implement when the sun stops shining and the darkness is about to come in. No computer model is ever going to tell you when the sun stops shining and you need to use your plan B, but your common sense can do so. 

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7 Comments:

Blogger Ajith said...

Great post mate.

There are banks who went on with their aggressive lending spree. They bought assets completely forgetting the cash reserve they have with them. Those are the companies which has gone bankrupt.

Data can be interpreted in different ways, its only a tool which can be used to take decisions, but common sense is vital as you said.

October 25, 2008 7:40 AM  
Blogger തോന്ന്യാസി ശ്രീ said...

Agree with you, Brijesh.

What Greenspan said reminds me of the phrase "bad workers always blame their tools". Use CS - Common Sense first, and then Computer Science.

October 25, 2008 8:25 AM  
Blogger Mani said...

"Greenspan has long praised computer technology as a tool that can be used to limit risks in financial markets. For instance, in 2005, he credited improved computing power and risk-scoring models with making it possible for lenders to extend credit to subprime mortgage borrowers." - It is undeniable that computing power during the past few decades has explored new territories, expanded horizons and created breathtaking new business opportunities. It has ultimately transformed the current time into the information era!

The per-capita availability of information across the globe has significantly increased during these times. This has also shifted quite a few paradigms for virtually every business entity in today's world. You can make better decisions; optimize business opportunities; calculate risks more accurately; create new services and products, by crunching the available information using the computing power. But it is very important to note that this has not altered any fundamental governing law to anyone's knowledge yet!

It is worth recalling couple of points - despite them being quite obvious - here. First: Data is very sensitive to time and space - it is very important to know the where and when data belongs to. Second: How you use the data is very crucial - "garbage in; garbage out" Think about whom you feed the data into: it is the computer and not the human. The computer is intelligent but only artificially! Another point worth noting is "All models are wrong but only some are useful"

The main reasons for the current financial meltdown are the systemic failure of a republican policy - free market capitalism and invalidity of risk management strategies followed by sub-prime mortgage players in the space of globalization and free market capitalism. Blaming on data for the failure by Greenspan is just a joke! The reason is very simple: There is something called validation of models - every risk analyst know what I am talking about it. I am shockingly left to wonder how someone like Greenspan whom is supposed to be not only highly intelligent but also very wise validated and okayed those computer models!

October 25, 2008 6:46 PM  
Blogger scorpiogenius said...

Good post Brijesh..

Surely, with the oil touching the 60$ mark from the high 140s, the middle east skyscraper boys will certainly start to feel the heat under their ass. That will be an avalanche of a bad news if the middle east construction industry falls...Imagine the situation of Kerala with all those jobless labourers and technicians on their flights back!!

Many of our cities are betting high on the IT Boom and it is bad news for the overall development of the state if the bubble bursts as you think...

Have you any good news for us buddy, at this bleak time? :))

October 25, 2008 8:49 PM  
Anonymous sajithn said...

there is an economist by the name Dr Batra in US ,he has written a book on greenspan and his fraud
http://www.amazon.com/Greenspans-Fraud-Decades-Policies-Undermined/dp/1403968594

After the dot com bust i saw in an interview where green span said that "we knew the dotcom was a bubble but it is better to clean up the bubble after it burst " .In effect he admitted that he and fed let it happen ..So much for honesty

October 25, 2008 9:00 PM  
Blogger Karthikeyan said...

Brijesh,
Alan Greenspan in fact went as far as to acknowledge there was a flaw in how he understood the markets were supposed to work. He also acknowledged there was a failure in regulation (though its too late now). This from the ayatollah of free market is a slap in the face for republican free marketers.

link

As for India, we are on our way to some tough times. If (i think its happening already) there is a downturn in IT, that would burst the real estate bubble (its deflating already). What keeps me thinking is would we have a subprime like crisis (IT guys laid off and/or the value of the underlying property going below what you owe the bank) in India and what the repercussions would be?

October 26, 2008 5:41 PM  
Anonymous Anonymous said...

Nair,
There are other people who blame the clinton administration for housing policy , which entitles every American a home.

Many people believe this is what caused the housing bust. But when u ask them why didn't the housing problem when Clinton was around or beginning of 2000 or 2001 nobody can explain.

It's not a surprise greenspans is giving lame excuses to cover up all the crap.
Prem.

October 26, 2008 5:56 PM  

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