The time has come to rethink how economics is taught our schools and universities. The reason for such thought is we are witnessing economic crises never witnessed before. All previous economic theories and thought are being discredited by this global phenomenon.
More realistically, economics today is where astronomy was in the 16th century, when Copernicus and Galileo had proved the heliocentric model, but religious orthodoxy and academic vested interests fought ruthlessly to defend the principle that the sun must revolve around the Earth.
Consider the following passage:
“Most economic theorists have been going down the wrong track. When economic models fail, they are seldom thrown away. Rather they are ‘fixed' - amended, qualified, particularized, expanded and complicated. So it comes as no surprise that behind this almighty collapse of our financial systems we learn of a complex mathematical algorithm called the Gaussian copula model this model developed by David X Li from China helped to price up collaterised debt obligations (CDO’s) and other asset backed mortgage securities.
More realistically, economics today is where astronomy was in the 16th century, when Copernicus and Galileo had proved the heliocentric model, but religious orthodoxy and academic vested interests fought ruthlessly to defend the principle that the sun must revolve around the Earth.
Consider the following passage:
“Most economic theorists have been going down the wrong track. When economic models fail, they are seldom thrown away. Rather they are ‘fixed' - amended, qualified, particularized, expanded and complicated. So it comes as no surprise that behind this almighty collapse of our financial systems we learn of a complex mathematical algorithm called the Gaussian copula model this model developed by David X Li from China helped to price up collaterised debt obligations (CDO’s) and other asset backed mortgage securities.
So to introduce you to the complex quantitive world of investment banking just read a few snippets from people whose job it is to package and sell these derivatives.
The model Mr. Li devised helped estimate what return investors in certain credit derivatives should demand, how much they have at risk and what strategies they should employ to minimize that risk. Big investors started using the model to make trades that entailed giant bets with little or none of their money tied up. Now, hundreds of billions of dollars ride on variations of the model every day."David Li deserves recognition," says Darrell Duffie, a Stanford University professor who consults for banks. He "brought that innovation into the markets [and] it has facilitated dramatic growth of the credit-derivatives markets."The problem: The scale's calibration isn't foolproof. "The most dangerous part," Mr. Li himself says of the model, "is when people believe everything coming out of it." Investors who put too much trust in it or don't understand all its subtleties may think they've eliminated their risks when they haven't.
The key word being “risk” gone are days when due diligence and pain staking analysis was required per complex deals you just have to take a look at the deals of BoA taking over Merrill Lynch colossal losses and write downs followed in England by Royal Bank of Scotland (RBS) and the ill fated takeover of ABN Amro, not only did RBS lose money on this deal it led to the collapse of the bank only being saved by government intervention. RBS’s executives were ousted by the government who at a treasury committee meeting (Feb 10th 2009) admitted to the ABN Amro deal being worthless. Risk taking, poor due diligence added to this lax regulatory controls and you have a recipe for disaster.
But we already know what caused this meltdown in our financial systems and now the wider economy and this blog will now focus on solutions the time for talking is over as President Obama stated Tuesday February 10th in Fort Myers. The road to recovery will be long and some unpleasant decisions will have to be made. The markets reacted coolly to secretary Geithner’s bank bailout plan, in reality it did lack transparency and direction this over time will be tweaked, my concern is how to value these toxic assets, and just how much money will be needed. $350bn does not seem enough with banks already reporting $1.2 trillion in non performing assets. I don’t know if the bad bank option will work as stated before we are in uncharted waters but a way must be found to get the banks lending, foreclosures stopped, and the creation of jobs. President Obama’s stimulus package is not a magic wand but a blueprint for the future; it will change and will need to be flexible to meet the demands of this crisis. What we need now is solutions and the drive and courage to face the unknown, 2009 will throw up challenges, surprises and casualties we need to be ready, alert and flexible to meet the future.
