the cause of the financial crisis..

unimpressed
how did a housing crisis become a financial crisis, ending up as an economic crisis?

how come highly trained professionals didn't see it coming?

a nice simple summary visualizing all the subprime mortgage, CDO, CDS, leverage, tranching, rating, AAA, default, frozen credit market stuff:


at the barebones level, wired magazine gives insight into the core mechanism in their article Recipe for Disaster: The Formula That Killed Wall Street.

the culprit:

the gaussian copula function

basically a quantity measuring the correlation (preciser: the dependence structure) of two random variables.

"the corporate CDO world relied almost exclusively on this copula-based correlation model."
"everyone was pinning their hopes on house prices continuing to rise."

the idea, published in 2000, quickly became a metric quants ubiquitously used to evaluate risk and a cornerstone of financial engineering allowing simple modeling of vastly complex risks. particularly default risks of CDO tranches. until august 2007...

the ideas:

• tame the nasty nature of real-world dynamical, complex and latent variables by substituting them with a clean and simple number summing up everything
• convey an image of what is happening: correlation is more like a constant than a fluctuating variable and all you need to know and compute
  
• let the method be adopted by investors, banks, rating agencies and regulators
  
• ignore any warning signs (for instance d. sornette in 2006: "this recurrent use [of gaussian copulas] has been ratified by the recommendations of the BIS concerning credit risk modelling. however, there are many indicators suggesting that this [...] approach may be grossly inadequate to account for large credit risks [...]." pg. 138)
  
• let everyone make a lot of money
• let quants forget about the concrete reality behind the math and crank up the models
• let managers, lacking formal math skills, execute transactions worth trillions of dollars based on the models
  
• forget about the underlying magic that makes it all work: a decade of soaring housing prices
• lend money to people without jobs and income
  
• be surprised when everything blows up in your face
  

cartoon from cagle.com

--
update 28th of june 2010:

who cares?

mood: more bewilderment and head-shaking
is the human brain big enough to save one of the most intelligent creatures? greenpeace asks cynically in an add, aiming at banning whaling amongst other ocean related concerns.

when i mention i'm vegetarian in restaurants, a frequent response is to point me in the direction of the fish...


greenpeace campaign

fact i: the ocean is humanities last frontier of ignorance

• 72% of earth's surface covered by sea
• 97% of the ocean is unexplored
• with one yearly NASA budget, the exploration program of NOAA (the National Oceanic and Atmospheric Administration) could be funded for 1600 years
• largest mountain range covering 23% of earth's surface area underwater (visited for the 1st time after the moon in 1973)
• coral reefs still unexplored between 60 and 150 meters
• there are better maps of mars than the 50% of total US territory which lies under the sea
• most of the southern hemisphere's underwater terrain is unexplored (more exploration ships in that region during captain cook's times than today)
• the seabed is harboring countless well preserved archaeological artifacts
• underwater hot springs are basically commercial grade heavy metals deposits
• underwater volcanoes are emitting methane

fact ii: the oceans are teeming with life

• although most of the ocean does not get exposed to photons from the sun, and hence there is no photosynthesis, it is completely erroneous to not expect life
• the antarctic sea is, unexpectedly and only recently discovered, teeming with marine life
• hydrothermal vent systems are islands of life
• bacteria replicating photosynthesis in the dark by chemosynthesis where accidental discovery as no one ever predicted their existence
• resilient bacteria living in ph 11 environments
• 7 new species found per hour of deep reef exploration
• 2000 to 2500 estimated new species in the indo-pacific ocean alone (vs. 5000-6000 known species)
  
• not only new species are still being discovered, but also new behavior and new ecology
• amazing variety of bioluminescent animals
  

fact iii: the seas are being destroyed at breakneck speed

• 90% of all big fish have disappeared in the last 100 years
• 50% of all coral reefs are destroyed
• for 1kg of fish ending up in a market, at least 10kg of bycatch was killed and thrown away
• 1.7% of the blue whale population is remaining
• 10% of the tuna fish population is remaining
• commercial trawlers are forced to access ever deeper seabed due to the depletion of fisheries; this completely destroys potential habitats which are totally unexplored and eradicates possibly unknown species
• throwaway plastic accumulating in the sea (half of the 100 billion pounds of plastic pellets a year are made into throwaway plastic produces of which a large fraction ends up in the sea)
• 100000 albatross chicks in remote habitats dying from stomachs filled with plastic trash
• some ocean water samples contain more plastic than plankton
• plastic debris concentrate pollutants and become "poison pills"
• these are been eaten by many fish at the bottom of the food chain
• gigantic garbage patches in the pacific and atlantic
  

Sylvia Earle's moving (and prizewinning) TED talk:


Robert Ballard: Exploring the ocean's hidden worlds


Captain Charles Moore on the seas of plastic


Richard Pyle: Exploring the reef's Twilight Zone


David Gallo fascinating TED talk:


update 20.04.2010:
Edith Widder: Glowing life in an underwater world


update 05.05.2010:


update 02.06.2010:
Brian Skerry reveals ocean's glory -- and horror


update june 30th 2010:


update july 12 2010:


update july 27 2010: