Its a few minutes to the midnight clock before 2010 is welcomed and I assure you 2010 is a special year. It is the year following 2009 which will always be remembered as the year when the second worst global recession after the great depression hit the world. As is customary around this time of the year, experts and analysts will look at the best and the worst of things that happened to the human race in the past 12 months. Without a doubt, the recession will definitely be number one on most ‘bad’ lists followed by the making of a movie like ‘The Race to Witch Mountain’.
True to my nature ….
[and having some extra time on my hands], I picked up some research material to see the overall trend of things in 2009. Books, blogs, finance.yahoo.com and finance.google.com proved to be enough for me to paint a good picture [still with a lot of room for improvement] of what happened. Here I will only look at the reasons [atleast the ones which I feel are most relevant] for the failure of the financial markets.
Classical and Neo Classical Economic ….
theories got a wake up call finally. The new economic plans including stimulus are partially based on pure Keynesian teachings. The question that still remains to be answered is ‘Why did Capitalism fail ?’. Was it greed ? Was it plain simple stupidity on the parts of banks ? Was it the lack of regulation ? Maybe it was all this and more.
Lets look at capitalism for a minute. Capitalism states that all markets are efficient and information produced is available and shared by all people. In todays day and age this is a fair statement. There is enough data out there for rational investors to get out of bad positions or stay in the good ones. So if data is on the average easily accessible, what went wrong ? Read on.
The over reliance on normality based prediction models …
and the erronous data that they produced, in my opinion, is to blame. [DISCLAIMER: I HAVE AN ACTIVE INTEREST IN RISK MANAGEMENT].
Risk models are based on a normality distribution which does not take into account any unusual spikes. Most of these models are based on the axiom that future can be predicted by past. Bell curved calculations by necessity ignore black swans and thus risk managers supply measurements which dont consider these time bombs.
Somehow the failures of the risk models seems the same as getting caught counting cards in black jack. The risk modellers kept counting the deck [synonymous with looking at the past], made their money [synonymous with the great returns] before getting caught like Jim Sturgess’s character ‘Ben Campbell’ by Lawrence Fishburne’s character ‘Cole Williams’ in the movie ‘21′ [synonymous with the black swan events of 2007 onwards].
Whats the way ahead ?
I am not an expert on economic policy or even risk management therefore I dont have an answer but what the governments all over have done by introducing the stimulus is, in my opinion, a step in the right direction. Its a very Keynesian thing to do and while I suspect supporters of capitalism are having difficulty breathing, the markets in order to come back up need a crutch to hold on to and if that crutch comes in the form of a stimulus package …. so be it !
