Monday, April 05, 2010

All elements of the sequence, please!

Ondelette (someone's pen name on wrote:
As I wrote in my longer response, you are missing too many events to put together any chains of causality. The choice of your events is also quite far from random. So you are not looking at reality, you are looking at a contrived sequence. If I have a sequence of fractions, 1, 1/2, 1/3, 1/4,... and I say what is the sum? And you say, let's look at the partial sum formed by 1, 1/4,1/9,..., I say, but you won't get the correct picture of the sum by looking at that. And you say, but those are facts, ... and I say, but that isn't the sequence, and you say, but that's a sequence and it happened. We can argue all day, but the simple fact is that the sum of the whole sequence diverges while the subsequence you've extracted sums to pi squared over six.

Seems to me that this contrived sequence is what a lot of people indulge in. E.g., on the financial crisis, a bunch of folks are puzzled by the report on Lehman Brothers:
The Examiner did not find sufficient evidence to support a colorable claim for breach of fiduciary duty in connection with any of Lehman’s valuations. In particular, in the third quarter of 2008 there is evidence that certain executives felt pressure to not take all of the write‐downs on real estate positions that they determined were appropriate; there is some evidence that the pressure actually resulted in unreasonable marks. But, as the evidence is in conflict, the Examiner determines that there is insufficient evidence to support a colorable claim that Lehman’s senior management imposed arbitrary limits on write‐downs of real estate positions during that quarter.

This is being taken to mean that effective regulation is not possible, because see, there was nothing detectably wrong with Lehman Brothers.

And it all seems very complicated and mysterious, until you learn of the mis-regulation that made these findings feasible in the first place.
See this OpEd in the NYT.

In 2006, the agencies jointly published something called the “Interagency Statement on Sound Practices Concerning Elevated Risk Complex Structured Finance Activities.” It became official policy the following year.

What are “complex structured finance” transactions? As defined by the regulators, these include deals that “lack economic or business purpose” and are “designed or used primarily for questionable accounting, regulatory or tax objectives, particularly when the transactions are executed at year end or at the end of a reporting period.”

How does one propose “sound practices” for practices that are inherently unsound? Yet that is what our regulatory guardians did. The statement is powerful evidence of the permissive approach bank regulators took toward the debt-dissolving financial products that our banks had been developing, hawking and using themselves for years. And it’s good reason for Americans to be outraged by the “who me, what, where?” reaction of Mr. Bernanke and the S.E.C. to the revelation of Lehman’s Repo 105 scam.

The story is that the regulators proposed some rules, the industry shot it down, the regulators caved. But read the OpEd.

A similar mystery was addressed by rjwalker in the comments to the first post linked.
>>So will there ever be a way for regulators to know whether or not a bank is skirting the limits?

Yes. Re-instate significant liability for lawyers and accountants advising such companies.

In the early 90’s a law was passed reducing/eliminating such liability, making corporate opinion shopping king of the hill and removing a lot of advisor backbone to say ‘no.’

If you disregard the entire sequence of regulations that were dismantled and the mis-regulations that were issued, and then look at only one of the problems, it seems insolvable. This is an area where the system has to be viewed as a whole to understand and control its behavior. And you cannot construct a history or a causal chain if you arbitrarily pick and choose the events you want to consider.