[biohacker42]

This is interesting, but I'm struck by the sheer amount of serious analysis on this topic. It always struck me as very simple requiring no deep understanding.

There's an old saying on wall street, the harder it is to understand the deal the bigger the profit. The truth of this should be self evident. Add to that the fact that the people gambling weren't gambling with their own money. That way if they won then got big bonuses, and if they lost they simply didn't get bonuses. Clearly the only rational action in this situation is to go all in with other people's money.

Is it really that complicated? You wouldn't give your money to someone else and send them to Vegas, tell them to gamble if they win you split the profits, if they lose you lose your money.

You shouldn't invest in things you don't understand, and mind that old wall street saying.

But people do invest in things they don't understand, and pyramid schemes, and tulips, none of this is new. Sure some fancy math was involved this time, but that's only tangential.

I think everyone is concentrating on the fancy math because it's like magic, and then it's not their fault, it's not the same old story of everyone just being stupid again like in .COM 1.0, oh no - It's magic!

[joe_the_user]

There's a quandary here. If someone is, say, a medical equipment VC, they have to invest in technologies they can understand only in outline, since no one is going understand everything about them.

But finance is different in the sense that any investor has to understand things down to where the money is coming from. You correctly reason that "innovation" in finance is simply a system for gambling with other people's. That's indeed more or less fraud by your reasoning.

But the tricky part is that an investor in technology has to know where the substantial engineering technology ends and the insubstantial "financial technology" begins. It's OK not to understand the first but deadly, over time, not to understand the second. So the problem can get tricky despite the underlying situation being simple.

[kurtosis]

Yeah I think you're totally right on here. I would go even further and suggest that these pseudo-scientific valuation models were cynically exploited to make it sound like the risks were calculable.

I think an analogy to medicine is appropriate - for many years the desperation and naivete of the sick was exploited by frauds selling patent medicines. Many makers of these bogus cures undoubtedly sincerely believed in their efficacy. Watching this history would make you suspicious of anyone who claimed that they could cure your illness with a drug. Despite this sordid reputation, there really are wonder drugs. If medicine can be made scientific so can finance.

[joe_the_user]

If medicine can be made scientific so can finance.

Uh, one thing to be careful with in such a statement is reasoning by analogy.

Consider if someone says:

"If physics can be made scientific, so can pertual-motion-machine-construction"

Or

"If chemistry can be made scientific, so can alchemy!"

Or

"If astronomy can be made scientific, so can astrology!"

The problem is clearer. Not every "field" is subject to valid innovation since some fields are inherently bogus. It is a hard problem determining which fields can "scientifized" so you might not be wrong. But I personally think that the real scientific economists are those that have argued that you're not ever going to find a "financial innovation" which adds value to the economy as a whole.

[kurtosis]

I strongly disagree - I don't think any fields - even perpetual motion machine construction or astrology - are inherently bogus. We should demand that these fields make falsifiable predictions and then test them to find out which ones aren't false. Of course we can't conclude that they are inherently bogus when we haven't tested them. If we have tested them and found that they are false then that's all we need to know. (I'm all for testing a genuinely new perpetual motion machine, almost all "new perpetual motion machines" have already been tried or depend on principles that have already been tested and proven false.

Let me reiterate since it seems that my message was a little unclear - the purpose of the medicine and finance analogy was say that even though there were many bogus financiers making false promises about their products by using simple models where they don't apply - this doesn't mean that there could never be non-bogus financiers that take a more rigorous and transparent approach to their use of models. We should demand the construction of financial instruments which cannot be "booby trapped". This is a case for more and better financial innovation, not less of it.

Of course this takes a broad view of financial innovation to include such things as auction design, election methods, etc.

I will also retract my statement that the valuation models were pseudo-science - to the extent that they made real predictions they were scientific. But they were undoubtedly cynically exploited.

[dantheman]

In fact the mere problem of discerning pseudo-science from science is almost impossible by an fixed criteria.

[kurtosis]

Not sure what you mean by fixed-criterion How about about just demanding falsifiable predictions, and doing experiments to test them?

[dantheman]

Most people think astrology is bunk science, but they can make predictions and do experiments.

Throughout history physics has had experiments whose results were incompatible with current models, which eventually lead to new theories (relativity, etc) but how do you know when contradicting information disproves your theory or will expand it.

[roundsquare]

I think we have an issue of defining pseudo-science here.

Definition 1: A field that can't be can't make falsifiable predeictions. By this definitino, astrology is certainly a real science.

Definition 2: A field that makes false predictions. By this definition, most peoplle thing astrology is a pseudo-science.

[bmalicoat]

I agree with you entirely. But from the person looking for (or getting) a mortgage, they likely didn't know the lender was going to chop up their mortgage and mix it with bits of hundreds or thousands of others' and sell it to another party. It's obvious, like you say, that the system wasn't incentive compatible and that the people writing and selling the mortgages had no reason to ensure the borrowers paid.

Sadly there are still no regulations preventing this from happening again.

[dantheman]

What issue does the person getting the mortgage with how it's financed? You seem to try and remove the responsibility from the borrower, which is where it should be. This is most likely the biggest financial decision they will ever make and they should understand it.

[bmalicoat]

Yes, but there is no way for them to know that their mortgage will be sold, that is strictly up to the financier and the third party. Therefore a borrower cannot know what is happening to their mortgage other than they have to pay it.

However this doesn't remove the irresponsibility of taking a mortgage that you cannot afford to pay, which may be your point. Sorry if I misunderstood.