Nevertheless, it seems possible that the financial success of Paulson and others was a consequence of careful analysis and shrewdness, and that other people of sufficiently high intellectual caliber and rationality would have been able to predict it as well.
I have an economist friend who predicted the tech bubble, but shorted too early, and ended up losing quite a bit of money in the process. Knowing that chickens are coming home to roost is not enough; you need a good idea of when they're going to arrive, and to have the solvency to be able to stick to your beliefs. (If Keynes's comment--"The market can stay irrational longer than you can stay solvent"-- fits you, then shorting bubbles seems unwise.)
As is always the case in finance, those who recognized the impending pop of the housing bubble kept their analysis secret
I do believe there were people predicting the bubble would burst before it burst, and some of them were even people who don't predict a bubble bursting every year. It's not clear to me that a handful more mathematicians pointing out impending disaster would significantly shift public opinion, and hoping that the government would act to burst a bubble...
Interesting idea.
However, if you're trying to prove that mathematicians are known to have highly transferable skills, don't cite a few famous people, I would expect that in any field. Cite companies hiring mathematicians with the intent on training them in a different area.
We already have a whole industry built up around the topic of analyzing the markets. Why would this provide any improvements? I know of commentators who thought housing was a bubble as soon as 2002, but a few people talking doesn't get a bubble popped. You're talking about putting a handful of ivory-tower nerds up against the entire weight of first-world culture. I do not imagine that this could actually be successful. And frankly, given the abysmal track record of smart people poking their heads into fields they don't understand and trying to overhaul the whole thing from scratch, I suspect this effort stands a real chance of doing more harm than good.
I encourage all folks to stand up for sanity at any given time. People talking about how houses were a bubble in 2005 were doing God's work, so to speak. But making it a special effort is weird, and expecting a bunch of neophytes to do better analysis than professionals because they can do pure path is absurd. Finance done by pure mathematical methods leads to things like the Gaussian cupola fiasco - the math was impeccable, the assumptions were absurd, and the instruments underpinned by this analysis burned down, fell over, and the...
Bryan Caplan seems to think that the meltdown scenario's effects were accurately estimated: http://econlog.econlib.org/archives/2013/05/conditional_ins.html
Many will look at the Lehman forecasts and confidently declare, "What fools they were." My reaction, though, is bewilderment. How can experts nail the hard question of "What will happen to our investments given housing prices?" yet botch the easy question of "Will unprecedented increases in nominal housing prices continue indefinitely?" I wish I knew.
Mathematicians sound useful for answering the former question, yet no more useful than anyone else for answering the latter question.
It’s been claimed that the cost to US taxpayers in bank bailouts was $9 trillion.
No! The bailouts, and the loans, have been paid back; the government made a profit on the AIG bailout. There was risk, but long run tax burden has not risen by $9 trillion.
As of December 31, 2012, the Treasury had received over $405 billion in total cash back on Troubled Assets Relief Program investments, equaling nearly 97 percent of the $418 billion disbursed under the program.
But TARP was just a small part of the whole picture. What concerns me is that there seem to have been somewhere between $1.2 trillion and $16 trillion in secret loans from the Fed to big financial institutions and other corporations. Even if they've been repaid, the low interest rates might represent a big transfer of wealth from the poor to the wealthy. And the fact that I'm seeing figures that differ by more than an order of magnitude is far from reassuring, too! The GAO report seems to be worth digging into. If not mathematicians, at least accountants could be helpful for things like this!
kept their analysis secret, because sharing it would have allowed others to partially close the arbitrage opportunity
This claim seems incomplete. If I have secret knowledge of an inaccurate price, my motivation is to keep that secret... for as much as a few hours, if that's how much is required for me to decide on, place, and verify trades which take advantage of that price. Once I've made my trades, I would prefer that the price adjusts to a more accurate value as soon as possible so that I can cash out and re-diversify my portfolio. Unless my secre...
The problem is not doing transparent high quality analysis... it's getting that analysis believed and acted upon. And this becomes much harder when there are people with a vested interest in seeing that analysis not acted upon. As the Upton Sinclair quote says, "It is difficult to get a man to understand something when his salary depends upon his not understanding it."
Behind The Housing Crash is a collection of interesting stories written by a loan analyst who had predicted the housing crash several years in advance. The book can be boiled down fairly simply: "Nobody listened."
You're looking to get voices. Until those voices have ears, they can shout all they want to no effect.
The Sumner critique says that the Great Recession was more 'caused' by failure to supply enough money (when the market was clearly anticipating almost zero inflation) to keep NGDP on a level growth path, suggesting that the main path toward resolving this problem would be figuring some way to further convince the Federal Reserve to adopt NGDP level targeting. Also, as I understand it, even some of the people making money off shorting the housing market were quite loud about it - it's not obvious that a lack of transparency is the problem. To make money y...
I found the article "The Deflationist: How Paul Krugman found politics" educational on that point.
I had thought of another way that mathematicians could contribute to global welfare using mostly math skills.
A lot of newcomers to bitcoin often mentioned that it looked to them that the calculations look wasted. Those who have read about bitcoin know that this is not true as the calculations are used to secure the network. The calculations really don't have other uses.
The essence of a bitcoin like problem is - tough to crack, but easy to verify once the solution is in. A talented mathematician/chemist team could team up to try to map protein folding or...
But there’s a historical track record of mathematicians being able to pick up these skills and use them to powerful effect.
As someone who's wondering how much math to study, how do folks think the causality works here? Does studying math make it easier to pick up stuff (e.g. by training your brain on hard intellectual labor somehow), or do people who pick up stuff easily tend to study math?
The Dow Jones Industrial Average dropped by almost 50% and took over 4 years to recover.
Minor quibble here...It's my understanding that the DJIA is not useful indication of a cost to the economy.
I'm not sure whether it's a question of math. In a field like bioinformatics most of the important software is open source. In fiance it isn't.
If you want transparent fiancial analysis I would suggest to push for a big open source financial simulation. You might even want to start a new license to ensure that every one who contributes code also publishes his code.
There are already many mathematicians in finances, they're the ones who came up the models showing that sub-prime backed securities warranted AAA ratings.
Note: I completed a PhD in Mathematics from University of Illinois under the direction of Nathan Dunfield in 2011. I worked as a research analyst at GiveWell from April 2012 to May 2013. All views expressed here are my own.
About this post: I've long been interested in ways in which mathematicians can contribute high social value. In this post, I discuss a tentative idea along these lines. My thoughts are very preliminary in nature, and my intent in making this post is to provide a launching point for further exploration of the subject, rather than to persuade.
Recessions as a serious threat to global welfare
In 2008, the US housing bubble popped, precipitating the Great Recession. The costs of this were staggering:
It’s been claimed that recessions cause a drop in prosocial behavior.
All told, the Great Recession had massive negative humanitarian disvalue, and preventing another such recession would have massive humanitarian value.
Transparent financial analysis as a possible solution
There are actors in finance who accurately predicted that there was a housing bubble that was on the brink of popping, and who bet heavily against subprime mortgages, reaping enormous profits as a result. The most prominent example is John Paulson, who made $3.7 billion in a 2007 alone, starting from a base of less than $1 billion. There are less extreme examples that are nevertheless very striking.
It’s difficult to determine the relative roles that skill and luck played in these peoples’ success, and the situation is further obscured by hindsight bias. Nevertheless, it seems possible that the financial success of Paulson and others was a consequence of careful analysis and shrewdness, and that other people of sufficiently high intellectual caliber and rationality would have been able to predict it as well.
As is always the case in finance, those who recognized the impending pop of the housing bubble kept their analysis secret, because sharing it would have allowed others to partially close the arbitrage opportunity, reducing the potential to profit. If these people had made their thinking public, it could have resulted in other people betting against the housing bubble earlier on, popped the housing bubble when it was smaller, possibly substantially lessening the severity of the ensuing recession. While there were people who publicly voiced concern, a large number of people would have had a bigger impact
This suggests that transparent financial analysis by intellectual elites could carry massive humanitarian value.
Mathematicians as unusually well positioned to perform such analysis
In the course of my graduate school days, I became familiar with mathematical community. There’s a wide cultural gulf between pure math and finance. My experience was that mathematicians generally view finance as “dirty business,” on account of:
I believe that this gulf has led to a potential opportunity being overlooked: mathematicians may be ideally suited to perform transparent financial analysis that reduces damage from financial bubbles.
This idea occurred to me a few weeks ago. Ideas for philanthropic interventions generally fall apart upon closer examination, and so I wasn’t too optimistic about it holding up. So I was surprised when Neal Koblitz (co-creator of elliptic curve cryptography) raised the same idea in unrelated correspondence:
If mathematicians had been noticing the dubious ways that people in the financial world were claiming to be applying mathematics, and if they had publicly and loudly criticized the misuse of mathematics, then the world might have been spared the collapse of 2008 (or, rather, it wouldn't have been as bad). If mathematicians could have played a role stopping the credit-derivatives bubble before it got out of hand, the economic value of doing that would have been in the trillions of dollars.
When an idea occurs to two people independently, the case for it being a good idea is strengthened. Moreover, Koblitz has a long history of involvement with humanitarian efforts and so can be expected to have perspective on them.
Some reasons why mathematicians seem unusually well suited to the task are:
Transferable Skills — Most mathematicians are unfamiliar with some of most important tools used in finance: statistics, data analysis & programming. But there’s a historical track record of mathematicians being able to pick up these skills and use them to powerful effect. James Simons transitioned from differential geometry to quantitative finance, and became one of the most successful hedge fund managers ever. Cathy O’Neil did a PhD in algebraic number theory under Barry Mazur’s direction, and got a job at DE Shaw, which is one of the most prestigious hedge funds. Mathematicians who are motivated to learn these skills are well positioned to do so.
There are other skills that are very important for successful financial analysis – in particular, one has to have a good eye for empirical data. This is a skill that’s not directly transferable, but it still seems likely that a nontrivial fraction of mathematicians could develop high facility with it.
Intellectual Caliber — The mathematics community has a very dense concentration of intellectual power. James Simons offers a direct point of comparison between math and finance:
Simons won the Oswald Veblan Prize in Geometry before leaving academia to start Renaissance Technologies. There are 25 living mathematicians who have won this prize. The prize is awarded exclusively for work in geometry/topology, and if one looks more broadly at all mathematical fields, one can generate a list of about 100 living mathematicians who were at least as accomplished as Simons at the same age.
After leaving academia, Simons made $10 billion in quantitative finance. What I find most interesting about this is that the situation is not that Simons succeeded where other mathematicians of the same caliber had failed – rather, Simons is virtually the only pure mathematician of his caliber to have left academia. This raises the possibility that there are a handful of elite mathematicians who could make much better financial predictions than most present day actors in finance. Less accomplished but capable mathematicians may also do very well.
Cautiousness — Mathematicians are naturally intellectually conservative, as they spend much of their time rigorously examining arguments for flaws. Thus, they’re unusually unlikely to succumb to greed and fear, which are factors that are thought to play a large role in the behavior of financial markets, and which lead to speculative bubbles. This is corroborated by some of Cathy O’Neil’s remarks on finance.
Implications
The above considerations suggest that mathematicians could contribute enormous social value by engaging in transparent financial analysis.
Many mathematicians who I know wish that they could contribute more social value. In the essay Is there beauty in mathematical theories?, the great mathematician Robert Langlands wrote:
In a letter to A.-M.Legendre of 1830, which I came across while preparing this lecture, Jacobi famously wrote
It is true that Mr. Fourier thought that the principal goal of mathematics was their public utility and their use in explaining natural phenomena. A philosopher like him should have known that the only goal of Science is the honor of the human spirit, and that as such, a question in number theory is worth a question concerning the system of the world.
I am not sure it is so easy. I have given a great deal of my life to matters closely related to the theory of numbers, but the honor of the human spirit is, perhaps, too doubtful and too suspect a notion to serve as vindication. […] Moreover, the appeal to the common welfare as a goal of mathematics is, if not then at least now, often abusive. So it is not easy to find an apology for a life in mathematics.
A fair number of mathematicians don’t have any choice but to do pure math. Gromov wrote:
You become a mathematician, a slave of this insatiable hunger of your brain, of everybody's brain, for making structures of everything that goes into it.
I'm very sympathetic to Gromov's remark, and I think that for people who constituted in this way, it’s probably best not to try to suppress these urges, as such attempts tend to be unsustainable and result in lower contributions to global welfare rather than higher ones.
But for mathematicians who are:
there may be a major opportunity to contribute enormous social value by conducting transparent high quality financial analysis.
This question warrants further investigation.