April 06, 2008
THE (DATA) PIN FACTORY
Adam Smith was the worlds greatest magician. In the Wealth of Nations, you learnt how the trick (division of labor creates global capitalist economy) was constructed, but got to still be amazed when it actually worked two hundred plus years later.
I have landed on Father Adam after gathering quotes on data quality (below) and data manipulation over time. The evergreen problem of twisting and tainting data for personal gain is certainly tied to subprime. And it would be fun to stop there and point fingers. If you were looking to do so, I highly recommend using the Til Schuermann February 2008 presentation to the PRMIA Credit Risk Forum in New York as a reference. He provided a spot-on breakdown of the production process of a subprime mortgage backed security as involving eight groups tied together by deadly frictions that included: predatory lending, mortgage fraud, adverse selection, principal/agent [conflict], model error, and moral hazard. (See reference below.)
But its not the frictions specific to MBS that are useful for future reference. It is that we are increasingly dependent on a small division of the population to get the process (of reliable data production and delivery) right. When the trick turns nasty, ever larger proportions of the population suffer.
Good operational risk management requires in-depth knowledge of how data is being manufactured and used.
“Figures often beguile me, particularly when I have the arranging of them myself; in which case the remark attributed to Disraeli would often apply with justice and force: 'There are three kinds of lies: lies, damned lies, and statistics.'" Mark Twain, Chapters from My Autobiography, July 1907
“Managed earnings was an important engine of the system, and its goal, at least implicitly, was to raise corporate stock prices whether or not increases in intrinsic corporate values were achieved.” John C. Bogle, The Battle for the Soul of Capitalism, November 2005
"In 1983, the Bureau of Labor Statistics [BLS] was faced with an awkward dilemma. If it continued to include the cost of housing in the Consumer Price Index, the CPI would reflect an inflation rate of 15%, thereby making the country's economy look like a banana republic. Worse, since investors and bond traders have historically demanded a 2% real return after inflation, that would mean that bond and money market yields could climb as high as 17%… The BLS's solution was as simple as it was shocking: exclude the cost of housing as a component in the CPI, and substitute a so-called 'Owner Equivalent Rent' component based on what a homeowner might 'rent' his house for… While the BLS was correct in assuming that this statistical ruse would fool the average citizen into believing that inflation was only 2% (and therefore be willing to accept a meager 4% return on his bank savings), what is remarkable is that the ruse also fooled the bond traders…” Professor Robert Hardaway, University of Denver Sturm College of Law, September 2007
1) http://www.prmia.org/Chapter_Pages/Data/Files/2154_2848_Til%20Schuermann_presentation.pdf
Posted by jtunkey at 03:28 AM
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