Financial Crisis 2012 - Worse than 2008

Tyler Durden's Guest post of Zero Hedge is an excellent analysis of all the head winds that is against us in 2012. Maybe we should listen to the Mayan prophecy... just kidding. The main reasons given by the author that the imminent collapse is much worse than 2008 is due to the following reasons:

• Oil prices higher now than in 2009
• Derivatives up more than $100 trillion since 2009
• Government debts exploding
• Weak GDP growth
• Europe in trouble
• Small investors leaving the market
• China hitting a wall

Go and read the post above it is an excellent analysis, I find cross holding of sovereign debt pictures are very interesting. The interactive chart of the Euro Debt Web is by BBC and it can be found here

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• " Founder Of $30 Billion Hedge Fund Says Euro Banks Insolvent, Euro Situation Much "Worse Than 2008″ Alex Jones' Infowars: There's a war on for your mind! (2012indyinfo.com)
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Icelandic Krona vs US Dollar - A Power Law Distribution

Image via Wikipedia

The Icelandic Krona currency exchange index follows the Power Law, it can be seen in the most rudimentary of analysis...

Here is the analysis of ISK-USD exchange rate data for however long I could get, a simple histogram shows visually that the exchange rate is distributed by a power law. In addition, I was able to do a Log plot of the observations and it clearly follows a path that should give us

enough indication that the ISK exchange does not follow a Normal "Bell" curve distribution.

However, last week I was talking to a currency trader and he told me that before the crash of the Icelandic Krona last year, they calculated the proabability of ISK crashing and they found it to be a 8 sigma (read highly unlikely! or A Black Swan) event... the fact that it happened proves atleast to me that the methods and theory used to analyze the ISK is not correct. I am writing a paper with Dr.Helgi Tomasson with University of Iceland with the title "Can Power Law help us avoid the highly improbable tail events?" hopefully we will be able to answer the above question.

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• Eve Online offers lessons for the financial crisis (telegraph.co.uk)

Risk Management

I had a very interesting conversation with a Risk Manager of a bank, my question was very simple... how did you not see the coming storm? quite frankly he was paid to think about it all the time. His answer was quite simple, Yes, he was paid to think about it and he did think about it and made sure every venue he got a chance to communicate it to the Management of the bank he DID. But the management just did not understand the consequences or take the possible actions based on his recommendation! Well, I don´t expect any other answer from him... but there is some meat in his argument. If I really don´t understand that I am standing on a rail and a freight train was going to run over me and the person warning me speaks Chinese or a language that I don't understand... why would I move?

I think we underestimate the risks or miscalculate the payoff from risks, here is an article that talks about that and fallacies of Risk Management, which again I believe is an oxymoron. I think board of directors of companies should expect the management of companies to have a check list like the one airline pilots have before they fly. I don't believe for one second that it would prevent a Black Swan event but it would at the least not be a surprise, actually if it is not a surprise then it cannot be a Black Swan event. I am contradicting myself... then again I am fallible

A new way to look at economics

I am quoting from an article written in FT by Beneoit Mandelbrot and Nassim Nicholas Taleb...

" The traditional Gaussian way of looking at the world begins by focusing on the ordinary, and then deals with exceptions or so-called outliers as ancillaries. But there is also a second way, which takes the exceptional as a starting point and deals with the ordinary in a subordinate manner – simply because that “ordinary” is less consequential."

I think this paragraph has convinced me that we need to throw the old ways of looking at the problem and start with a new perspective. With that said, I am seriously thinking about pursuing my PhD in Economics. Maybe, the title of my thesis would be "What they don't teach you in Economics and Econometrics".

Randomness

I have finished listening to Nassim Nicholas Taleb's book The Black Swan. My understanding on using the Gaussian method to describe social sciences like economics has been altered forever. Believe me I spent quite a lot of time in Graduate School learning and reading about the beauty of "the bell curve" to describe random variables. Although it was elegant, pure and tight in describing some systems I feel I should have been more skeptical of its inference capabilities. I also think my professors should have spent more time describing situations where it does not work which is any random variable that is derived through aggregation for example total stock returns from a portfolio of stocks, wealth, stock prices, interest rates, currencies exchange rates, i.e. all macroeconomic indicators. When I think about this I am not sure if the above variables are random at all, as they all have some form of dependency.

Nassim Hussain Taleb - oh why oh why did I not read him earlier!

I have been listening to Fooled By Randomness by Nassim Nicholas Taleb a derivatives trader who has been calling all the statistical models used by banks as inadequate to manage risk. I think it is high time all "Risk Managers" take notice and do something about their infalliabilities. Lets be honest, we don´t have a clue when it comes to predicting the improbable event... heck we even argue about the premium we have to pay for our life insurance given the event of untimely death the argument to get a deal on life insurance was just a waste of breath!

In following Taleb´s chain of thought I have been doing more reading about his work (I still have the Black Swan to read), here is a very interesting article about "The Fourth Quadrant" - his hypothesis of mapping the improbable event, do we really care it is a subprime crisis or the US dollar bust? Well, I think we need to start buying insurance for the fact that the US dollar could go bust... improbable you say? Think again... time and time again we have pushed aside thoughts our brain is not built to fathom but then again atleast the thing I want to get out of understanding this concept is that we humans are built this way, so lets not take ourselves too seriously when we know that "something is absolutely" the truth. Read his interview on calling the models all Banks relied on - Value At Risk or VAR models as total BS! what amazes me is that he was calling this bogus in 1996! I wish I had read his work before, but hey I got into banking only two years back so I am a faster learner than most of the Bank Risk Managers I know.

My lessons from the reading, accept the Randomness in our lives and make sure you have insurance cover when the S#$% hits the fan!