Crossposted from mathbabe.org from May 14, 2013. The views expressed are those of Cathy O’Neil.

I’ve discussed the broken business model that is the credit rating agency system in this country on a few occasions. It directly contributed to the opacity and fraud in the MBS market and to the ensuing financial crisis, for example. And in this post and then this one, I suggest that someone should start an open source version of credit rating agencies. Here’s my explanation:

The system of credit ratings undermines the trust of even the most fervently pro-business entrepreneur out there. The models are knowingly games by both sides, and it’s clearly both corrupt and important. It’s also a bipartisan issue: Republicans and Democrats alike should want transparency when it comes to modeling downgrades- at the very least so they can argue against the results in a factual way. There’s no reason I can see why there shouldn’t be broad support for a rule to force the ratings agencies to make their models publicly available. In other words, this isn’t a political game that would score points for one side or the other.

Well, it wasn’t long before Marc Joffe, who had started an open source credit rating agency, contacted me and came to my Occupy group to explain his plan, which I blogged about here. That was almost a year ago.

Today the SEC is going to have something they’re calling a Credit Ratings Roundtable. This is in response to an amendment that Senator Al Franken put on Dodd-Frank which requires the SEC to examine the credit rating industry. From their webpage description of the event:

Marc is going to be one of something like 9 people in the third panel. He wrote this op-ed piece about his goal for the panel, a key excerpt being the following:

Section 939A of the Dodd-Frank Act requires regulatory agencies to replace references to NRSRO ratings in their regulations with alternative standards of credit-worthiness. I suggest that the output of a certified, open source credit model be included in regulations as a standard of credit-worthiness.

Just to be clear: the current problem is that not only is there wide-spread gaming, but there’s also a near monopoly by the “big three” credit rating agencies, and for whatever reason that monopoly status has been incredibly well protected by the SEC. They don’t grant “NRSRO” status to credit rating agencies unless the given agency can produce something like 10 letters from clients who will vouch for them providing credit ratings for at least 3 years. You can see why this is a hard business to break into.

The Roundtable was covered yesterday in the Wall Street Journal as well: Ratings Firms Steer Clear of an Overhaul - an unfortunate title if you are trying to be optimistic about the event today. From the WSJ article:

Mr. Franken’s amendment requires the SEC to create a board that would assign a rating firm to evaluate structured-finance deals or come up with another option to eliminate conflicts.

While lawsuits filed against S&P in February by the U.S. government and more than a dozen states refocused unflattering attention on the bond-rating industry, efforts to upend its reliance on issuers have languished, partly because of a lack of consensus on what to do.

I’m just kind of amazed that, given how dirty and obviously broken this industry is, we can’t do better than this. SEC, please start doing your job. How could allowing an open-source credit rating agency hurt our country? How could it make things worse?

I don’t have time to write a blog post.but these articles are better than I could write, anyway.

Occupy Offshoots Return

Dodd Frank Defanged, or Why Occupy the SEC is so badly needed

Please join some Alt-Banking members and others protesting the Bank of America Shareholder meeting tomorrow — Wed. May 8th..

You don’t need to be in NYC. There are lots of protests around the country.

We will be at the Bank of America Tower at 6th Avenue and 42nd St starting at noon. If you are willing to log into Facebook (please be cautious) more info here.

Info about past protests on our blog, the LA Times and elsewhere.:

The “Fantastic performance artist” will appear as the Ethical Fiscal Fairy. Not to be missed.

It poured rain but a “small but fierce” crowd showed up including the Ethical Fiscal Fairy, of course!

Here are a couple of photos

This Sunday’s Times magazine has an article that unintentionally illustrates a big problem with the political/economic system today. The “respectable” debate — that is, the debate Obama and others in power listen to — is restricted to one between the failed ideas of W Bush and the only slightly better Clinton policies.

This article holds a debate between Glenn Hubbard, adviser to Bush and Romney, and Larry Summers, Treasury Sec. under Clinton and adviser to Obama.

It is surprising, and appalling, that Hubbard gets any respect at all. He is the “architect” of Bush’s failed policies. Haven’t we had enough of that? Unfortunately cutting taxes on the rich is a policy that will never die. Quelle surprise, as Yves Smith would say.

Summers isn’t quite as discredited. Not everything went wrong in the Clinton years. But Summers was a prime mover in squelching regulation of derivatives and getting rid of Glass-Steagall. He was also instrumental in the earlier rounds of bank bailouts — remember the “Committee to Save the World”.

Even the principals in the merger that killed Glass-Steagall, John Reed and Sandy Weill agree that was a mistake.

The problem is that we keep going back to the old, failed ideas. There is a mystique that only the bankers and business people know how to run the economy. Well they know how to run it to their own benefit but it is not working for the 99%. Their arguments have all the substance of the Emperor’s New Clothes.

Hey Adam Davidson, if you like sports analogies, shouldn’t we look for a coach with a new playbook. There are lots of people out there with new, better, ideas. How about James Galbraith or Dean Baker?

Our protest of the Citigroup shareholders meeting was our best attended and definitely the most noticed by the media.

Financial Times: Banks got bailed out, we got sold out

Marni got the most notice, well done.

Dealbreaker: Spandex-clad roller-girl

Huffington Post: Fantastic Performance Artist.

They were also interviewed by the Associated Press and Korean and Dutch news agencies. Will post as they are published.

YES, WE WILL! PICKET CITIGROUP SHAREHOLDERS’ ANNUAL MEETING!
Outside the Hilton Hotel, Sixth Avenue between 53rd and 54th Streets.
Wednesday, April 24th at 8-10 am.

Event Listings:

• NYCGA.net
• Facebook

Some things take intolerably long to change. The following was written almost a year ago for “Occupy the Citi,” which was a “Day of Public Outrage and Education” held by Occupy Astoria LIC at the “other” Citigroup Tower, the one in Queens. The text needs only minor changes – we turn “four years” into five, switch the name of the suit at the top from Pandit to Corbat – and presto! It’s as timely as ever; a sad truth. This is why Occupy Wall Street is still protesting Citigroup next Wednesday morning. This time we’ll be at the annual shareholders’ meeting. (Note: Following views and opinions belong to Nicholas Levis. Blame him.)

Why Occupy the Citi? What Are Our Grievances?

Five years ago, Citigroup and other major Wall Street banks became insolvent as a result of their own predatory and reckless actions in the mortgage-backed security and derivatives markets. This caused the most dramatic financial crash since 1929.

The institutions responsible for the resulting global depression and worldwide misery constitute a public danger. They should have been liquidated. The executives should have been fired and subjected to criminal investigation. A banking system that causes such a disaster should have been reinvented.

Instead, a government corrupted by Wall Street money decided that the insolvent “zombie banks” were “Too Big To Fail” (TBTF). While smaller and often more solvent banks were allowed to go bankrupt, the TBTFs were rescued with trillions of dollars from taxpayers and the Federal Reserve.

Citigroup alone received $45 billion in direct cash bailouts from the Treasury – the taxpayers – and was privileged with an incredible total of $2.5 trillion in near-zero interest loans (GAO-11-696, p. 131) as well as additional guarantees from the Federal Reserve. Together, the TBTF banks received more than $13 trillion in bailouts from the Treasury and Federal Reserve, and ongoing potential taxpayer exposure on all government guarantees for banks to date exceeds $3.5 trillion. [Note: In the year since this was first written, much has been made of how banks have "paid off" TARP or other bailouts, without noting the continuing exposure in case of future failure, or asking: Why were criminal institutions entitled to a bailout in the first place?]

Since the crisis, while the Federal Reserve discount window has offered the TBTFs loans at almost zero percent interest, the big banks have also been able to buy Treasury bills paying 3 percentage points higher. In other words, the US government is providing free money and free profit to the TBTFs, helping to keep them afloat. Furthermore, in 2009 the government suspended “mark to market” accounting rules for banks, which means that banks can value their assets at ideal value, rather than at the prices actually available on the market. In short, banks are allowed to cook their books so that they can look solvent.

Because they were bailed out, the TBTFs were able to continue foreclosing on individual debtors, for whom no effective rescue has been offered.

Because We the People were forced to rescue banks like Citigroup, Goldman Sachs and Bank of America, today they continue to pay exorbitant bonuses to the executives who helped to crash the world.

Thanks to taxpayer money, Citigroup and its siblings can continue to pay for an army of lobbyists in Washington and influence legislators with campaign donations. Citigroup was #3 among the 10 biggest corporate campaign contributors in U.S. politics over a 20-year period, just behind Goldman Sachs. Its spending peaked during the crash year of 2008, in the run-up to receiving its bailouts. Citi’s biggest recipients in the 2010 election cycle included our New York senators, Charles Schumer and Kirsten Gillibrand, and Queens Congressman Joseph Crowley. This doesn’t count Citi’s spending on lobbyists in Washington, which totaled $62 million from 2001 to 2010.

Thanks to the TBTF doctrine, Citigroup can still buy favorable PR by purchasing endless ad time to tell us of its supposed charitable works, and, incidentally, by sponsoring our beloved New York Mets.

How does Citigroup show its gratitude for the federal rescue? In 2010, Citigroup declared $4 billion in profits and paid no federal income tax. In fact, it received a $1.9 billion tax refund. (Similar numbers apply in the cases of Bank of America and Goldman Sachs.)

During the final phase of the housing bubble, Citigroup was one of several institutions known to have conned investors into buying securities that were designed to fail, even as they bet against the same securities they were selling. When the government found evidence of one such multi-billion-dollar fraud, however, no one was prosecuted. Instead, the US Securities and Exchange Commission (SEC) asked Citi to pay a penalty worth only a fraction of the amount defrauded from the investors: a mere business expense. The SEC settlement – which for now has been blocked by a courageous judge – did not even require Citigroup to acknowledge wrongdoing.

Today, the Wall Street banks bailed out by the public continue to profit from predatory actions. In a system where money controls politics, Wall Street is above the law… (continued)

Continue reading →

Crossposted from mathbabe.org. The views expressed below are those of Cathy O’Neil.

As Rortybomb reported yesterday on the Roosevelt Institute blog (hat tip Adam Obeng), a recent paper written by Thomas Herndon, Michael Ash, and Robert Pollin looked into replicating the results of a economics paper originally written by Carmen Reinhart and Kenneth Rogoff entitled Growth in a Time of Debt.

The original Reinhart and Rogoff paper had concluded that public debt loads greater than 90 percent of GDP consistently reduce GDP growth, a “fact” which has been widely used. However, the more recent paper finds problems. Here’s the abstract:

Herndon, Ash and Pollin replicate Reinhart and Rogoff and find that coding errors, selective exclusion of available data, and unconventional weighting of summary statistics lead to serious errors that inaccurately represent the relationship between public debt and GDP growth among 20 advanced economies in the post-war period. They find that when properly calculated, the average real GDP growth rate for countries carrying a public-debt-to-GDP ratio of over 90 percent is actually 2.2 percent, not -0:1 percent as published in Reinhart and Rogoff. That is, contrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower.

The authors also show how the relationship between public debt and GDP growth varies significantly by time period and country. Overall, the evidence we review contradicts Reinhart and Rogoff’s claim to have identified an important stylized fact, that public debt loads greater than 90 percent of GDP consistently reduce GDP growth.

A few comments.

1) We should always have the data and code for published results.

The way the authors Herndon, Ash and Pollin managed to replicate the results was that they personally requested the excel spreadsheets from Reinhart and Rogoff. Given how politically useful and important this result has been (see Rortybomb’s explanation of this), it’s kind of a miracle that they released the spreadsheet. Indeed that’s the best part of this story from a scientific viewpoint.

2) The data and code should be open source.

One cool thing is that now you can actually download the data – there’s a link at the bottom of this page. I did this and was happy to have a bunch of csv files and some (open source) R code which presumably recovers the excel spreadsheet mistakes. I also found some .dta files, which seems like Stata proprietary file types, which is annoying, but then I googled and it seems like you can use R to turn .dta files into csv files. It’s still weird that they wrote code in R but saved files in Stata.

3) These mistakes are easy to make and they’re mostly not considered mistakes.

Let’s talk about the “mistakes” the authors found. First, they’re excluding certain time periods for certain countries, specifically right after World War II. Second, they chose certain “non-standard” weightings for the various countries they considered. Finally, they accidentally excluded certain rows from their calculation.

Only that last one is considered a mistake by modelers. The others are modeling choices, and they happen all the time. Indeed it’s impossible not to make such choices. Who’s to say that you have to use standard country weightings? Why? How much data do you actually need to consider? Why?

[Aside: I'm sure there are proprietary trading models running right now in hedge funds that anticipate how other people weight countries in standard ways and betting accordingly. In that sense, using standard weightings might be a stupid thing to do. But in any case validating a weighting scheme is extremely difficult. In the end you're trying to decide how much various countries matter in a certain light, and the answer is often that your country matters the most to you.]

4) We need to actually consider other modeling possibilities.

It’s not a surprise, to economists anyway, that after you include more post-WWII years of data, which we all know to be high debt and high growth years worldwide, you get a substantively different answer. Excluding these data points is just as much a political decision as a modeling decision.

In the end the only reasonable way to proceed is to describe your choices, and your reasoning, and the result, but also consider other “reasonable” choices and report the results there too. And if you don’t like the answer, or don’t want to do the work, at the very least you need to provide your code and data and let other people check how your result changes with different “reasonable” choices.

Once the community of economists (and other data-centric fields) starts doing this, we will all realize that our so-called “objective results” utterly depend on such modeling decisions, and are about as variable as our own opinions.

5) And this is an easy model.

Think about how many modeling decisions and errors are in more complicated models!

Crossposted from mathbabe.org. Views expressed are those of Cathy O’Neil.

Last night I went to an event at Barnard where Ina Drew, ex-CIO head of JP Morgan Chase, who oversaw the London Whale fiasco, was warmly hosted and interviewed by Barnard president Debora Spar.

[Aside: I was going to link to Ina Drew's wikipedia entry in the above paragraph, but it was so sanitized that I couldn't get myself to do it. She must have paid off lots of wiki editors to keep herself this clean. WTF, wikipedia??]

A little background in case you don’t know who this Drew woman is. She was in charge of balance-sheet risk management and somehow managed to not notice losing $6.2 billion dollars in the group she was in charge of, which was meant to hedge risk, at least according to CEO Jamie Dimon. She made $15 million per year for her efforts and recently retired.

In her recent Congressional testimony (see Example 3 in this recent post), she threw the quants with their Ph.D.’s under the bus even though the Senate report of the incident noted multiple risk limits being exceeded and ignored, and then risk models themselves changed to look better, as well as the “whale” trader Bruno Iksil‘s desire to get out of his losing position being resisted by upper management (i.e. Ina Drew).

I’m not going to defend Iksil for that long, but let’s be clear: he fucked up, and then was kept in his ridiculous position by Ina Drew because she didn’t want to look bad. His angst is well-documented in the Senate report, which you should read.

Actually, the whole story is somewhat more complicated but still totally stupid: instead of backing out of certain credit positions the old-fashioned and somewhat expensive way, the CIO office decided to try to reduce its capital requirements via reducing (manipulated) VaR, but ended up increasing their capital requirements in other, non-VaR ways (specifically, the “comprehensive risk measure”, which isn’t as manipulable as VaR). Read more here.

Maybe Ina is going to claim innocence, that she had no idea what was going on. In that case, she had no control over her group and its huge losses. So either she’s heinously greedy or heinously incompetent. My money’s on “incompetent” after seeing and listening to her last night. My live Twitter feed from the event is available here.

We featured Ina Drew on our “52 Shades of Greed” card deck as the Queen of diamonds:

Back to the event.

Why did we cart out Ina Drew in front of an audience of young Barnard women last night? Were we advertising a career in finance to them? Is Drew a role model for these young people?

The best answers I can come up with are terrible:

1. She’s a Barnard mom (her daughter was in the audience). Not a trivial consideration, especially considering the potential donor angle.
2. President Spar is on the board of Goldman Sachs and there’s a certain loyalty among elites, which includes publicly celebrating colossal failures. Possible, but why now? Is there some kind of perverted female solidarity among women that should be in jail but insist on considering themselves role models? Please count me out of that flavor of feminism.
3. President Spar and Ina Drew actually don’t think Drew did anything wrong. This last theory is the weirdest but is the best supported by the tone of the conversation last night. It gives me the creeps. In any case I can no longer imagine supporting Barnard’s mission with that woman as president. It’s sad considering my fond feelings for the place where I was an assistant professor for two years in the math department and which treated me well.

Please suggest other ideas I’ve failed to mention.

This week, a climate change expert will give a talk on the History of CO2: Past, Present and Future.

1. Carbon Cycle and Phanerozoic History of CO2
2. Climate history over last 11,000 years (recent paper from Science)
3. Link between CO2 and T (Vostok Ice Cores, paleo records, Berner)
4. Where we’re headed with CO2 and climate (not so bad now, but look at RCP 8.5)
5. The bathtub: avoiding overflow (MIT psych paper)
6. Extreme Weather Events and Loaded Climate Dice (Hansen et al)

It will be Sunday from 2-3 PM. Followed by our regularly weekly Alternative Banking meeting.

Details here:http://www.nycga.net/events/event-edit/?action=edit&event_id=93

Cathy O’Neil, mathbabe, data scientist, former Wall Street quant will explain how private information is collected, stored, sold, and used in Internet models including e-scores (electronic credit scores), advertisements, and other fun stuff.

Sunday, March 31  2-3 PM: Will be followed at 3 pm by the regular weekly meeting of OWS – Alternative Banking working group.

Details here: