An Immodest Proposal

Having spent many a night thinking at the level of sheer stupidity and irresponsibility in actors creating, buying, and selling financial instruments a dramatic action must be undertaken to prevent the creation of the next collateralized debt obligation which will enrich a select few individuals before damning the population at large dependent on a stable economy for goods, services, and employment. The current economic crisis was not unavoidable, and could have been prevented if someone in a position to do something would have listened to the arguments against allowing the creation and trade in some of the horrible bastardized securities that imploded bringing down the rest of the financial markets, including the reduction of Iceland from a global financial powerhouse to competing with developing nations for relief from the International Monetary Fund.

It is my proposal that the SEC ought to create a division staffed by professional epistemologists to investigate novel and potentially bunk financial instruments, and that there should be a position held b a financial epistemologist that reports to the President and Congress on proposed changes to trading regulations. Our current economic crisis is rooted in poor treatment of information.

In approving mortgage applications FICO scores were given an ontological status above other relevant factors including borrow income and existing debts held by the borrower. Risk models were taken to have supremacy over factors as basic as a borrower’s ability to repay the mortgage, and this occurred because the banks creating these mortgages were able to quickly sell these mortgages to willing buyers before the lending bank had time to actually experience any risk from having created the mortgage in the first place. Brokers readily bought up and packaged these debts if they were not packaged by the bank already for various funds for which they received commissions for selling to investors, with the caveat that these securities may have been bought and repackaged many times over before reaching a final individual investor looking for a bond like investment promising steady returns over an extended period of time.

There were people who recognized this as a bad idea. Newsweek has a short piece on Senator Byron Dorgan’s opposition to legislation lowering the barriers between banks and brokerages back in 1994, the legislation passed. Very rarely though does anything in economics happen on a timeline of now, or even on a timeline of in the immediate future. In two recent articles the New York Times did postmortems on the problem in the risk management strategies at play before the financial collapse. The problems at work are indeed getting some attention after the fact.

What the core problem in the situation is one of information. The collection of information, the evaluation of information, and the preservation of information are where error may occur or even be systematized. A more sophisticated quantitative model may produce more reliable results in many cases, but a model used in practice can be no better than the information going into it. Someone needs to be evaluating the significance and the status of the information going into these systems. There are already many statisticians and other quant people working on these problems. If we are to make a sincere effort to avoid future mistakes though, we need people with solid training in the science of applied epistemology involved in the decision making process. Garbage in garbage out is a well known maxim in computer science. A prettier algorithm cannot compensate for a poor decision making process in deciding how to feed an algoritm, provided the algorithm is an accurate model of circumstances in the first place.

Today in an Op-ed column for the times David Brooks presented a supposed epitaph to the death of philosophy based on his understanding of contemporary ethics.* If our current crisis has taught us anything is that we need more philosophy and not less, if our society lacks a love of knowledge what other attitude are we going to take as a culture with regard to knowledge. What consequences would it hold for the decisions that must be considered as a society. Or worse what would become of a society with an open disdain and hostility towards knowledge and what crises would they lead themselves blind into.

*His case though neglects that the sort of ethics he criticised are very similar to those of Aristotle in the Nicomachean Ethics, and have been and still are the subject of much debate. The sheer number of people in America who follow a command view of ethics for religious or other reasons alone is enough to dismiss his assumptions out of hand. If I were allowed to only make one prediction it would be that ethic and meta ethics will still be a lively fields one hundred years from now.