How the fate of the US economy rests on a Dell workstation
Quick, someone send Bernanke a supercomputer
The global economy is teetering on the brink of disaster.
So, you might think the quants and smart-alecs of the financial industry would have a giant supercomputer humming away somewhere, processing zillions of what-if scenarios per second and sucking in all manner of real-time economic data from the global markets and government bureaucracies to crunch some numbers and plot a logical set of economic policies to clean up this mess they got us into. No?
After hearing a report on National Public Radio's Morning Edition program describing a computerised economic model created by one-time Princeton University economic professor and present Federal Reserve chairman Ben Bernanke, called the Financial Accelerator, I certainly got the impression that the United States government had some pretty hefty simulations at its disposal to try to figure out what happened to the economy and how to fix it.
Bernanke, in case you have been hiding under a rock (a sensible course of action, really), is an expert on the economic and political forces that caused the Great Depression.
Sim Wall St
Given his expertise and the fact that Bernanke and his then colleague, New York University economics professor Mark Gertler, came up with the equations way back in the 1980s to simulate portions of the US economy as it deals with a credit crunch, you would think we would have a much more sophisticated set of tools at the disposal of the Federal Reserve. I certainly got that impression from the NPR report, which you can take a gander at here in its text version.
You might think that this massive $700bn bailout of the US financial services industry at least had some simulations backing up its numbers - particularly because we live in a world where we can view the weather live from satellites, and gather an enormous amount of physical data about air and water and land that can be put into simulations that can tell us with at least some accuracy what the weather will be like anywhere on the planet within a few hours.
Uncle Sam has dedicated several petaflops of computing power to redesigning nuclear war heads and simulating nuclear explosions (thereby getting around the Nuclear Test Ban Treaty, which forbids actually blowing up a real new nuke design to test it). You'd think at least one central bank (most likely the Federal Reserve Bank, given the central nature of the US economy since the end of World War II) would have a supercomputer cranking through scenarios right now. After all, the big banks and brokerages are doing Monte Carlo simulations to assess the risks of buying and selling securities using more or less real-time stock data.
This seems like a reasonable assumption, right? Right.
So I contacted Gertler to try to get some kind of understanding about how the Financial Accelerator model works, and what supercomputer it is implemented on. The acceleration that the model is talking about is how a credit crunch, caused by a crisis in confidence in some aspect of the economy, builds on itself and accelerates a decline. (You can read a 1996 paper put together by Bernanke, Gertler and their partner, professor Simon Gilchrist of Boston University, called The Financial Accelerator and the Flight to Quality here (pdf), and an interesting follow-up speech by Bernanke given in June 2007 called The Financial Accelerator and the Credit Channel here (pdf).)
Like the rest of you, I wanted to know what the model was saying giving the current conditions in the US stock, credit, and jobs markets.
I was able to reach Gertler by email. "Things are pretty hectic for me this week," he explained. An understatement of comic proportions had this not been such a serious bit of business.
The UK version...
The UK version probably "runs" on a Sinclair ZX 80.
They are helpful...
Interesting that we should discount the modelling as useless. It isnt, but its pointless putting up lights at a railroad crossing if everyone is just going to drive flat out through them anyway. You may as well us a desktop computer and a less complex model if both are going to forecast a meltdown and nobody is going to take heed anyway.
You know a tsumani is likely to happen, you can only really model the impact of various waves.
You'd expect it to be pure science. Problem is you dont know the extent of the actual earthquake as input. You can only provide scenarios and track the likehood of each occurring.
Having studied the so-called black art of econometrics and computer science as well, I have seen good models pick fallacy out of what looks like reasoned argument and bad modelling make the case for whatever you'd like.
Locally they did a repeat of a documentary that aired over a year ago, it showed the then current high loan default rate and the huge problem that was beckoning about now with ARM loans. There were some nice graphs and the impact totally assessable. The issue is you have to model various scenarios, do the bulk of people stay in there and try and cover things, do they walk away.
Quite frankly, if I can get through the number of scenarios (probably a lot), and better monitor the indicators, then we have a better chance of understanding the extent. The we'd really know if $700B was enough, where the money should be put (ie buying into banks, dropping it from a chopper, funding mortgage relief, giving it directly to Haliburton). US action to buy into banks seems to be copying the UK and European approach, perhaps there bigger systems and models given them more insight into better strategies.
The best way to model markets is with a market.
New Zealand boffins have created "iPredict", an exchange where you trade stocks in political, economic and social events. In their simplest form, these stocks pay $1 if an event comes true, or nothing otherwise, and the price these stocks trade for is the prediction.
This lets humans process information from their unique/varied perspectives, and make value judgments. OK markets ain't perfect, but they're still the best way of harnessing the collective wisdom of a crowd. No supercomputer required.