Pricing a CDO - Not only Bad Math, Bad Computation too

A working paper, Computational complexity and informational asymmetry in financial products, Sanjeev Arora, Boaz Barak, Markus Brunnermeier, Rong Ge. sheds some light on the complex mathematical models upon which credit default obligations and other derivatives are based.

What Arora et al. prove is not only are many derivative mathematical models impossible to compute, never mind in real time, because they require more computing power than the world possesses, the missing information to run a mathematical model is a very good place to cheat with.

To understand what CDOs, derivatives are, see this post, complete with video tutorials. For some background on the mathematics behind derivatives, read We Want the Formula and this one on some of the probability functions.

Onto the paper. Firstly this quote:

One of our main results suggests that it may be computationally intractable to price derivatives even when buyers know almost all of the relevant information, and furthermore this is true even in very simple models of asset yields.

Durable Goods (M3) for November 2009 - New Orders Flatline, up 0.2%

The Durable Goods report (M3) for November was released on December 24th. The two graphs below show Durable goods since 1992 and then just for this recession period. Regardless of the trend, one can see we have a long way to go on new orders to get back to some real growth indicators.

M3 Nov. 09

Labor Activist Tim Costello Died, age 64

Tim Costello has died. He was an ardent fighter against globalization and it's glorified labor arbitrage agenda.

Mr. Costello was hailed by many academics and labor advocates as a bona fide worker-intellectual. A genial, mustached native of Boston, he drove fuel-delivery trucks, worked as a lobsterman, founded a group that battled against the fast-growing use of temporary workers and developed close links with labor advocates in China, Italy and Mexico.

His most notable book was “Globalization From Below: The Power of Solidarity” (2000), written with Jeremy Brecher and Brendan Smith, which became a primer for labor advocates who argued that globalization was destroying jobs and reducing wages in the United States while exploiting workers in Asia.

Christmas Movie Marathon - The Age of Uncertainty

hot buttered popcorn It's Christmas, along with Friday Night Videos! Party Time! Time to relax, put your feet up on the couch, lay back, and watch some detailed videos on economic policy!

This week is a marathon, in honor of Christmas day.

Economist or more social scientist, John Kenneth Galbraith, wrote and presented an economic series in 1977, The Age of Uncertainty. Galbraith was kind of a dinosaur by 1977, with Milton Friedman, Thatcherism and Reagan taking power of the political economy. Now that we are suffering through the consequences of unbridled corporate driven (written) policies, it might be nice to go back memory lane and revist Galbraith's view of of economic history.

The series has 15 parts and the 12 which overview economic history are in this post. Happy Holidays.

Fannie Mae & Freddie Mac Get "Unlimited" Bail out!

What a time to bury a press release,Christmas Eve, the headlines awash on health care bill Senate passage. Well, some of use are wired to God and despite cooking pomegranate glazed ducks and wrapping presents, we're not asleep at the wheel!

To find the juice, one must even look between the lines of the U.S. Treasury Press release:

Treasury is now amending the PSPAs to allow the cap on Treasury's funding commitment under these agreements to increase as necessary to accommodate any cumulative reduction in net worth over the next three years. At the conclusion of the three year period, the remaining commitment will then be fully available to be drawn per the terms of the agreements.

The Peddling of Toxic Waste, otherwise known as CDOs being investigated

Seems the SEC is just catching up to the finance blogs.

The New York Times article, Banks Bundled Bad Debt, Bet Against it and Won (great title, about sums it all up!) outlines some new investigations.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

A little more on revised Q3 GDP

You may have seen noticed Q3 GDP was revised downward to 2.2%. This is the third and final revision. Originally Q3 GDP was 3.5%. Here is the full BEA release.

A reminder, GDP is:

$Y=C+I+G+{(X-M)}$

where

Y=GDP, C=Consumption, I=Investment, G=Government Spending, (X-M)=Net Exports.

What happened?

Here is the original breakdown of GDP components first reported:

Price index - +1.6%
Consumption - +3.4%
Non-Res. investment - -2.5%
Residential Fixed Investment + 23.4%
Exports - + 14.7%
Imports - +16.4%
Gov. spending - +2.3%
Private Inventories - + 0.94%

In the breakdown of Consumption originally we had:

Strange Bedfellows.

At the risk of weekly over exposure to the blog Firedoglake, I really feel that this post, Jane Hamsher and Grover Norquist Call For Rahm Emanuel's Resignation, deserves special attention. I can think of few people in the blogosphere or elsewhere who are more liberal than Jane Hamsher. On the other hand, Grover Norquist has been the leader of "movement conservativism" for more than 2 decades. So, anything that they might do jointly deserves a second look.

New Home Sales Tank 11.3% for November 2009

The Economic Mood of the nation could end up being bipolar with the way headlines swing economic indicators. Yesterday the world was all giddy with the surge in existing home sales (with underlying analysis being more sobering) and today's New Home Sales Commerce Report will cause a pre-holiday funk.

Sales of new one-family houses in November 2009 were at a seasonally adjusted annual rate of 355,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development.

This is 11.3 percent (±11.0%) below the revised October rate of 400,000 and is 9.0 percent (±15.3%)* below the November 2008 estimate of 390,000.

Governator seeks federal bailout

Schwarzenegger is looking less and less like an action hero and more like a panhandler.

Facing another huge deficit, the governor wants $8 billion or threatens massive cuts in social services. He also plans to renew push for offshore oil drilling.
Reporting from Sacramento - Facing a budget deficit of more than $20 billion, Gov. Arnold Schwarzenegger is expected to call for deep reductions in already suffering local mass transit programs, renew his push to expand oil drilling off the Santa Barbara coast and appeal to Washington for billions of dollars in federal help, according to state officials and lobbyists familiar with the plan.

December 2009