Is This Crisis Different? Not Really
From the time that the subprime mortgage debacle surfaced in 2007 to the dramatic loss of trust in the banking community that led to the credit crunch in 2008, we have heard knowledgeable people say that this time it's different. "This ... is different. ... Never before has housing finance been so embedded into the global financial engine," said HousingWire.com, an organ for the mortgage market, in May 2008.
A similar expression came from a blogger named Hellasious, claiming to be an investment banker, who said in July 2008, "This is not a 'regular' credit contraction. ... No, it's truly different this time."
The implication of these and other comparable statements is that we are witnessing a unique or unprecedented phenomenon. The question is whether or not that's true.
To attempt to answer that means looking into history. The fact is that the past can -- if used rightly -- provide insight now and into the future.
Two authors, both economists -- Carmen M. Reinhart, of the University of Maryland, and Kenneth S. Rogoff, of Harvard University -- have done just that by studying the historical record for a February 2008 report titled, "Is the 2007 U.S. Sub-Prime Financial Crisis So Different? An International Historical Comparison."
"The first major financial crisis of the 21st century involves esoteric instruments, unaware regulators, and skittish investors. It also follows a well-trodden path laid down by centuries of financial folly. Is the 'special' problem of sub-prime mortgages this time really different?" they begin.
After studying 18 previous post-World War II banking crises in industrial countries, they draw conclusions that suggest that this time, perhaps, is not so different.
Now in its second year, the subprime meltdown poses the question: How should firms respond during an economic downturn even as a new Wall Street emerges?
Overly Optimistic Programming
First, consider the implications of the New York Times headline on Saul Hansell's Sept. 18, 2008, blog, "How Wall Street Lied to Its Computers." After interviewing Wall Street information technology veterans, of which Hansell is one, he explained that most Wall Street computer models radically underestimated the risk of complex mortgage securities.
"That is partly because the level of financial distress is 'the equivalent of the 100-year flood,' in the words of Leslie Rahl, the president of Capital Market Risk Advisors, a consulting firm. But she and others say there is more to it: The people who ran the financial firms chose to program their risk-management systems with overly optimistic assumptions and to feed them oversimplified data. This kept them from sounding the alarm early enough."
The immediate answer to how firms should respond is that they need to look behind the headlines and see the data streams that have outpaced the trading infrastructures. The growth in messages on Wall Street from 120,000 per minute in June 2005, to 907,000 per minute in June 2008 makes the need for shorter latency pressing, according to Larry Tabb, founder of TABB Group, during a Wall Street & Technology vendor perspectives webcast on June 19, 2008 [available on demand at wallstreetandtech.com/low-latency]. What companies need to deal with this is a new data strategy.
A data strategy is about identifying what people need in order to make real-time decisions. It establishes the frequency -- intraday, perhaps, or hourly -- with which new data comes in, and how it's stored and made accessible in real or near-real time to users. It's the architecture for a sustained, continuous flow of data to the consuming applications in an environment where high-frequency and high-speed execution is essential to give a complete perspective of what is going on in the markets.
A data strategy is the basis of an adequate risk platform that the chief risk officer and management team can use to assess risk management across the enterprise. A strong strategy ensures that the CRO and management team will be able to assess the concentration of risk and will be empowered to overrule individual trading desks.
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