Arnold Kling  

Feynman on Suits vs. Geeks

Other People's Money... An Education Debate...

Megan McArdle quotes Richard Feynman's analysis of the Challenger disaster. I was drawn to this paragraph in particular:

why do we find such an enormous disparity between the management estimate and the judgment of the engineers? It would appear that, for whatever purpose, be it for internal or external consumption, the management of NASA exaggerates the reliability of its product, to the point of fantasy.

I have been arguing that this is what took place with mortgage securitization. The suits kept saying that everything was fine, even though the geeks thought otherwise.

The suits are the ones who champion the Paulson plan and say that taxpayers will make a profit.

Have a nice day.

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COMMENTS (5 to date)
Thomas Dinsmore writes:

The geeks, on the other hand, knew that the securities were junk then and worthless now.

Arnold Kling writes:

It's not that they were worthless, but that they have a lot of downside risk should house prices decline. So, if you're Freddie Mac or Fannie Mae and you go into the high-risk loan market, you owe it to your creditors (nominally the people who invest in your debt, in practice the taxpayers) to set aside plenty of capital. Of course, if you factor in the cost of that capital, you probably can't afford to play in that market.

Thomas Dinsmore writes:

It wasn't possible during the boom to make a geekish argument in favor of the underlying credit quality of the mortgage business. Instead, most arguments were founded on some variant of the "greater fool" theory, wishful thinking about housing prices, or faith in the system.

Experienced mortgage analysts knew very well that lenders were inviting trouble, but in the institutional culture of the industry conservative voices were sidelined in favor of those who were willing to tell management what they wanted to hear.

bgc writes:

Yes but what was the reason NASA wanted/ needed to exaggerate the reliability of their product?

Because NASA were clients of government, who insisted on unrealistic reliability as a condition of funding. NASA management were (merely) responding to government pressure - this was their survival task. Government was the distal cause of the Challenger disaster by the external distorting pressures they put onto the system.

Likewise it was the government pressure outside of the economic system, that distorted the working of the economic system and prevented self-correcting feedback, which should be regarded as the ultimate cause of the crisis.

So, the Republicans analysis is more deeply correct than the Democrats.

taxtrumpet writes:

There was a time when companies increased their reservies on financial statements during good times, because experience taught that good times do not last forever. The exerience was that something bad would happen someday that had its origins in the good times, but was unrecognized during the good times. After all, firms do not have perfect knowledge. The SEC criticized this because it smoothed earnings by dampening them in goods times, and increased them in bad times by drawing down the reserves. So during good times, the SEC says unless you can point to a specific problem, or a history of problems, reserves cannot be set up. Then, when bad things happen, reserves are inadequate, and the impact on earnings is very big. I think this causes volatility. Absent the SEC ruling, I think firms would have established larger reserves, and the financial meltdown would have been less serious.

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