Reading time: < 1 minute

As you may have noticed, I am re-focusing this blog. In particular I will be writing on development economics, monetary policy, fiscal policy and other topics. That said, I still have much to learn about these topics so I am going to put this site on a brief hiatus while I continue my education at arguably one of the best finance and economics schools in the world – The University of Chicago Booth School of Business.

I am very excited about getting back to my finance and economics roots and I hope my future posts will prove to be educational, informative and insightful.

Reading time: 2 – 3 minutes

Vote for my SXSW 2010 panel

I had a fantastic time at SXSW last year but I was left wanting one thing and that was more finance and economics related content. There are so many interesting things happening at the convergence of interactive media, technology and finance and the field is ripe for innovation.  Given that, I was amazed at the lack of content around finance.

So, I decided to do something about it. I put forth an idea for a panel for SXSW 2010 called “Data is Money: How geeks are changing finance.” (Please vote for it here: http://bit.ly/LBApG and spread the word!)

This panel will bring together experts in finance and technology to talk about how the future of finance will be influenced by data geeks and technologists. We will explore new financial data formats, like XBRL, and discuss how these formats, along with other recent advances, will allow all of us to play a role in the creation of a better financial system.

Jesper Andersen, co-founder of Freerisk.org, is already on board for the panel and Charlie Hoffman, the father of XBRL and author of the forthcoming book XBRL for Dummies, will be joining us as well (schedule permitting of course).  I will also pick up one or two more speakers if the panel is chosen.

It should be a great panel and I hope all of you out there will vote for it so that it will be chosen. The topic is important and certainly relevant given where the economy is today.

Vote for my panel early and often: http://bit.ly/LBApG Thanks for your support!

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Other great economics and finance related SXSW panels you should vote for:

“Saving the New Economy from the Past”

“Banking 2.0: Financial services driven by people and emerging technologies”

Reading time: 3 – 5 minutes

Being back in school and taking statistics and finance classes again has reminded me how much I love data. I am not one of those crazy guys who loves data in an unhealthy way and thinks that more of it will solve of all of the problems in the world mind you.  Nor do I believe it can always be trusted. The world is too uncertain and it is often hard to use data to predict the “once every 10,000 years” events that often do the most to shape the world we live in (read The Black Swan by Nassim Taleb for more on that).

What is interesting to me as of late is that we really have reached the point of having free and ubiquitous data.  In fact, we probably have too much data. I would argue that the financial crisis happened partly due to the fact that too much data was available for humans to effectively analyze and understand. I mean, let’s get real, it isn’t like the data wasn’t there.  If you looked at the right data and crunched the numbers you could have seen, as some did, that we were in for a world of hurt.

So now that we are at the point where data is essentially a commodity of sorts we have to figure out better, faster and cheaper ways of analyzing and visualizing data.  The better we get at this the better decisions we’ll make and the more crises we can avert.

FlowingData posted a quote from Google’s Chief Economist Hal Varian that sums things up nicely:

I keep saying the sexy job in the next ten years will be statisticians. People think I’m joking, but who would’ve guessed that computer engineers would’ve been the sexy job of the 1990s?

The ability to take data—to be able to understand it, to process it, to extract value from it, to visualize it, to communicate it—that’s going to be a hugely important skill in the next decades, not only at the professional level but even at the educational level for elementary school kids, for high school kids, for college kids. Because now we really do have essentially free and ubiquitous data. So the complimentary scarce factor is the ability to understand that data and extract value from it.

I think statisticians are part of it, but it’s just a part. You also want to be able to visualize the data, communicate the data, and utilize it effectively. But I do think those skills—of being able to access, understand, and communicate the insights you get from data analysis—are going to be extremely important. Managers need to be able to access and understand the data themselves.

Hal Varian, The McKinsey Quarterly, January 2009

Since I have been thinking more about data and specifically how the financial crisis could have possibly been averted if we could have had a better handle on the mountain of data crammed into arcane forms like 10-Ks and 10-Qs, I have been reading up on XBRL.

XBRL, or Extensible Business Reporting Language, is an open standard for business reporting that I am very excited about.  It could do for financial data what feeds and xml did for content.  When all of the data is structured we can then start to set up smart software to analyze the large amounts of data that exist.  That’s a big deal.

The good news is that XBRL is slowly becoming mandated for public companies in the U.S. an abroad so we’re not far off from being able to analyze and visualize financial quickly and easily.

XBRL, as I tweeted earlier, is the intersection of some of my favorite things: software, structured data and finance.  I am planning on digging into XBRL much more and will probably write about my findings as I, well, find them. Stay tuned.

Reading time: 3 – 5 minutes

Being a long time student of finance (starting digging into the markets at the age of 13) I have been particularly interested in the financial crisis that we are in the midst of.  I have been thinking through why something as large as this crisis happens.  Of course, for something so large and complex, there are a number of things that had to come into play to create the scenario but one macro theme in particular leaped out at me.

The theme I am talking about is removing faces from finance.

What do I mean by that?  My thinking is this: once you remove relationships from financial transactions and instruments things start to get messy.

If you are once removed, for example when you buy the stock of a company that you don’t have any personal relationship with, you are probably OK and you hope that the management is giving you quality data to asses.  There’s trust there.  However, when you get further and further away from a face to face relationship with, say, derivatives like CDOs, things simply get out of hand.

I have never been a fan of derivatives and other “abstract” financial instruments.  I always found it odd that no one really knew what the underlying assets were.  Was it Joe’s house, Acme Corp., both? To the creators and traders of these securities it was just paper (digital “paper”) with an assigned value.

I am not the only one who was worried about the issues that could be caused by abstracting finance.  Warren Buffett was worried too.  He once referred to derivatives as “financial weapons of mass destruction.”  Buffett also referred to derivatives this way:

“There is an electronic herd of people around the world managing an amazing amount of money who make decisions based on minute-by-minute stimuli,” said Mr. Buffett, adding, “I think it’s a fool’s game.”

His partner Charlie Munger was also not a fan.  Munger once said:

“The accounting being deficient enormously contributes to the risk,” said Munger, lamenting that executives and shareholders were getting paid on “profits that don’t exist.”

Exactly. Profits that don’t exist and assets no one really understands or can put a face to is a recipe for disaster.

At this point I should note that when I say face to face I don’t necessarily mean it literally.  I am more or less referring to the relationship one has with an asset and how close they are to it.  That being said, let’s take a look at the banks.  I will keep it short since I all of you already know what I am going to say.

Banks, given the market’s appetite for CDOs, were able to grant loans and then immediately get rid of them to someone who would package them up and send them off to a big bank like Merril Lynch who would then create CDOs, etc. etc.  Do you see the issue here?

A bank’s business is to take in money in the form of savings and distribute it (and thus take on risk) in the form of loans on which they make their interest (i.e. their profit).  Normally the banks have to look someone in the eye and really figure out if the person will pay the bank back since the bank is stuck with a bad loan if the person doesn’t pay.  The loan default is the bank’s risk.

With CDOs the bank can make a loan and immediately offload their risk (although as we saw a lot of banks didn’t offload the risk fast enough).  Now, as you can see, the bank isn’t incented to look at borrowers as closely.  They are incented to give as many loans as they can and then ship them out the door.  That is when finance becomes faceless, and also “risk-less” for one party, and when one persons transaction is viewed as risk-less the outlook becomes bleak since nothing is really inherently risk-less (just like there is no such thing as a free lunch).

We need to get back to face to face finance where people make deals with people they know and trust and they have to since they have to hold that risk.  We should really think twice the next time we try to abstract finance and create derivatives.  While cool and intereting to finance wonks creating derivatives is probably not a good practice nor does it create long term value for society.