A great American financial crisis - Emperor's new cloth!

A friend of mine asked me to explain the reason behind the current American financial crisis. This post is an attempt at it.

Non controversial and simple explanation: Banks and Financial institutions that are part of this crisis (most of American Banks/Financial institutions) had lots of debts to pay and they did not have enough money to pay :-) That's it!

Reason is simple, but the real difficult question is, how did the Banks and Financial institution get into this messy situation?! Especially if one considers the following facts.

1) These institutions attracted the brightest people
2) Offered highest remuneration
3) Had all the support of government and policy makers (remember we're living in a relative world)
4) No major world disasters, no world war, no calamities, no terrorism (9/11)
5) These institution did not do illegal practice, no frauds, no drug trafficking, arms trade etc. As per books they all had fair business practice
6) World economies were booming until the point of failure.

Then how come this sudden heart attack?!

Well, the last word has the key - "heart attack" affects the 'over' healthy- obese people rather than people who are starved.

Now moving towards analyzing the cause of this sudden financial heart attack. I believe its because of the following 4 reasons. (Disclaimer: these are not researched opinion just another Sunday afternoon thoughts)

1) Emperor's new cloth
2) 'Messy' complexity : Domino effect
3) Social trap : Nazi concentration camp
4) Too much power in one place: Alavuku minjinaal amudhamum nanju - A Tamil proverb which translates to "Over the limit even nectar becomes a poison"

Diving into more details. I'll be using word 'Bank' to denote = Banks and all financial institutions that includes even the glamorous Investment banks.

1) Emperor's new cloth

During early days of banking, Banks offered simple services e.g safe guarding one's money and then moved on to offer lending (loans) etc.

Even buying was simple, early days if you had money you bought stuff or saved money to buy, however this changed to credit cards and EMIs.

Trends shows new products being invented by Banks to increase their service offering and thus fueling their growth. Note, current corporate culture is focused mainly at growth. This puts huge pressure year on year to grow and the going only gets tough as the size of the company increases. Its easy to grow from 1 to 5 than from 5000 to 25000, both has same percentage (500%) growth.

This natural pressure to grow fuels creation of 'innovative' financial instruments, two such examples are Derivatives and Hedge Funds.

These and many new products were churned out by banks/financial institution. These product were not understood (real risks/benefit) by most people but who wants to be seen as stupid - Just like the Emperor's new cloth.

There are exception - Warren buffet calls derivatives a 'time bomb'

2) 'Messy' complexity: Domino effect

Level 1:

In good old days it would have been easier for the bank branch manager to look into books and sort things out if there were any transaction flaws. Now a top manager in any bank can't help without an army of database administrators, system administrators, business analyst, domain manager and support staff working on to address certain flaws.Technology that drives the systems in these Banks has added to the complexity. It is now beyond a human capability to understand the entire system of even a single bank.

Level 2:

The financial product have became interwoven, repackaged and re-sold to others. No body understands the fundamentals of these products. I'm not denying that there weren't any shady practice like wrong rating by credit firms etc., fact is that I don't know about them so I'm leaving it out of the analysis.

However I'm convinced that even if you put the smartest mind, now, to dig out the risks of these products he/she will do a very poor job. There is just too much inter linking and assumptions.

Level 3:

So much interwoven and complex were these products and services that one event like 'sub prime debacle' had a domino effect that is threating to pull the entire financial system down.

Why the word 'messy'?

Truly complex system are simple to interact e.g the Google search system, you don't need to spend hours and hours to understand how to use Google. However building a Google like search engine is complex. (I tend to give Google as example, only because its an easy example)

3) Social trap: Nazi concentration camp

I've read about the greed of the Wall street people, I would strongly argue against it. Even if you or me were in the place we would have done the same thing because it was considered the smartest and typically a great business sense.

The power of social trap is so strong that even high IQ and highly paid people can be made to do stupid things without their knowledge.

The social trap is also one of the reason for bizarre human behavior like concentration camp, motivating suicide terrorist, Hindu's attack on churches etc

The competition to grow and harness opportunity was a Zero Sum Game that all the banks had to play otherwise they would have supposedly lost business. It was considered normal as everyone were into these kind of products and service.

4) Too much power in one place: Alavuku minjinaal amudhamum nanju - A Tamil proverb which translates to "Over the limit even nectar becomes a poison"

It is easy to make more money with money than anything else and Wall street was the shining example of this. People at Wall street made more money than any hard working researcher, entrepreneur, manufacturer or worker.

The power of Wall street was so huge that CEOs and company's board made short term decision that would please Wall Street.

Folklore has it that Google had avoided going to IPO for long time because of the fear of power of Wall Street on its free decision taking.

The Wall Street was beyond the regulators and could decide fate of many companies. The bankers and financial honchos ruled the engineers, workers, entrepreneurs, creators and became the heart of the economy.

Concluding remarks:

Real growth will only come by scientific discoveries, technology breakthrough, creation, enriching the culture, Art, building a healthy community and producing clean and green goods and not by manipulating numbers, power point, conferences or networking events.

More quotes from Prof B.M Hegde's Oration

This post lists some of the interesting quotes from Prof B.M Hegde's oration. (I'm not sure if these are his own quotes. I heard it from him first)

"Bad teacher preaches,
good teacher teaches,
great teacher reaches"

"Competition with others is mediocrity,
competition with self is excellence"

"Tree with fruits bends low"

Which loosely translates to: people with true skills are humble.

"There is no pill for every ill,
but definitely there is ill for every pill"

"Pill thrills but kills"

About pain killers

"Eat 6 times a day - eat anything, but in limited quantity"

"Good health = Capacity to love and work"

"If you need justice, don't go to court
If you need honor, don't go to police station
If you need good health, don't go to hospital"

"Leading cause of death

1. Modern Medical treatment
2. Heart attack
3. Cancer

These are results of a scientific study"

" For ~1400 years human believed blood was pumped by liver

This concept was first published by Greek physician Claudius Galen (A.D 131 -200 "

The new paradigm that heart pumps the blood was discovered by English physician William Harvey. Human civilization has been through many such paradigm shift, earth is flat, sun/moon revolves around earth etc. Dare to question the popular knowledge/belief.

" Be wise as a serpent
and harmless as dove"

He quoted from the Bible.

Human body and non-linear mathematics.

Didn't I promise more articles that justifies the title of this blog!

Recently I attended Prof B.M Hegde's oration, I was forced to attend this, but eventually glad that I was forced.

B.M Hegde was former vice-chancellor of Manipal University. The oration was an eye-opener to the challenges faced by modern medicine. This post is not about the oration, the medical challenges or the brilliant speaker that Prof B.M Hedge is.

It is about one particular theory (actually hypothesis) that the oration touched upon.

"...this talk will point out the fallacy in the very basis of modern medical science (the linear mathematical laws). Human body, in modern medicine, is treated as simple electro-biochemical machine like a motor car engine. Unfortunately, the human body is only a non-linear chaotic dynamic system continuously run by food and oxygen."

Prof B.M Hegde shared that David Eddy (Stanford professor of Cardiac surgery) resigned his job to study mathematics to give modern medicine a better mathematical base for non-linearity.

Prof also said that 30 years research on non-linear working of the heart will be presented soon and went on to say that if the heart were to be simple muscular pump pushing blood into the vast swimming pool of millions of miles of capillaries which are so narrow that even a single red blood cell cannot pass through without changing its shape, it would have stopped functioning almost when we were born! There is a lot more to it than what we have been thinking so far! The present concept of heart as muscular pump makes a mockery of all known physical laws of the universe.

I've been making related statement to my friends circle for a while: "All human scientific advancement so far has been made based on linear mathematical model, however all future advancement will be made by understanding of non-linear mathematical models"

When I mean all...I mean all - electrical, computing, civil, mechanical and medicine (you could add all streams of education). I added medicine after listening to prof's oration, it re-enforced by own understanding that indeed its all fields of study. All these field's goal has been to build a predictable system (linear system).

Look around, gadgets, white goods and most stuff used in every day life is based on linear mathematical model except love, happiness, sorrow, fun and sensex !(list is not complete)

Just in case you need to know what is linear and nonlinear system?

What is linear system (mathematics)?

- Linear
- Linear system

What is non-linear system?

- Nonlinear system

Ain't there any popular example of non-linear system. Yes!

Google is the first glimpse of true non-linear man-made technical advancement and of course Sensex. However the credit will still go to Google as Sensex is not build on non-linear system, in fact it completely relies on linear system. Number of share in one's DMAT account doesn't change randomly, only the value of shares change to reflect market value, but number of share is same unless one buys or sells shares, it is just the market dynamics which is unpredictable.

But the truth is we're surrounded more by non linear systems than linear - e.g Traffic pattern, Disease spread, Progression of Rumors, City's growth, audience clapping for a performance, Star hysteria, Climate, fashion trends....countless.

Its just that we don't see them yet as non-linear mathematical models.

Why the word 'Non Linear' in the blog title?

Starting a blog is easy, blogger and wordpress, makes it a no brainer. Sustaining it, posting regularly, is very difficult. Yeah, every blogger knows it.

The main challenge is getting the theme, style and purpose of the blog right. One needs to answer: Why? for whom? Is there enough to be written?

Lets come to my blog, with a weird blog title like 'non linear media', I certainly can't post about the jolly good time I had with my school friends during annual get together or why I almost had got into road rage when crazy two wheeler bumped into my car?

Yes, I know there is not even one follower for my blog! So I can write whatever I can/want and it will not matter, but ya 'now wat, it doesn't feel right nor its fun, so the motivation gets killed.

So, when a friend suggested that I can overcome blogger's posting block (BPB) by changing the title and starting afresh, I gave it a hard thought. I'd only 2 posts in '08 and 1 post in '07.

After much thinking I couldn't let go of my love for "Non linear" and "Media", however I changed everything else the template, look and feel, additional information, tagging etc.

I added the tag line "Sharing my love for non linear mathematics, media and technology" and suddenly I was able to feel the purpose of this blog and answer the questions why? for whom? will I've enough to write?

Don't expect the answers in the post, the answers will be in form of various posts that I'll be posting hence forth. All the gadgets (that you see on the right) will make this blog dynamic and constantly changing, thus taking pressure of me.