A while back I was talking to some math people about how credit default swaps (CDSs), by their very nature, contain risk that is generally speaking undetectable with standard risk models like Value-at-Risk (VaR).
It occurred to me then that I could put it another way: that perhaps credit default swaps might have been deliberately created by someone who knew all about the standard risk models to game the system. VaR was commercialized in the mid 1990’s and CDSs existed around the same time, but didn’t take off for a decade or so until after VaR became super widespread, which makes it hard to prove without knowing the actors.
For that matter it is reasonable to assume something less deliberate occurred: that a bunch of weird instruments were created and those which hid risk the most thrived, kind of an evolutionary approach to the same theory.
I was reminded recently of this conspiracy theory when Joe Burns talked to my Occupy group last Sunday about his recent book, Reviving the Strike. He talked about the history of strikes as a tool of leverage, and how much less frequently we’ve seen large-scale strikes and industry-wide strikes. He made the point that the legality of strikes has historically been uncorrelated to the existence of strikes – that strikers cannot necessarily wait for the legal system to catch up with the needs of the worker. Sometimes strikers need to exert pressure on legislation.
Anyhoo, one question that came up in Q&A was how, in this world of subsidiaries and franchises, can workers strike against the upper management with control over the actual big money? After all, McDonalds workers work for franchisees who are often not well-off. The real money lives in the mother company but is legally isolated from the franchises.
Similarly, with Walmart, there are massive numbers of workers that don’t work directly for Walmart but do work in the massive supply chain network set up and run by Walmart. They would like to hold Walmart responsible for their working conditions. How does that work?
It seems like the same VaR/CDS story as above. Namely, the legal structure of McDonalds and Walmart almost seems deliberately set up to avoid legal responsibility from disgruntled workers. So maybe first you had the legal system, then lawyers set up the legal construction of the supply chain and workers such that striking workers could only strike against powerless figures, especially in the McDonalds case (since Walmart has plenty of workers working for the mother company as well).
Last couple of points. First, only long-term, powerful enterprises can go to the trouble of gaming such large systems. It’s an artifact of the age of the corporation.
And finally, I feel like it’s hard to combat. We could try to improve our risk or legal system but that makes them – probably – even more complicated, which in turn gives massive corporations more ways to game them. Not to be a cynic, but I don’t see a solution besides somehow separately sidestepping our personal risk exposure to these problems.
I am looking into the history of anti-discrimination laws like the Equal Credit Opportunity Act, (ECOA) and how it got passed, and hopefully find data to measure how well it’s worked since it got passed in 1974.
Putting aside the history of this legislation for now – although it is fascinating – I’d like to talk this morning about this paper from 1989 written by Gregory Elliehausen and Thomas Durkin from the Board of Governors of the Federal Reserve System, which discusses the abstract question of approaches to defining and regulation around discrimination.
This came up because when Congress passed ECOA, they left it to the regulators – in this case the Federal Reserve – to decide exactly how to write the rules, which pertain to credit decisions (think credit card offerings). From the article:
The term “discriminate against an applicant” was defined in Section 202. 2(n) as meaning “to treat an applicant less favorably than other applicants.” By itself, this rule does not offer an unquestionably unambiguous operational definition of socially unacceptable discrimination in a screening context where limited selections are constantly being made from a longer list of applicants.
The paper then goes on to list 3 separate regulatory approaches to anti-discrimination regulation. I have found these three definition really interesting and thought-provoking. I won’t even go into the rest of the paper on this post because I think just this list of three approaches is so interesting. Tell me if you agree.
1) The “effects-based” approach to regulation. This is the idea that, we don’t need to know how you actually make credit decisions, but if the effect is that no women or minorities ever get credit from you, then you’re doing something wrong. If you want to be really extreme in this category you get to things like quotas. if you want to be less extreme you think about studying applications that are similar except for one thing like race or gender, kind of like the the male vs. female science lab application test studied here. Needless to say, effects-based regulation is not in use, it’s considered too extreme.
2) The “intent-based” approach to regulation. This is where you have to prove intent to discriminate. It’s super rare that you can do that, because it’s super rare that people aiming to discriminate are dumb enough to make it obvious. Far easier to embed discrimination in a model where you can maintain plausible deniability. Although intent-based regulation is considered too extreme in the other direction, it seems to be what surfaces when there’s a legal case (although I’m not a legal expert).
3) The “practices-based” approach to regulation. This is where you make a list of acceptable or unacceptable practices in extending credit and hope you cover everything. So for example you aren’t allowed to explicitly use race or marital status or governmental assistance status in your credit models. This is what the Fed finally decided to use, and it makes sense in that it’s easy to implement, but of course the lists change over time, and that’s the key issue (for me anyway): we need to update those lists in the age of big data.
Tell me if you think there’s yet another approach not mentioned. And note these regulatory approaches correspond to different ways of thinking about or even defining discrimination, which is itself a great reason to list them comprehensively. I think my future discussions about what constitutes discrimination will be informed by which above approach will pick up on a given instance.
Every now and then you see a published result that has exactly the right kind of data, in sufficient amounts, to make the required claim. It’s rare but it happens, and as a data lover, when it happens it is tremendously satisfying.
Today I want to share an example of that happening, namely with this paper entitled Regulating Consumer Financial Products: Evidence from Credit Cards (hat tip Suresh Naidu). Here’s the abstract:
We analyze the effectiveness of consumer financial regulation by considering the 2009 Credit Card Accountability Responsibility and Disclosure (CARD) Act in the United States. Using a difference-in-difference research design and a unique panel data set covering over 150 million credit card accounts, we find that regulatory limits on credit card fees reduced overall borrowing costs to consumers by an annualized 1.7% of average daily balances, with a decline of more than 5.5% for consumers with the lowest FICO scores. Consistent with a model of low fee salience and limited market competition, we find no evidence of an offsetting increase in interest charges or reduction in volume of credit. Taken together, we estimate that the CARD Act fee reductions have saved U.S. consumers $12.6 billion per year. We also analyze the CARD Act requirement to disclose the interest savings from paying off balances in 36 months rather than only making minimum payments. We find that this “nudge” increased the number of account holders making the 36-month payment value by 0.5 percentage points.
That’s a big savings for the poorest people. Read the whole paper, it’s great, but first let me show you some awesome data broken down by FICO score bins:
This data, and the results in this paper, fly directly in the face of the myth that if you regulate away predatory fees in one way, they will pop up in another way. That myth is based on the assumption of a competitive market with informed participants. Unfortunately the consumer credit card industry, as well as the small business card industry, is not filled with informed participants. This is a great example of how asymmetric information causes predatory opportunities.
I’m just recovering from a killer flu that had me wheezing and miserable for 5 days. I have a whole backlog of rants and vents but no time this morning to even start, so instead let me suggest you read this article (hat tip Chris Wiggins) about a New York Times reporter who crashed the yearly party of Kappa Beta Phi, a Wall Street secret society. Pretty amazing, if true.
At first glance this seems totally weird, for two reasons. First, debit cards by construction have no ability to go below zero, so they are not directly relevant to the concept of credit, which is by definition when you borrow something and then hopefully pay it back. Second, my first, second, and third intuitive response to credit bureaus is to give them less information, not more. I already think they have way too much data about us. Their recent foray into using social media data is super creepy, for example, and threatens the “no outdated information” rule of the Fair Credit Act, for example.
I watched Orman explain her reasoning about her card, which I believe launched in 2012, and I kind of get her points about why she thinks this is a good idea (even though she clearly has a conflict of interest here): some people have trouble with credit cards, and for that reason they should use debit cards or cash, but cash has no data trail and thus people who are in only cash can never improve their credit scores enough to qualify for things like mortgages and car loans, which they may well be able to handle.
Here’s the thing, though. Her card actually has bad terms, and loads of fees, and it doesn’t look like FICO is actually going to use data from her cards to build peoples’ credit scores after all. Oh well.
Here’s an idea, which is not original at all but hasn’t gotten momentum because it doesn’t make bankers money: instead of shitty and expensive debit cards, let’s have the Post Office open a national bank and let people put money for free on their phones. Systems like this already exist in Kenya (Matt Stoller calls it a “M-Pesa style mobile cash system” in this fine post about the Post Office Bank idea) and in Ghana, and they work great, and let me once again mention there are no fees. It’s a free service as long as you have a cell phone, and it certainly doesn’t have to be a fancy smart phone.
In the short term, such a system will free poor people from getting ever increasingly ripped off by banks and companies with their crappy pre-paid debit cards. It might not give them stellar credit scores, but I’d argue that it’d still be an improvement.
In the asymptotic limit of that system, we’d have a pretty sharp division between people who live in the world of credit, with good FICO scores, and people who deal in cash and mobile cash, with bad or nonexistent FICO scores. It would be hard to get a good mortgage or car loan if you are in the latter group, but that’s already true (unless you count the kind of mortgages Wells Fargo gave to minorities to rip them off).
In the longer term, if we wanted to give credit scores to people who deal in cash, we could use their mobile cash records to deem their spending habits “credit worthy”.
In the much longer term, it would be great if we stopped pretending (I’m looking at you Suze Orman) that having a bad FICO score is a moral failing: it’s really mostly a sign of being broke. If we want to help people get out of debt spirals, then let’s talk about a Basic Guaranteed Income.
Crossposted on the Alt Banking blog, the below reflects a discussion at Alt Banking from last Sunday’s meeting.
People have been making a big fuss about JP Morgan Chase CEO Jamie Dimon’s recent raise. They seem to think that, what with all the lawsuits that JP Morgan Chase has been involved in this past year, exposing so much fraudulent behavior which directly contributed to so much human suffering, the guy should be somewhat humbled and punished. They even wanna question his right to stock options he shoulda had way back in 2008, when the world was on fire. The nerve!
I mean, maybe by some definition of “earned” he doesn’t deserve those 20 sticks. Maybe they think they have better plans for the bonus money. But from where I sit, the guy should have gotten way more, considering he set the price of fraud by big banks so low and in so many different ways.
I estimate that he should have gotten at least $100 million, using a very basic fact that the regulatory arbitrage which he displayed, and which now exists as a precedent for all bankers for the rest of eternity, benefitted not just him, not just JP Morgan Chase, but all the Too-Big-To-Fail banks. For that reason, every TBTF bank should give him at least $20 million as a reward for their future profitable fraudulent earnings. Since there are at least 5 TBTF banks, I’m just scaling up in a super reasonable way.
I know that might sound weird, for Bank of America and Goldman Sachs, which are generally speaking competitors to JP Morgan, to give Jamie Dimon cash money. And they might want to keep it on the DL for that matter, for the sake of appearances.
But after all, this is the guy who called Attorney General Eric Holder on the phone and negotiated a settlement, for christ’s sake! Who DOES that? That’s really above and beyond the chutzpah of even the most criminal of masterminds. Only the creamiest of the crop, only the most devoted of banker psychopaths can get away with that shit. That is to say, Jamie Dimon, and maybe Lloyd Blankfein (Dear Lloyd: I don’t doubt for a minute that you will have your day too, very soon, and then all the big boys will pitch in for your supersized bonus).
So what are you waiting for, Citigroup? Wells? When are you guys ponying up what we all know Dimon deserves from all of the elite institutions protected from prosecution? I say you guys perform the equivalent of a kowtow in Wall Street terms, which is of course monetized, in the form of a check. Send it on over.
Come to think of it we should also offer extra cash to HSBC’s legal team, and for that matter Eric Holder himself. If it hasn’t already been done.
A couple of days ago I was listening to a recorded webinar on K-12 student data privacy. I found out about it through an education blog I sometimes read called deutsch29, where the blog writer was complaining about “data chearleaders” on a panel and how important issues are sure to be ignored if everyone on a panel is on the same, pro-data and pro-privatization side.
Well as it turns out deutsch29 was almost correct. Most of the panelists were super bland and pro-data collection by private companies. But the first panelist named Joel Reidenberg, from Fordham Law School, reported on the state of data sharing in this country, the state of the law, and the gulf between the two.
I will come back to his report in another post, because it’s super fascinating, and in fact I’d love to interview that guy for my book.
One thing I wanted to mention was the high-level discussion that took place in the webinar on what regulation is for. Specifically, the following important question was asked:
Does every parent have to become a data expert in order to protect their children’s data?
The answer was different depending on who answered it, of course, but one answer that resonated with me was that that’s what regulation is for, it exists so that parents can rely on regulation to protect their children’s privacy, just as we expect HIPAA to protect the integrity of our medical data.
I started to like this definition – or attribute, if you will – of regulation, and I wondered how it relates to other kinds of regulation, like in finance, as well as how it would work if you’re arguing with people who hate all regulation.
First of all, I think that the financial industry has figured out how to make things so goddamn complicated that nobody can figure out how to regulate anything well. Moreover, they’ve somehow, at least so far, also been able to insist things need to be this complicated. So even if regulation were meant to allow people to interact with the financial system and at the same time “not be experts,” it’s clearly not wholly working. But what I like about it anyway is the emphasis on this issue of complexity and expertise. It took me a long time to figure out how big a problem that is in finance, but with this definition it goes right to the heart of the issue.
Second, as for the people who argue for de-regulation, I think it helps there too. Most of the time they act like everyone is a omniscient free agent who spends all their time becoming expert on everything. And if that were true, then it’s possible that regulation wouldn’t be needed (although transparency is key too). The point is that we live in a world where most people have no clue about the issues of data privacy, never mind when it’s being shielded by ridiculous and possibly illegal contracts behind their kids’ public school system.
Finally, in terms of the potential for protecting kids’ data: here the private companies like InBloom and others are way ahead of regulators, but it’s not because of complexity on the issues so much as the fact that regulators haven’t caught up with technology. At least that’s my optimistic feeling about it. I really think this stuff is solvable in the short term, and considering it involves kids, I think it will have bipartisan support. Plus the education benefits of collecting all this data have not been proven at all, nor do they really require such shitty privacy standards even if they do work.