March 30, 2014

How do we rein in runaway obsessions with data, like that of the Basel Committee?

Sir Tim Harford’s article “Big mistake?”, March 29, is just great.

When Harford mentions that “Google’s own search algorithm moved the goalpost when it began automatically suggesting diagnosis when people entered medical symptoms” he refers to the problem of knowing whether the data one looks at is original or is data which has resulted from the looking.

In other words when acting upon the data one interferes with the data. That is for instance what happened in the case of the Big Basel Committee Mistake.

Regulators looked at credit ratings and decided that when these were excellent, banks needed to hold less capital, and so banks then made higher risk adjusted returns on equity, and so the banks naturally rushed in to increase their holdings of these assets… so much that these assets very fast became very dangerous to the banking system as a whole, as in the case of AAA rated securities and Greece.

That to me was perfectly clear would happen when in January 2003 FT published a letter in which I said: “Everyone knows that, sooner or later, the ratings issued by the credit agencies are just a new breed of systemic error to be propagated at modern speeds. Friend, please consider that the world is tough enough as it is.”

Unfortunately since there is still little data that shows regulators have fully understood the problem, I wonder how Harford or anyone else suggest we reign in the runaway obsessions with data.