Guest essay by Michael R. Smith, C.C.M.
Forbes, “Absolute Return” column, April 21, 2008, page 246:
Here’s another name you should own, Freddie Mac ($29 per share)…Freddie is cheap at 1.1 times book [value].
Less than five months later, Freddie Mac’s stock was worth 25¢ per share, a loss of 99%. It has since recovered to 70¢ per share, so the loss is “only” 97.6%.
A forecast of a stock of a single company five months into the future seems easy. The company had government backing (federally sponsored corporation). What could go wrong?
Yet, the forecast published by Forbes, short of an outright bankruptcy, could not have been more inaccurate. It is worth examining how a situation that seemed rock solid (government-backed securities!) became catastrophic to see if there are any lessons that might apply to the atmospheric sciences.
The assumptions that Freddie Mac (and other financial stocks) were low risk was primarily a result of computer models. As one expert stated (using pseudonym at http://blogs.zdnet.com/Murphy/?p=1265 ),
The problem is inherently complex – imagine being asked to value a portfolio of 10,000 residential mortgages issued to a total of something like 17,652 individuals. Each mortgage balances some issue amount against some payment stream; each has had zero or more payments recorded against it, each has an initial interest rate; an interest computation method; zero or more early payment opportunities; some mention of late or missed payment penalties and conditions, and an expiry, renegotiation, or call date.
While I do not doubt that is “complex,” the level of complexity is miniscule when compared to the complexity of the earth-atmosphere-ocean system and their interactions. Yet, faith in these model valuations led to a prediction that Freddie Mac stock was “cheap” when a meltdown of the financial system, largely due to the incorrect valuations and risk estimates by computer models, was less than 180 days away.
After the meltdown occurred, a second Forbes article stated, “All existing models for calculating risk, he [Nassim Taleb] says, should be thrown out because they underestimate extreme price swings. ‘The track record of economists in predicting events is monstrously bad,’ he says.” (February 2, 2009, p. 21) Of course, we learn this after our home values and values of our 401K’s are wrecked.
Given the failure of these models to predict the implosion six months hence, would you invest the remainder of your 401K on what the same model predicts for the next six years or, if you are in your 20’s, what it predicts for sixty? I don’t know what your answer might be, but common sense would indicate applying the forecasts from these models to your portfolio with extreme caution.
June 1, 2009, we learned from The New York Times that “Models’ Projections for Flu Miss Mark by Wide Margin.” The model predicted, according to the Times, “by the end of May, there would only be 2,000 to 2,500 cases in the United States… On May 15, the Centers for Disease Control and Prevention estimated there were upwards of 100,000 cases in the country…”
Just six months earlier, the models’ predictive capability were touted because of real time input from Google (www.cidrap.umn.edu/cidrap/content/influenza/panflu/news/nov1308google-jw.html ). Now, the flu has been declared a “Pandemic” by the World Health Organization (/www.pandemicflu.gov/ ) in spite of the modest number of cases projected to be in existence by June, 2009, by the models. Another critical short-term modeling failure.
Question: If the model predicts low risk for the next six months, would you decide to forego a flu shot? Again, your answer might be different, but common sense would dictate getting the shot.
How do these examples relate to climate modeling and policy?
We currently have climate models that have missed the fact that atmospheric temperatures peaked 11 years ago and that oceanic heat content has, at best, failed to increase. See: http://climatesci.org/2009/03/04/large-uncertainty-in-the-simulation-of-the-global-average-surface-temperature-by-the-ipcc-models-a-study-reported-on-the-weblog-the-blackboard/ , http://climatesci.org/2009/02/09/update-on-a-comparison-of-upper-ocean-heat-content-changes-with-the-giss-model-predictions/ , among many others.
Given the inadequate performance of these models over the last 5 to 10 years, why do we believe we can make accurate, highly specific forecasts 50 to 100 years in the future? Is it because we are so close to the problem we are blinded to the dangers like the economists who did not see the meltdown coming?
Almost no one familiar with meteorology or climate models would disagree that they are more complex than the mortgage valuation or influenza prediction models. The basic processes of the earth-ocean-atmosphere are incompletely understood and we barely understand many of their interactions.
We also know that forecasting the weather beyond five days is dicey at best. Then why are we making 29,000-day weather forecasts? Don’t think we are doing that? Consider the following:
“By the period 2080-2099, devastating heat waves of the kind that killed more than 700 people in Chicago in 1995 will occur three times per year.” (USCCP, p. 119, citation below)
That is a weather forecast – a forecast of specific meteorological conditions at a specific time and place. The document is filled with similar predictions, along with recommendations based on those predictions.
We are sometimes told that climate forecasts can be made because the “weather” errors will be cancelled out because they are “random.” Here is what was said about the mortgage computer models,
Now, because you can predict roughly the probable range for most of these assumptions but not the actual values the variables involved will have for each of the time periods you have to consider, what you do is write a monte carlo simulation in which you try tens of thousands of value combinations and plot the results to see what, on average expectations, the portfolio might be worth.
Notice, that at this point even something as large as 0.0005% error in the outcome would be completely insignificant – so randomization error should have no effect, right? (op. sit.)
It was believed by most the mortgage instruments were safe because the errors (i.e., a higher default rate of subprime lenders) would cancel out (because the risks were spread) and because, if desired, default insurance could be purchased from institutions like AIG. Of course, AIG used similar models to determine its risk. We just learned how well that worked.
In spite of these spectacular failures of less complex computer modeling in economics and public health, the atmospheric sciences seem to be making similar miscalculations. If your common sense would lead you to disregard these models’ forecasts when planning your portfolio and whether you get a flu shot, I would suggest we adopt a much more modest approach to the use of climate models. While they are useful research tools, the numerous uncertainties (cloud feedback, particulates, volcanic ash, the current quiet sun, etc.) are so great we cannot claim to have forecast skill decades into the future.
Otherwise, when I read, during a period of falling temperatures and ocean heat content,“Global warming is unequivocal,”* I hear, “Freddie Mac is cheap.”
- U.S. Climate Change Program, Key Finding #1, January, 2009, http://downloads.climatescience.gov/sap/usp/prd2/usp-prd-executive-summary.pdf
Michael R. Smith is CEO of WeatherData Services, Inc., An AccuWeather Company, and a Fellow of the American Meteorological Society. This weblog represents his personal opinion. AccuWeather’s Global Warming Blog can be accessed at: http://global-warming.accuweather.com/ .
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Thanks, Michael.
Its a good analogy with the financial systems. In the finance world we know ALL the physics, and ALL the maths. We know the actors involved and we know the range of possible actions. Yet we still get it totally wrong.
We can make similar parallels with the Kyoto / Copenhagen ideas. The idea that we can have a world committee that will stop the world’s climate from ever changing for the rest of time. Why not start off with a much simpler project like world peace ?
Predicting is hard. But some have more foresight than others. Trouble is, you never know who is making the best prediction until after the fact. And since they tend to be “flexible” predictions are always far removed from testable hypotheses. And given the obvious tendency of prophets to fail, it is puzzling that so many believe them…
O/T. Space site has sunspots 12 but says on picture caption that sun is blank i.e.: spotless. What’s up with that?
Every model that works, works until it doesn’t. What separates the working models from the failed models is the range of conditions that went in to building it and the understanding of the relationships among the contributors. Any chaos-rich system, be it climate, finance, organization or health, can be properly modeled only by those who approach their topic with extreme humility. Truth is not only stranger than fiction, it is far stranger than recent history.
Because so much data became available with the advent of satellite measurements in 1979, near the end of the mid-century cooling trend that had climatology students like me writing papers on the coming ice age, I believe that many modelers have put too much credence into the available rich satellite data instead of the existing but less-available contemporary accounts of temperature from non-satellite sources. The only things that started in 1979 (besides maybe Rickie Lee Jones “Chuck E’s in Love”) were satellite measurements of temperature and ice extent. How many references do we read to “Highest Ever” (temperature) or “Lowest Ever” (ice extent) as if history began with the new data?
Financial models fail when the real world behaves in ways that are beyond what the model anticipated. Massive mortgage defaults were never allowed for in the financial system. What has not been allowed for in GCMs?
I predict that, at the end of their lives, everyone will die. Beyond that, everything about the future is speculative wishing and hoping, whether arrived at via séance or supercomputer (though the séance is cheaper).
Don’t forget we have all ready run out of natural resources (Club of Rome). The Kuwaiti oil fires from Desert Storm will prove Nuclear Winter models are correct. Soviet style Marxist economies are superior to capitalism and will never fail. And so it goes…
Well, to be fair, the models were assuming “normal” market conditions. What we had was a system greatly skewed by government manipulation. How would climate models hold up in the face of some sort of intentional manipulation by human beings?
In the financial markets where had a situation where Congress mandated that Freddie Mac and Fannie Mae have at least 50% of their loans with the “underprivileged”. This forced them into a situation where they were forcing the loan originators into absolute lunacy in order to get the quotas met. Washington Mutual, for example, with their “Power Of YES” program had given up even doing income verification. If you could walk into the branch, you got a loan. It eventually became almost a sort of ponzi scheme where bringing all these people into the housing market inflated demand for housing which inflated prices. As prices rose, the resulting equity in the loans acted to lessen the “risk” in the models because what was a 100% “no down payment, interest only” loan now had 15% or 20% equity.
Then things REALLY started going stupid. They started giving “reverse amortization” loans. These are where you not only don’t pay anything on the principal of the loan, you don’t even pay all the due interest. The idea being that appreciation equity would outpace the growth in the balance due to accumulated unpaid equity. So you get a 6% loan but pay only 4% interest with the other 2% going onto the loan balance. As long as the property appreciated at greater than 2% a year, everybody wins. AND they were betting on property values increasing forever. And thanks to the Sarbanes/Oxley “mark to market” requirements, when values went up on a new home sale, the lenders could mark up the value of ALL their loans in that market. But that turned out to be a double-edged sword.
Then two things happened. First they reached the bottom of the barrel. There were fewer and fewer people to give loans to. Everyone that wanted one had one. Then interest rates went up. When rates went up, adjustable mortgages adjusted up. Marginal borrowers began to default. Foreclosures appeared on the market selling for bargain prices. Now because of Sarbanes/Oxley, when a house sold at below market, they had to mark DOWN all their investments in that market. That forced them to have to come up with more reserves meaning take the money they would otherwise lend out and hold it in the vault as reserves against defaults. They were holding minimum reserves because a guy named Geithner at the New York Federal Reserve ruled that since the values of the underlying assets were increasing, they could consider the loans practically “riskless” as long as they carried default insurance. AIG was selling the default insurance. They were insuring “riskless” loans and collecting a monthly premium for it. A giant cash cow.
Now once property values began to defauly, AIG had to pony up the “default insurance”. Declining median prices forced the lenders to mark down all the assets in these markets, stop lending, and build up reserves. Now that the loans were no longer “riskless” and no longer had any appreciation equity (and likely “under water”) AIG’s reserve requirements for premium insurance went through the roof. That program when from a cash cow to a cash sponge practically overnight. There wasn’t enough capital in the markets to provide AIG with what it would need. So the whole string of dominoes collapsed.
But the real tragedy is that the people who created that whole mess are now in charge of cleaning it up and so far they have done so by shoveling money at the problem.
I don’t think we have so many positive feedbacks in the climate going unmodeled as we had in the financial markets. TARP was supposed to be a circuit breaker by buying up the toxic assets easing reserve and insurance requirements but so far not a dime of TARP money has been used to buy up those toxic assets it was billed as being for. Instead it has quite literally gone into the reserves of the lenders, pockets of supporters and used to leverage out executives who are not cronies.
This collapse was brought to you by government manipulation of the markets. They were warned in 2005 and in 2007 that this exact scenario was coming. YouTube has video of Maxine Waters and Barney Frank saying that those warnings were figments of the imagination of their political opposition.
Expect the same thing to happen when government starts trying to manipulate climate.
OK, this is a good summary of Mr Smith’s opinion. But, it is a waste of bandwidth when it is a personal opinion.
As a Fellow of the Amer Met Soc, what is Mr. Smith doing about getting an official pronouncement from the Society about this?
Or at the very least, getting any official statements from the Society about AGW withdrawn.
observer (20:41:02) :
O/T. Space site has sunspots 12 but says on picture caption that sun is blank i.e.: spotless. What’s up with that?
Sunspot group 11020 had a quickie display; looks to be gone now. Even that group’s earlier spots were hard to see from SOHO. Though SWPC listed an event as being observed Friday, their report made no mention of it. See:
http://www.swpc.noaa.gov/forecast.html
Fany Mae, Freddy Mac, Managed on the basis of State Directives, selling mortgages to those who could not afford them and those who speculated with real estate, triggering the real estate crises that turned into the financial crises and now into a depression.
How much more State meddeling can we afford?
After this debacle the State is burning money at a rate never seen in history.
How can people who grab for power with a track reord of mismanagement make responsible policies in regard to our climate and our economy?
Although they state otherwise….they can’t!
The bigger the Government, the bigger the ambitions, the higher the taxes,
the bigger the mess.
Five?? That’s being pretty generous.
On May 15, the Centers for Disease Control and Prevention estimated there were upwards of 100,000 cases in the country…”
As of yesterday, June 12, the CDC was reporting 17,855 known cases in the United States.
http://www.cdc.gov/h1n1flu/update.htm
The World Health Organization reports 29669 cases world wide but are reporting only 13,217 cases for the United States, substantially under-reporting, but this is probably due to lag-time for the reports getting into the system.
http://www.who.int/csr/don/2009_06_12/en/index.html
I haven’t looked to see what the projection on likely unreported cases is, but the confirmed cases are substantially under the number suggested in this post. It would be nice to see documentation of provenance for these figures.
Here is something to truly ponder…
Randomness is a measure of ignorance.
Your argument is flawed in its basic premise; you are using logic and reason. It’s like bringing a knife to a gun fight. Your opponents are politicians of every stripe that smell tax money to be made from AWG and greens, environmentalists and other anarchists who won’t be satisfied until we are all living in mud huts. Neither use logic or reason and it’s senseless to combat directly them that way.
We live in the era of “the short attention span”; be thankful for it. Ideas that took decades or centuries of thought to digest in the past now pass through the body public in a few months to a few years. AWG is well on its way past the peak of the curve and is starting its downward slide on the backside.
Your opponents used fear and uncertainty to push their cause; emotion is a far more powerful weapon than reason. What offended me was twisting science into becoming their handmaiden; science was the last pure and unpoliticized respected authority and it was whored-out into buttressing the unsupportable pro AWG viewpoint. Particularly vile was the parade of 10,000 scientists thing as if science depended on consensus.
The first sign-post of trouble in the AWG camp was the assertion “the science on this subject is settled” comment. In effect, that statement said no further arguments would be brooked. It struck me as being hysterically defensive and uncharacteristic of an assured and defensible belief. It was then that the tide turned.
The public does have a short attention span. Its focus is helped by the current economic downturn to concentrate on the essentials instead of esoteric matters better afforded when times are good. Secondarily, the growing weight of recent experience helps as well; summers are cooler and winters are colder than before. They have been for a decade. Everyone notices that and throws this practical experience against the arguments to the contrary.
My guess is the AWG fad has passed its zenith. Watch out for the politicians though, they will be the last to give it up once they have gotten the scent of money.
Mariss
I just noticed the following Google Ad showing up under this article:
Ads by Google
SALE – The Great Warming
with Keanu Reeves and Alanis Morissette – only $9.95
http://www.thegreatwarming.com
How many hits on that do you think they’ll get from WUWT readers? LOL.
Liberals don’t understand that the financial crisis was created by REGULATION as Crosspatch explained above. It was the stupid fools that regulated and forced these idiotic loans upon our society. Fannie Mac and Freedie Mae demanded that loans be made that would never have been made in a Free Market, but they had to be. Very similar to the thousands of windmills being constructed, every single one of them mostly with government money. The government makes it a riskless investment mandating that our old fashion electrical companies buy their erratic, intermittent, undependable power that is mostly produced at the wrong time of the day and the wrong season of the year. Then the electrical companies get on the teet, they workforce actually grows to handle this intermittentcy, they charge more and become more powerful and realize playing along has its’ benefit. Of course, all along being led and pushed by the wide-eyed speculators who will stop at nothing to take our civilization down. The graduation party goes on downstairs, what kind of world will these young adults try to make their way in? On with 80% less energy based on some computer theory? No instead, they will just PAY PAY PAY.
Leon Brozyna (21:02:28) :
I predict that, at the end of their lives, everyone will die. Beyond that, everything about the future is speculative wishing and hoping, whether arrived at via séance or supercomputer (though the séance is cheaper).
You wrong… I’m eternal… 🙂
Seriously, I don’t know why the WHO dictated that flu is now a pandemic. Flu is everywhere each year! The difference is that statistics are now of public domain when, before this scare wide campaign, the NHID was sharing information only with members.
Esperanto estas mirinda lingvo uzis de milionoj da homoj.
The article does not mention Long Term Capital Management, a computer driven hedge fund (based on the ideas of two of its directors who shared a Nobel prize) that went bust.
Scientific and engineering models may be have more forecasting ability than economic models because economic and financial future events depend on human action, and people do not always react the same way. Some of us know some history and we don’t repeat the mistakes of the past…we make our own mistakes.
Crosspatch….models do not assume normal conditions…economic models assume that there are relationships between variables and time lags which are true. The model then blows up when the relationship is not true. And I generally agree with the rest of your post.
Take a look at this site which shows actual unemployment vs the council of economic advisers forecast with and without the stimulus as a current example of model gone wrong.
http://michaelscomments.files.wordpress.com/2009/06/stimulus-vs-unemployment-may-corrected.gif
Lets get back to environmental management. Engineers traditionally use a factor of safety ( also known as the factor of ignorance ) to cover for all possible uncertainty in their calculations, the actual operating conditions, the quality of constrction materials, etc. As the knowledge base expands and the uncertainty is reduced, the factor of safety is correspondingly adjusted. While the trend has been to smaller factor of safety, it is not unusual for the factor of safety to increase with increasing risk.
But lets face it, while environmental management would like to project an image of being scientifically based the real stimulus is really by politicians meeting frequently in international conventions, meeting of parties, UN meetings etc. At the end of those meetings a result has to be provided to the public often called a declaration, minister’s statement, etc. As each politician goes to the meeting with their own national interest first and foremost, it is really difficult to come up with a specific agreement so the declarations often ends with vague and high sounding sales slogan. The factor of safety is replaced by vague words like ” precautionary principle”. Dont worry about trying to establish some range of factor of safety –if the potential impacts is hgh enough then act. In other words — the expected value is the prduct of zero and infinity. So in climate change, the proponent of AGW is harping at the infinity term or near infinity with the other party looking at the near zero probability.
OT The May Gistemp figures appear out due to a strange reading for May at Amundsen-Scott at the South Pole. See The Blackboard for more discussion. At -51.4C this may average beats the previous low by over 2 degrees C! Perhaps someone had a midnight BBQ party next to the weatehr station!
http://rankexploits.com/musings/2009/giss-temp-rose-to-055c-in-may/comment-page-1/#comment-14530
Alas, there is nothing common about having sense enough to see the obvious when all the rent seekers surrounding you are screaming about the end of the world.
Climate modeling suffers from more than complexity. Lackof accurate boundary conditions, insufficient understanding of key variables i.e, air pollution and aerosols and most of all wrongheaded assumption about the existence of positive feedback. There are plenty of arguments against existence of positive feedback, the workof Drs. Lindzen and Spencer, paleoclimatic data and the fact that any system controlled by positive feedback is inherently unstable.
There are only two things there that support positive feedback.
One, the rather childish assumption that increasing temperature will result in more atmospheric water vapor concentration and increased greenhouse effect. Implied in this assumption that the water vapor will just stay there and will not move, precipitate aor contribute to cloud formation.
Secondly, the much more solid knowledge that without assumption of positive feedback, the whole edifice of global warming will come crashing down leaving its proponents without a government grant to support their lifestyle.
crosspatch (21:11:17) :
Expect the same thing to happen when government starts trying to manipulate climate.
————-
Remember this one from the G-8 global warming deal. Oh how we laughed:
“Merkel and Blair also suggested a target of keeping global temperature increases to less than 2 degrees Celsius by 2050, which is not part of the deal.”
I remember it like it was yesterday but it was, in fact, June 8th, 2007. I had visions of some great big German climate contraption with, of course, stainless steel dials and knobs, and blue, make that green, lights. Of course, the climate temperature setting would be a dial about three feet in diameter, with the temperature settings in big white letters around it, and the photo op would be Angela turning the dial to whatever temperature the very important Committee had decided was to be the global setting.
The real scary thing though is that they actually believed it.
You could make quite an impressive list of these “Government Experts Say” stories.
AIDS, SARS, Avian Influenza and our latest Porcine Bogeyman.
We in the UK are now told that our Swineflu epidemic will now strike in the Autumn, when the educational institutes are full of students (Funny, most are still full now)