How Quadum Could Have Stopped the 2008 Financial Crisis

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Seriously, we would have!

Our generation saw the worst of financial circumstances during the 2008 crisis. If we go back in time and analyse carefully the situation behind the whole drama, we will find it was fuelled by a new class of assets named Collateralised Debt Obligations(CDOs) rated AAA by rating agencies such as Moody’s and S&P.

If we were to summarise 2008 financial crisis, here is how it goes:

Banks found it hard to sell the influx of lower-rated tranches of mortgage-backed securities; to fix this problem, they bundled tranches of many different low-rated securities (a BBB rating or lower) based on home mortgages in many different places. In this way, they were able to get some 75 percent of the resulting collateralised debt obligations(CDOs) rated AAA. It might not sound like much, but this rating made all the difference in the attractiveness of these securities to large investors, since many pension funds and institutional investors are required to invest only in the highest-rated bonds, which rarely default. By elevating bonds based on the riskier tranches to a AAA rating, banks could offer higher-yielding assets to major investors. And since the agencies rated them as safe, investors around the world bought them — big time. The problem was that the three big ratings agencies were paid by the banks selling the bonds. This defied the basic logic and made the whole system susceptible to corruption.

Lured by these AAA ratings, every investor wanted to have a fair share of the CDOs. Everyone from individual investors to pension funds invested huge amounts and eventually, lost all of that.

The 2008 financial disaster was not something that happened overnight but was the result of a 3-decade long timeline of events that began with the issuing of first CDOs in 1987 by bankers at now-defunct Drexel Burnham Lambert Inc. Then, with the launch of Synthetic CDOs in 1997, the problem only got worse.

Joseph Stiglitz, a Nobel Prize winning economist, said, “The rating agencies as one of the key culprits… They were the party that performed the alchemy that converted the securities from F-rated to A-rated. The banks could not have done what they did without the complicity of the rating agencies.”

The catastrophic crisis was predicted by a very few people in the financial world. Infact, Raghuram Rajan, presented a paper titled “Has Financial Development Made the World Riskier?” which mentioned how the financial world is one step away from an impending doom. But, he was laughed out of the room with Alan Greenspan calling him a “Luddite”.

But, 3 years later, Rajan had the last laugh.

But, how would have the situation been like if a crowdsourced model such as Quadum existed in 2008?

A crowdsourced ecosystem such as Quadum which would have had access to data would have revealed the true picture of the market much sooner than the bubble burst. For instance, the mortgages in the CDOs mentioned earlier were given highly inflated ratings of AAA. And it took a market crash to realise that they were heavily fallacious. Quadum, through its crowdsourced data scientist community could have figured out the validity of these false ratings simply by running an algorithm. More importantly, Quadum incentivises people to find these flaws by rewarding them with tokens.

Well, we couldn’t be there in 2008 but we will be there to avoid the next financial crisis. 😄

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