Too lazy to be knowns January 30, 2012 at 4:15 pm

You will recall the famous (and unfairly derided) Rumsfeld quote:

[T]here are known knowns; there are things we know we know.

We also know there are known unknowns; that is to say we know there are some things we do not know.

But there are also unknown unknowns – there are things we do not know we don’t know.

Until recently, I thought that this was sensible. But musing about what people knew about AAA RMBS, it strikes me that there is another situation: the things that we are too lazy to know.

Let me explain. In 2006, some people – including some people I knew – knew that AAA RMBS were sensitive to house prices. They knew that prices could fall, and that if they did, the securities would drop in value. However, they had not done the analysis to go beyond that, so they didn’t know how sensitive some of these securities were to a drop in house prices (especially one early in their life, before reserve accounts had been built up). In short, the risk of these assets was not a known unknown, nor an unknown unknown, but more of a too-lazy-to-be-known.

This form of ignorance is widespread and important in finance. People are peripherally aware that there is more to be known about a topic, and that that knowledge is somewhat relevant, but they don’t find out. They prioritize, they ignore stuff that’s difficult; whatever. The point is that it isn’t just Knightian uncertainty and risk that can get you: it is the stuff that some people know, but that you have never looked at properly.

8 Responses to “Too lazy to be knowns”

  1. Lots of people who bought that stuff never poked and prodded the underlying collateral. They bought a rating rather than a bond and were elated that the bonds in question were wrapped in a bundle of As.

  2. John – agreed completely. They knew that there was more to know and did not bother finding out.

  3. […] There are knowns, unknowns and stuff you are too lazy to look at properly.  (Deus Ex Macchiato) […]

  4. There are also dubious facts and assertions your bonus depends on accepting.

  5. […] Too lazy to be knowns […]

  6. vbounded, and the regulatory constraints on what you can and cannot buy.

  7. Another issue that goes with this one, though I’m not sure if it supports or undercuts the thesis: When the rating agencies quantitatively modeled the risk of RMBS securities they rated, their models placed a lot of stock in the idea that you could mix together a pool of mortgages from all around the country and lower the risk by a lot because various housing markets would be largely uncorrelated. If one drilled down into the quant models, at some place there would be matrix with mostly zeros away from the main diagonal representing non-correlation. In fact, we know that the housing markets and rates of mortgage default all across the U.S. (and even elsewhere around the globe) were highly correlated – something the rating agency models just assumed was not the case. If they had assumed high correlation from the outset, their models, even ones wrong in other ways, would not have put AAA ratings on those securities.

    Coming back to your theme, the question is “Did the agencies really believe there was no chance that housing markets could be highly correlated or was it a chance they were too lazy to model/investigate?”

  8. I like the fact that the facts known or not are facts none the less that have an unalienable position in influencing the outcomes of the decision makers. To call the omision of thesefacts lazy is realy an attempt to redefine the meaning of the word, negligent. Methinks.