Cracking the credit crisis: Is performativity a useful concept?
July 12, 2010
The past two weeks have seen another episode in the new “culture wars” within economic sociology. I’m referring of course to Zuckerman’s attack on performativity for obscurantism, ontological relativism and theoretical weakness. Over the years, attacks on performativity and actor-network theory have turned into a literature on its own (see this, this and that). Here at SocFinance we cannot keep up with such enthusiasm, but welcome the free publicity.
None of the critics, however, has engaged with the latest analysis coming from the performativity camp – MacKenzie’s brilliant work on the credit crisis. The outcome is paradoxical. While the anti-performativists attack the performativists for rejecting “empirical reality,” the leading performativist has been doing actual research in the very real world of the credit crisis. As Don Quijote said, “ladran, Sancho, luego cabalgamos” (They bark, Sancho, which means we are galloping.)
For a more integrative form of academic dialogue, consider the initiative of Bruce Kogut. Last fall he invited economists and sociologists to share their views in a symposium on the risks posed by quantitative finance. More to the point, he took the brave step of inviting MacKenzie to give the keynote speech. The outcome is summarized in a superb conference proceedings paper, and for those who are too busy to read the 73 pages of tight technical prose of the original MacKenzie manuscript, Kogut’s summary is an excellent place to start.
MacKenzie’s analysis is the story of how gaming took over mortgage finance. Mortgage finance took a turn to rocket science with the entry of derivatives traders in the decade of the 2000s. They brought with them the single-factor Gaussian Copula model, the key tool that would eventually be used by rating agencies. But this arrival did not translate into a happy intellectual marriage of experts in mortgages and experts in derivatives. Instead, it led to two what Mackenzie calls different “valuation cultures”: derivatives experts, and mortgage experts. The derivatives experts had the heavy mathematics and the hard data. The mortgage traders, on the other hand, kept to their qualitative methods, and were able to incorporate “soft” information that does not go into the models: whether the mortgage holder is going to retain his or her job, whether he or she has additional loans not on the mortgage documents, or whether the mortgage was obtained at bottom or the peak of the market.
The gap between the two valuation cultures created a profit opportunity. Because the raters only used hard data, issuers were thus able to hit a certain rating with mortgages that were, if the soft information was taken into account, essentially not worth it. Three economists, Rajan, Seru and Vig have recently offered evidence for this:
Using data on securitized subprime loans issued in the period 1997–2006, we demonstrate that as the degree of securitization increases, interest rates on new loans rely increasingly on hard information about borrowers. As a result, statistical default model fitted in a low securitization period breaks down in the high securitization period in a systematic manner: it underpredicts defaults for borrowers for whom soft information is more valuable (i.e., borrowers with low documentation, low FICO scores and high loan-to-value ratios)
Hence the counter-performativity. Introducing the copula model into the rating of derivatives made bad mortgage securities valuable. And this created an incentive for originators to create even more bad mortgages — after all, they could be packaged into securities and into derivatives that looked solid. As MacKenzie put it at the conference, “ABS CDOs [mortgage derivatives] changed ABS (mortgage securities], and ABS changed the mortgage market in ways that undermine the empirical validity of the models”. MacKenzie even provides the conditions for this form of counter performativity to take place. It takes, according to him, systemic (large-scale) adoption and the elimination of diversity.