We hear a lot about "complexity" as a contributing factor to the financial crises. Steven Schwarcz (Duke) pins blame on the complexity of financial products like asset-backed securities.

We need to be precise about what "complexity" means. In a paper (not quite ready for ssrn, but which I'll post in December), I outline three types of complexity for financial products:

1.  Contractual complexity: this form of complexity measures how intricate the contractual terms of a financial product are. For example, how complex are the terms governing subordination and how many tranches of securities are being issued. I don't think contractual complexity poses as big a problem for sophisticated investors.

2.   Derivative complexity: this form of complexity is created by the fact that asset-back securities and derivatives derive their value from underlying assets.  But those underlying assets may in turn derive their value from other assets -- mortgage-backed securities are used to create CDOs which are used to back CDO squareds. Rinse, lather, repeat ad infinitum.

The problem with derivative complexity is that small errors in calculating the risk associated with underlying assets are magnified at each step of the securitization and credit derivative chain. So that a small error in calculating the risk of default on mortgages can translate into huge errors in pricing CDO squareds. The risk of error is magnified when there are unexpected correlations in losses on assets. For a great paper on this topic, see here. The problem is that, given multiple layers of securitization and hedging, it is now extremely difficult for any investor or swap counterparty to identify the ultimate assets that underlay their financial instrument.

Derivative complexity is a huge problem for financial products.

3. Systemic complexity: This form of complexity captures the idea that the value of financial instruments like asset-backed securities depends not just on the value of underlying assets, but the value of substitute financial instruments in the marketplace. These values, in turn, depend on market interest rates and on the trading behavior of multiple financial institutions. As I noted in an earlier post, homogeneity among the trading strategies of many firms can pose serious systemic consequences.

One approach to forms of complexity would be to put regulatory limits on the complexity of financial products. I'm not sure (1) how these regulations would work effectively, (2) if we understand the cost of prohibiting additional risk spreading, and (3) if this is politically feasible.

So I explore alternatives of using technology to help investors - particularly but not exclusively the sophisticated investors who purchase asset-back securities - better understand these forms of complexity.

One proposal is to require that assets going into a securitization have data tags affixed to them to allow investors to trace back and find the ultimate underlying assets that back their securities. This builds off the SEC's XBRL initiative, which requires issuers to affix data tags to their electronic SEC filings to allow investors to download information directly into spreadsheet and other analytic software. Data tagging assets has already been proposed, but I'm not sure if policymakers understand why this is so important.

Technology can also help us improve securities disclosure beyond asset-backed securities.  I also examine whether we can make all securities disclosure more interactive. For example, financial disclosure ranging from Value-at-risk models (which attempt to quantify the financial risk a company faces) to valuations of inventory contain embedded assumptions. Interactive disclosure would allow investors to change assumptions and see how financial numbers would change.

We can also learn quite a bit from software about re-designing the "look and feel" of all electronic disclosure to help investors sort through volumes of disclosure. Consider how much easier computers with icons and drop down menus are (courtesy of the graphic user interface) are now then when we had to type in command prompts into DOS. Redoing the "menu design" of disclosure also builds off ideas from behavior law and economics about structuring the menu of choices available to consumers to improve investor decision-making in the face of cognitive biases.

I've already posted about open source risk models.

This is a work-in-progress and feedback is welcome. For one critique of this paper, see here.

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Now that the kids are asleep, I finished the Sunday Times.  A few questions based on the profile of Bloomberg's expansion:

1. When will Google take on Bloomberg?

2.  When will either take on Lexis and Westlaw?

There was a one sentence hint in the article that Bloomberg is beta testing some web-based product for law firms.  Anybody know what that product looks like?

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is fun. A new search site for the times when you feel non-linear. Or if you just want a visual approach to search. Here's a search of "Gordon":

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The new site is supposed to appear tomorrow, but I still won't visit. It's amazing to me that Yahoo! is the second most popular site on the internet. It is so full of distracting ads and celebrity stories that I can't get anything out of it. Like Kara Swisher, I much prefer the older Yahoo! pages to the modern clutter. The new page seems like a improvement, but at least half of that page is completely worthless to me. I much prefer using multiple tabs to the cramped style of Yahoo! Which is why I also stopped using iGoogle after a very short trial.

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Bing is Microsoft's new search engine. Or so I am told. If you go to the Bing site, you will get a blank page a page announcing that Bing is "coming soon." Very sleek, but not very functional. Microsoft CEO Steve Ballmer "unveiled" Bing today at the WSJ's D: All Things Digital conference, but the site won't be up and running until next week.

If you read tech blogs, you have known for some time that Microsoft was going to use the word Bing as the brand for its new search engine. My parents would think first of Bing Crosby, but I thought of Dave Bing. Still, I suspect Microsoft will have us all associating the word with search before long, even if they can't figure out how to launch the site at the same time as it is unveiled.

By the way, here is the press release from Microsoft, and here is the new logo ...

Screen captures for the site can be found here. I don't see anything revolutionary about Bing, and the new bells and whistles seem redundant or boring. A generous sampling:

• xRank "Lets you quickly see if your favorite celebrity is hot or not."
• Sentiment Extraction "Bing summarizes user and expert reviews from across the Web to help you make an informed decision." 
• Rich Listing Results "Offers a quick snapshot of information relevant to your decision, such as restaurant location, phone number, one-click directions and menu."
• Travel "Shows the best deals on flights and hotel accommodations so you can make informed decisions about your travel arrangements."
• Hotel Rate Key "Uses a color-coded rating system that indicates whether the current rate for a specific hotel appears to be a deal."
• Related Searches "Offers a list of queries that are relevant to your topic; in this case, a search for U2 delivers some of the band’s popular videos in the search results page."
• Health "Bing provides access to medical information on symptoms, diagnosis and medical procedures from nine trusted medical resources."

I find the current version of Google almost always gets me where I want to go. Am I in the minority? Competition for Google is nice, I suppose, but show me something new and interesting I can do with search if you want me to switch.

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Public data. So far, you can retrieve only unemployment rates and populations, but they are promising more in the near future. Like cookie prices. Now that could be useful.

What's Popular? An iGoogle gadget. I have stopped using iGoogle, but if this gadget could be integrated into SSRN or limited to law review articles, that could be cool.

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The founders, Biz Stone and Evan Williams, talked to Maureen Dowd. Clever stuff:

[DOWD]: I would rather be tied up to stakes in the Kalahari Desert, have honey poured over me and red ants eat out my eyes than open a Twitter account. Is there anything you can say to change my mind?

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Jerry Yang is stepping down as Yahoo's CEO. He assumed that role on June 18, 2007, and this is his stock price legacy ...

The big spike at the beginning of February 2008 corresponds to Microsoft's bid for Yahoo. The initial offer: $31 per share. Microsoft eventually raised its bid, but it never came close to the asking price. And Yahoo's has been taking two steps down and one step up since Microsoft walked away.

Now the question everyone is asking: when will Microsoft enter the picture again? The answer seems to be, as soon as Yahoo gets a new CEO.

UPDATE: Yahoo's stock jumped up today, responding favorably to the news of Yang's departure. He has been portrayed as the stumbling block in negotiations with Microsoft, and it appears the market is expecting some sort of move now that Yang is gone. Unfortunately for Yahoo's shareholders, that move, if it comes, will not come close to Microsoft's initial offer. Then again, Microsoft's stock isn't what it was in February, either.

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We spent a good chunk of the summer following Microsoft's attempt to court Yahoo! In the end, Microsoft was driven away, in part because Yahoo! gave its heart to another suitor, Google. Now comes word that Google has dumped Yahoo!, ostensibly because of antitrust problems and complaints from customers.

Google's Chief Legal Officer David Drummond said that abandoning the alliance wasn't "legally necessary" but "the right thing to do because Google and Yahoo have been successful in online advertising and we realized that any cooperation between us would attract attention."

Do you get the feeling that this result is just fine with Google? The proposed deal with Yahoo! staved off an immediate competitive threat from Microsoft and left two wounded and frustrated competitors in the resulting rubble.

Now, if Google actually planned all of this, that would be really impressive.

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Now that I am flush with money again, I have decided to stay in academia, and I have added my name to Academia.edu, a Facebooky-style site recently launched by Richard Price, a Fellow of All Souls College, Oxford. The goal, according to Richard, is to "list every academic in the world," and he is one person closer to that goal as of five minutes ago.

The site already had BYU listed, but I was the first faculty member of the law school to enroll, so I had to create the law school as a department. I also created a few new sub-specialties within law. Having spent only a few minutes on the site, I am not positive that I "get" it completely, but the potential value of the site seems to lie in the "research interests," particularly as those become more specific. I could imagine being introduced to new communities of scholars through a site like this in areas where I am not already writing heavily.

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Have you tried Google's big new competitor yet?  I ran a few searches, and was surprised at the different stuff I got.  Cuil claims it searches a lot more pages than Google, and relies a lot less on popularity (and, as Mike Dorf notes, it's really unclear that the latter thing is a good thing).  I note, however that that Cuil has adopted the idea of the super simple search page.  We like competition at the Glom, and so we wish the best to Cuil and its campaign to find a place next to a corporation that is both smart and a poster child for network effects.  I gather that the backers of Cuil (and Mahalo, and so on), think that those effects ain't nothing but numbers.

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Just like it sounds, this site allows you to enter a website to see whether it's down.

And this part you could have guessed: the founder works for Twitter.

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In Sunday's NYT, an article reported that Time Warner, Comcast and AT&T were all pursuing strategies aimed at curbing so-called bandwidth hogs -- Internet users whose high-volume usage threatens to slow down everyone's Internet experience.  The Internet companies like to frame the problem as a free rider problem -- if everyone pays the same price for unlimited Internet usage, then a few MMORPG enthusiasts who also download movies and video clog up the works for those who just want to check email and get directions.  Users tend to fall into two, disparate camps:  using Internet for checking weather, headlines and email uses less than 5 gigabytes a month.  However, downloading one movie uses 5 gigabytes by itself.  So, it makes sense to charge varying amounts depending on usage, just like electricity, water, long distance, cell phones usage, etc. 

Except that I don't think electricity and telephones are good analogies.  The electric company provides power and also delivers it.  When you pay for the usage of electricity, part of that is for the infrastructure used to deliver it, but also part of your charge is for the actual product:  power.  When you download a movie from Netflix, your internet provider is someone different.  You have a merchant on the one hand and a delivery service on the other.  The burden of that delivery is borne by the internet provider, who has to come up with a way to charge you for it.  The internet provider would really be happy if you didn't download that movie.  (For example, Comcast's strategy is to slow down the Internet for bandwidth hogs, incentivizing less usage.)  But the merchant, Netflix, will not be happy with that result.  So, if internet providers begin charging "by the byte," then the online merchants who want to sell you products that must be delivered via the internet (music, TV, video, news, books) will lose business as the delivery charge rises.  As consumers feel incentivized to ration their own Internet usage, then online providers will feel the pinch.

So, here's my prediction.  Online providers such as Netflix, iTunes and television companies will borrow from one of two models.  One may be "free shipping," a la Amazon and Zappos.  The second may be something like the "toll free number," which allowed consumers to call out-of-town businesses back when long distance was almost prohibitively expensive. 

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If you aren't using Firefox already, the new Firefox 3.0 may make a convert out of you. Take a look at this screencast for a quick tour of new features. I have been using Release Candidate 2 for the past few weeks, and it's great. If you wait for the official release, you may be part of a new world record. But don't wait.

By the way, my favorite Firefox add-on, Foxmarks, is available is beta for Firefox 3.0.

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In writing that last entry, I noticed that TripIt was nominated for a Webby Award.

Take a look around over there, and you will find some interesting sites, including several that I have blogged about here. Mint, the wonderful financial management tool, was nominated. So was epicurious, the recipe site that I use to cook the family meal each Sunday. TED is also a nominee.

I was surprised that I do not read any of the five nominated business blogs. Or any of the law blogs.

But I found a cool Pink Floyd site, a great site for searching airline and hotel fares, and blurb.

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