Sunday, April 17, 2011

Analytics and Data Mining: Use, Abuse and Goldman Sachs

As a practitioner I always hope that the benefits of helping my clients to improve their use of analytical technologies will be somehow passed to their customers. Most of the applications of analytics are geared in that direction.  The whole idea of analytics is to enable you to serve your customers better than your competitor, so that you get in return their purchasing loyalty, and a larger share of their wallets.
However, not all users of analytics think that way. Some are only interesting about what they can get out of it, and customers are there to be milked for all its worth.
One such example is Wall Street’s biggest darling: Goldman Sachs.
It has been known that banks like that have been using analytics and data mining heavily. And not necessarily just as a value add to the customer but primarily to support various trading strategies. Analytics are being used to the abundance of market information to figure transaction flows, trends, whether the market will turn bullish or bearish, and to figure out excess returns.  In other words they are using powerful analytical capabilities coupled with super-computing power to game the system.
While it is illegal to trade on insider knowledge about company finances, these people are trading on insider knowledge about market order flow. That’s how Goldman Sachs and the other biggest houses make so much from trading. Economists have a term for that: “rent seeking” which extracts billions from the market without putting anything back. As one blogger points out: difference between usage of analytics between Google and Goldman Sachs is that Google wants to sell you a book you may be interested in, while Goldman uses analytics to take away all the books you ever bought.
So far, this wasn’t bad business for Goldman Sachs. Their profits soared, $2.3 billion in 2008 and $13 billion in 2009. Never mind the fact that financial markets were shaken and one million people lost their homes and other million lost their jobs.
But of late Goldman Sachs has been under increasing pressure from US lawmakers.  According to US senate sub-committee, which produced 639-page report on the financial crisis and Goldman Sachs role in it - one of the recommendations is that Goldman Sachs top executives are referred to the Department of Justice for possible prosecution.
This report provides the evidence that their sales people were selling securities to clients based on very shaky and volatile bonds, that they knew they will blow-up. So, they unloaded it as fast as they could on their clients, while at a same time there were betting on these bonds to fold. Scam!
Rolling Stone contributing editor Matt Taibbi says: Only reason this is controversial and we even asking if GS’s execs should be jailed, is because this is a financial service company, and things are not as obvious if this would be some other industry. If this was a car dealership – for instance – there would be no question”.
Taibbi continues: “Imagine if you are  Ford dealership and you get a full inventory of Ford Broncos that have brake defect and you decide not only to sell them, but also to give bonuses to your sales people who sell these defective products to encourage them to sell more. And then you go out and take life insurance policies on drivers of these cars you have sold to!”
That’s exactly what has happened here.  
And while there is a lot of evidence against Goldman Sachs, proving the criminal intent of its top executives will not be easy.  Add to that some powerful connections in Washington bought through political donations to the both parties and it becomes clear why not single Wall Street executive has been convicted after the recent financial meltdown.
And as for analytics here – well, you can use a screwdriver to fix a lot of things around the house, but you can also use it to take someone’s wallet.  It is just "a thing”, and how will it be used depends of the user's intent.

Goran Dragosavac

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