Innovation in action: real-world implementation and outcomes

¶ … Computerization

Background and History of Computers in Society

The Computer Revolution

The history of "computing" goes back thousands of years to the ancient Chinese (and other) cultures and their mechanical abacus-like tools for keeping track of large numbers in connection with ancient commerce and trade. By the Middle Ages, maritime merchants navigated the open ocean with the help of mechanical instruments that plotted courses in relation to the stars (Evans, 2004; Kaku, 1997).

Modern computer evolution began in earnest during World War II, in connection with the room-sized vacuum-tube computers developed to help the national effort to produce the atomic bomb that ended the war in 1945 (Kaku, 1997). Those first generations of computers required many thousands of glass vacuum tubes and ticker tape or punch cards and were capable of only a very small number of calculations at a time. Two decades later, computers had replace vacuum tubes with transistor technology that reduced their size and increased their processing power enough to conduct complex calculations and put men into orbit and eventually land on the moon in 1969 (Kaku, 1997).

By today's standards, even those Apollo-era NASA computers were no more powerful than a cheap modern-day electronic wrist watch or calculator (Kaku, 1997). In the 1970s, computers were beginning to be incorporated into the scientific sector and large business organizations, although primarily in the data processing and storage capacity; at that time, only the military pursued the potential of computers for the communications purposes that lead directly to the development of the modern Internet (Kaku, 1997; Larsen, 2007).

Within a few years after the introduction of affordable personal computers in the early 1990s, the Internet (then called, the "World Wide Web") revolutionized professional communications, business management, and personal communications (Evans, 2004). Today, virtually every aspect of modern life involves computers in some form (Kaku, 1997; Larsen, 2007). Undoubtedly, the societal benefits have been so many and so varied that they are almost uncountable. On the other hand, the increased reliance of society on computer technologies also introduces the prospect of an equally wide range and number of potential problems and risks associated with computers.

Benefits of Computerization

The computer revolution has completely revolutionized modern society. It now provides the technological basis of communications technology, modern media, transportation, engineering, biological and physical sciences, information analysis, storage, and retrieval, military and law enforcement operations and capabilities, retail and supply chain management, and education to list just a relatively few general areas (Kaku, 1997).

Risks of Computerization

Another result of the computer revolution is its capacity for potential risks and complications in any application that has become dependent on computer processes. Computer technology can also be exploited for criminal and terrorist purposes, generating something of an "arms race" between various stakeholders such as criminals and terrorists on one side and law enforcement and national security agencies on the other (Larsen, 2007; Mills & Byun, 2006).

The Financial Service Industry

A few years after the introduction and widespread incorporation of computer technology to modern business processes in the early 1970s, applications developed on first Wall Street and later throughout the worldwide financial sector transformed stock market transactions and international banking systems, making them far more complex than they were already. By the mid-1980s, investment and trading firms had given control of their most important transactions to post-graduate physicists and mathematicians who created complicated logarithms and modeling programs incapable of being understood by even the highest levels of professional in finance who ran the largest financial services companies in the world (Bhide, 2009; Nocera, 2009).

The modern-era computer processes allowed 24-hour, round-the-clock financial services programming and stock market trading transactions in tremendously large numbers of simultaneous complex calculations of modern instantaneous intercontinental stock trades. Likewise, computer applications and operational capabilities permitted the development of incredibly complicated commercial transactions that became the backbone of the U.S. investment banking industry in the 1990s (Nocera, 2009). Meanwhile the roughly simultaneous deregulation of the financial services industries during the Clinton administration greatly reduced oversight of various sub-industries, such as the mortgage and loan industry in particular (Lowenstein, 2007). A combination of factors including the development of an artificial private real estate "bubble," consumer behavior, unethical mortgage and loan practices, and the reliance of the financial services market on home values ultimately triggered the collapse of the U.S. economy in 2008 after the bursting of the housing bubble caused the failure of some of the nation's largest and oldest Wall Street firms (Bhide, 2009; Nocera, 2009).

Literature Review

General Benefits and Risks of the Computer Revolution to Modern Society

Michio Kaku is a physicist and a prolific science fiction author. His 1997 work, Visions: How Science Will Revolutionize the 21st Century is a nonfiction science book that traces the history of modern science. Kaku provides extremely detailed predictions of the future stages of human technological progress for the next several decades as well as centuries in the future, based on his understanding of scientific research and technological evolution. In the twelve years since its publication, Dr. Kaku's predictions for the last decade have proven tremendously accurate across a broad range of beneficial technological applications of computer technology in particular.

They Made America (Evans, 2004) is a more detailed historical account of the entire history of science that provides dates and very specific information about every established field of modern science dating back to antiquity. In Our Own Worst Enemy: Asking the Right Questions About Security to Protect You, Your Family, and America (Larsen, 2007), retired U.S. Air Force Colonel and national security expert Randall Larsen of the Harvard School of Government and the U.S. Defense University and Military College explains the many ways that the same computer technology that provides undeniable societal benefits also represent potential for catastrophic circumstances associated with their failure or deliberate sabotage or malicious infiltration.

The Verizon Security Team conducted a comprehensive review of cyber threats to security networks throughout professional business computer networks in 2008 (Baker, Hylender, & Valentine) and published their findings in Verizon Business Data Breach Investigation Report (Baker, Hylender, & Valentine, 2008). That report detailed the tremendous extent to which the security of modern computer networks is routinely compromised by malicious infiltration. Dr. Larsen (2007) details similar information as well as parallel reports of the vulnerability of the nation's most important and sophisticated military and other highly classified computer systems.

The Federal Bureau of Investigations (FBI) publishes the FBI Law Enforcement Bulletin, an unclassified monthly periodical for law enforcement authorities and officers. The lead article in its 2007 issue, "The Social Security Card Application Process: Identity and Credit Card Fraud Issues" (Ballezza, 2007) explains the way that computer technology intended for legitimate commercial transactions has been exploited by organized criminals for the purpose of financial fraud. Similarly, the article "Cybercrimes against Consumers: Could Biometric Technology Be the Solution?" (Mills & Byuns, 2006) that appeared in the Internet Computing Journal, IEEE explains how biometric technology is being developed to counter the continual threat of malicious attacks on Information Technology (IT) systems.

Computerization of Financial Services and the 2008 Economic Crisis

The literature tracing the incorporation of computer technology into modern business operations and commercial transactions includes Dr. Larsen's (2007) account of the complex dependence of modern American society and that of other First-World international societies. A New York Times retrospective analysis of the 2008 economic crisis entitled "Risk Mismanagement: Were the Measures Used to Evaluate Wall

Street Trades Flawed?" (Nocera, 2009), explains the way that the evolution of complex mathematics and computer modeling applications completely transformed the financial services and stock market industries in ways that invited problems and unanticipated risks.

Likewise, a Business Week analysis (Bhide, 2009) entitled "Why Bankers Got So Reckless" outlines the manner in which complex computer applications in Wall Street investment banking firms directly gave rise to the dangerously unstable interrelationship between mortgage lending and commercial transactions in the financial services and futures markets. Maria Bartiromo (2009) of Business Week published an interview with Historian Richard Nixon Smith on the 2008 collapse of major American financial institutions and the government's response entitled "Facetime: 'Historian Richard Norton Smith on Obama and the Economy.'

Time Magazine published "America's No.1 Export" (Fox, 2008), that explained how these changes in modern American business have made extending credit, the resulting debt, the processes of administrating and trading of debt the primary business "industry" in the U.S., substantially replacing the actual production of tangible goods and services. An earlier New York Times article, "Subprime Time: How Did Home Ownership Become So Rickety?" (Lowenstein, 2007). That same year, U.S. News & World

Report published a related article, "Yes, Housing Will Get Worse. But How Bad?" (Markels, 2007).

Illustrative Case Study Discussion -- The U.S. Economic Crisis of 2008

Incorporation of Computers into Modern Business

By the turn of the 21st century, it was no longer only large or complex professional industries and businesses that had completely virtually completely reliant on computer processes. Practically every aspect of modern municipal services, transportation, communications, as well as goods production and retail sales and services rely on computer networks for their routine business operations (Larsen, 2007). Today, even the local gas station and supermarket use computer technology and applications that are much more advanced in their capability than the computer systems used to launch and recover the first generation of spacecraft (Evans, 2004; Kaku, 1997).

Modern computer applications perform calculations and allow analyses of very high volumes of information that far exceed the capacity of direct monitoring by human operators (Larsen, 2007; Nocera, 2009). That is not necessarily inherently problematic; in fact, it is incredibly beneficial in too many ways to count. Today, international manufacturers and shippers can pinpoint the location of goods thousands of miles away in real time; supply chain managers in one office can monitor stock throughout hundreds of retail and wholesale outlets electronically and automatically adjust output and shipping schedules to match their rates of sale at the local level (Evans, 2004; Larsen, 2007). However, the interdependence of modern life in general and of modern business in particular and computer networks combined with some of the indirect results attributable to the evolution of business practices in the name of the profit motive created the potential for a perfect storm-like disaster in the first decade of the new millennium. The Evolution of Complex Problems in the Financial Services Industries

In the 1970s, financial analysts at the historic Wall Street firm Solomon Brothers devised various commercial transactions and related mechanisms that allowed the trading for profit of outstanding debts held by creditors such as the millions of home mortgages in the U.S. (Nocera, 2009). However, the complex nature of those transactions in any large number prevented a wide scale use of the new financial mechanisms that would eventually become the securitized mortgage debts that precipitated the collapse of the Wall Street companies who pioneered their use as computer technology became sophisticated and powerful enough to permit their negotiation for profit (Bhide, 2009; Nocera, 2009).

In principle, what happened in between approximately 1990 and 2007 was that investment banks began purchasing the millions of mortgage debts of private real estate held by banks and other lending institutions. Through incredibly complex computer applications and financial analyses, they had managed to develop ways of, in effect, "chopping up" millions of mortgage debt obligation and recombining them into tradable securities whose value was guaranteed by all of those underlying mortgages (Lowenstein, 2007; Nocera, 2009).

This fundamental change in financial securities allowed investment banks to transform what were previously non-negotiable financial obligations into negotiable instruments that could be used to secure subsequent investments for profit (Bhide, 2009; Nocera, 2009). As was the case with the evolution of greater and greater complexity of computer systems in modern society, the development of negotiable instruments backed by mortgage securities was not necessarily problematic in and of itself without the additional factor of human ingenuity applied in ethically questionable ways.

A Perfect Storm: Computerization, Complexity, Greed, and Unethical Business

One of the unintended consequences of the evolution of mortgage-backed securities in investment banking was that it eliminated the primary mechanism that had maintained the integrity of the real estate market and the mortgage system. Specifically, banks, lending institutions, and mortgage brokers traditionally extended credit to home buyers very carefully and only after a thorough review of the financial qualifications of those prospective lenders to ensure against their default (Bhide, 2009; Lowenstein, 2007). When homeowners default on their mortgages, the mortgage debt holder loses money because their profit is strictly a function of the interest and financing charges they apply to mortgage loans as the price of extending their credit. For this reason, lenders have always been extremely diligent about "vetting" prospective borrowers (Markels, 2007; Lowenstein, 2007).

The introduction of negotiable (tradable) mortgage-backed securities changed that entire relationship, simply because the original lending institutions typically no longer held onto those mortgage debts for more than a few months, weeks, or even days, before they sold the financial obligations that mortgages represent to investment banks (Bhide, 2009; Lowenstein, 2007; Markels, 2007). As a result, the original lenders no longer had any reason or financial incentive to be careful about who their borrowers were (Nocera, 2009).

Unlike the situation where a defaulting debtor costs the lender money, the process that emerged was that lenders could extend mortgage credit to just about anyone without worrying about whether or not the loan would eventually be paid off over decades as agreed or go just into default within several years of being issued. The fact that mortgage lenders could sell those obligations almost as soon as they were created meant the more mortgages they could sell, the more money they would make, and all without any concern about the qualifications of their lenders (Bhide, 2009; Lowenstein, 2007; Markels, 2007).

Mortgage brokers and real estate brokers have traditionally worked on commissions, earning more when they sell more homes. Once the lending institutions stopped caring about who borrowed money from them, mortgage brokers and real estate brokers throughout the country began selling homes much more aggressively, recruiting purchasers with no-interest loan offers (Lowenstein, 2007). In many cases, brokers and real estate agents actually coached prospective lenders exactly how to lie on their loan applications by inflating their income and their net worth to qualify for mortgage loans on homes far beyond their means to pay off. The so-called "no-doc" loan (for "no documentation") became standard practice throughout the industry (Lowenstein, 2007; Markels, 2007).

In fact, the practice became so widespread in the industry that brokers and bankers routinely referred to those transactions as "liar loans" (Bhide, 2009; Markels, 2007). Even worse, many real estate agents and mortgage brokers purposely misrepresented the terms of mortgage loans to unsophisticated borrowers, such as through the variable-rate mortgage. That mechanism is a mortgage obligation that provides an extremely low "introductory" monthly payment very similar to that traditionally used to entice credit card customers to open new credit accounts or transfer balances from one lender's card to another's (Lowenstein, 2007; Markels, 2007). In countless cases, home buyers were presented with extremely low monthly payments based on the variable mortgage rate concept for very expensive properties. After the first year or two of the life of the loan, the payments increased substantially, and often far beyond what the homeowner could afford (Lowenstein, 2007; Markels, 2007).

At the same time, housing prices were steadily increasing across the country. That was because in the process of securing all of these mortgages without any real concern about the loans they represent being repaid, brokers and borrowers were also overstating the appraised value of those properties (Lowenstein, 2007; Markels, 2007). In many cases, borrowers who could not afford their mortgages in the first place began borrowing additional money against the appraised value of those homes (Lowenstein, 2007; Markels, 2007).

As a result, property values continued to rise artificially, prompting ambitious builders to develop more and more homes, especially in areas with high projected growth such as large areas of California, the Southwest, and the Florida Coast. Furthermore, in many of those areas where housing prices were growing the fastest, a consumer pattern of buying homes and then selling or "flipping" them within the period of the introductory mortgage rate sprouted in which thousands of people purchased homes with no intention of actually living in them. They merely held on to them while their value increased and then resold them a year or two later as substantial profit. Many homes doubled or tripled in their appraised value in only a few years, increasing in price with every "flip" (Lowenstein, 2007; Markels, 2007).

Beginning in late 2006 and early 2007, analysts had begun issuing warnings about the possible consequences of this artificially inflated housing market (Lowenstein, 2007; Markels, 2007). Their concern was precisely that the artificial increase in housing prices and the resulting housing boom and "bubble" was not capable of being sustained indefinitely and that the nationwide increase in property development and home building would inevitably lead to an oversupply of homes.

An oversupply in the market would cause home prices to fall in accordance with the traditional economic rules in relation to supply and demand. Eventually, large numbers of homeowners would find themselves stuck with expensive mortgages for homes whose value had fallen far below the amount of their appraisal upon which the mortgage payment rates had been established at the time of the loans (Bartiromo, 2009; Lowenstein, 2007; Markels, 2007).