The importance and limitations of models are not well understood in general and certainly financial models in particular. While a lot of time may have been spent discussing these projects they are not “well vetted”.
What is not well understood is how “modeling errors” can cause widespread devastating and brutal consequences.
Background: One of the major causes of the sub-prime mortgage crisis was one modeling assumption. I will spare the reader the technical details. What is critical to understand that at the early stages, when sub-prime loans were first being “bundled” the model actually worked. It was possible to mix sub prime loans with regular mortgage loans and calculate the risk (and the price) of these “bundles” at a rate lower than the price of a stand alone sub-prime mortgage.
With easy profits to be made, at presumed low risk, the number of sub prime loans exploded. By the time the model builders realized that the number one critical assumption was wrong it was too late. In fact, by 2005/6 and certainly by 2007, Risk Officers recommending caution were routinely fired.
The Net Fiscal Model: This is Falls Church’s microscopic version of the above. Its key assumption that the cost structure of the past can be used to project cost into the future turned out to be incorrect. The absence, for example, of a capital cost calculation has led to conclusions that are largely unfounded.
Specifically, many of the “mixed use” projects were approved on a “Special Exemption” basis. The City has zoning codes which delineate the type of building and function that are permitted in a given area in the City. To build residential units in an area solely zoned commercial requires that the benefits of the project are so special that an exemption of the zoning code is needed. Only 4 Council votes are needed to grant a “Special Exemption”.
Underpinning the justification for these exemptions are the results produced by the Net Fiscal Impact Model. We now know the model is inadequate and is now producing unreliable results. The City Manager has tacitly agreed; since then the Model is currently being updated to better reflect the City’s capital needs.
Only uninformed candidates and the Editor of the FCNP would trivialize the importance of this issue by making the issue one of “Optimists” vs. those who are “gloomy”.