Zero Hedge has a post suggesting that the US economy will likely lag the world in the coming recovery.
While I agree with their analysis superficially the reality is that next question to be asked is who is going to lead the world out of the recession. Obviously the US's economy is limping, but so to is Europe's. Their banks are equally bloated and they have disjoint fiscal policies, a more rigid labor market is structurally lower growth. China and the Japan are net exporters, not mention Japan's massive debt/GDP and aging population. How can they as exporters lead the world economy when by definition they will need demand to increase ROW for them to export to? And basically that's it. We're bad off but Europe is worse and Asian needs us to export to. I don't see anyway way for the global economy to improve significantly without the US recovering first. I don't think fundamentally our economy should recover anytime soon but the Geithner's PIPP ponzi scheme may work at least as well Greenspan's ZRIP and the can could be kicked a few more years down the road.
Zero Hedge: "CONCLUSIONS
Ok, so we know the US economy is going to be running on fumes and commodities are going to get expensive - so what? Both messages have been tossed off the cuff by numerous talking heads but looking at it analytically and then combining the two leads to a very scary picture of what's in store. More specifically, the lab rats at ZH headquarters are now working on thinking about what price level action is going to look like, and what that implies for us as citizens first and investors second. We want to caution that this is more complicated than it initially seems as the kneejerk reaction to 'commodity price shock' is 'stagflation' - however, it would be short sighted to toss out that old chestnut without taking into account the massive market manipulations and macro shifts we have seen.
As always, we welcome thoughts, comments, feedback, opposing publications. Additionally, any (good) pieces on price action movement/CPI predictions would be greatly appreciated - cornelius@zerohedge.com"
Thursday, May 7, 2009
Sunday, April 26, 2009
Geithner Fucking up Perfectly Good Commercial Realestate Shorts
March 29: Geithner, McCain - Meet the Press, online at MSNBC- msnbc.com
updated 11:58 a.m. ET, Sun., March. 29, 2009
MR. DAVID GREGORY: Our issues this Sunday: Crisis management at the White House.
(Videotape)
PRES. BARACK OBAMA: It took many years and many failures to lead us here, and it will take many months and many different solutions to lead us out.
Story continues below ↓advertisement | your ad here
(End videotape)
MR. GREGORY: At the height of a global recession, the administration unveils a detailed plan to shore up the country's financial system and get the banks lending again.
(Videotape)
SEC'Y TIMOTHY GEITHNER: To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game.
(End videotape)
MR. GREGORY: With us this morning, in his first live Sunday morning interview, the man at the helm of the administration's efforts to combat the recession and save the banking system, the secretary of the Treasury, Timothy Geithner.
Then, a leading Republican voice in the Senate, the GOP's presidential candidate in 2008 and their ranking member of the Senate Armed Services Committee, Senator John McCain of Arizona. What does President Obama's former opponent think of the bank rescue plan and the president's new strategy in Afghanistan? We'll ask him in an exclusive interview. Geithner and McCain, only on MEET THE PRESS.
But first, here live is Treasury Secretary Timothy Geithner.
Welcome to MEET THE PRESS.
SEC'Y GEITHNER: Thank you, David. Good to be here.
MR. GREGORY: Thank you. I want to start with some basic terms here. Can you explain as simply as you can why increasing bank lending is so important to the economy?
SEC'Y GEITHNER: Absolutely, David. Economies require banks because they require credit. Credit is like the blood, it's like the oxygen of any economy. And for us to get the economy growing again, we need to make sure there's going to be credit available to businesses and families across the country so that businesses can meet payroll, so that they can expand, so that families can put their kids through college, can borrow to finance purchase of a car or a new house. That's, that's why financial systems matter, and there is now way to get this economy back on track unless we have a financial system that's working with the recovery rather than against recovery.
MR. GREGORY: My mother out in California, I presume, is watching this morning. She's like a lot of Americans, worried about her job and wondering why not just bank lending, but something called nonbank lending, securitization--what is that, and why does that matter to her?
SEC'Y GEITHNER: We, we came through a period where people borrowed too much and we let our financial system take on much too much risk. And the consequences of those choices, made over years, were--was a huge boom. And that boom--the air is now coming out of that, and that's causing enormous damage. And financial crises are, are brutally indiscriminate in the pain they--and suffering they cause. The burden falls not just on people who took too much risk, but on people who were careful and responsible in their business. That's why it's so unfair. That's why Americans are so frustrated and angry And that's why it's so important that your government act very aggressively to help contain the damage.
MR. GREGORY: But I want to go back to what--I want to understand the terms here. What is securitization, and why does that matter?
SEC'Y GEITHNER: In our system we have banks--community banks, large banks, small banks--that provide credit to businesses and families. But in our markets we also have these securitization markets where--which, which match investors directly with borrowers through the capital markets. We need both those to work. Both are not doing enough now. They're not working, doing the kind of job they need to do to get credit going again. And so to fix this mess we're in, the mess we inherited, need to make sure banks are strong enough...
MR. GREGORY: Right.
SEC'Y GEITHNER: ...but we also need to make sure these credit markets are working again.
MR. GREGORY: And let me--on that point, on the nonbank lending, the securitization market is where actually most of the lending goes on right now. Is that right?
SEC'Y GEITHNER: Well, well, typically in, in our financial system, somewhat less than half of lending for businesses and consumers comes from those markets. So we need to get those markets going again just as we need to fix our banking system. And the programs we put in place are already having some effect in helping unfreeze those markets. So just as an example, last week the Fed announced--the Fed put in place a program with the Treasury, very powerful program that led to about $9 billion in new issuance of automobile loans and credit card loans. That was more than you saw in the past four months combined.
MR. GREGORY: Mm-hmm.
SEC'Y GEITHNER: That will help bring down interest rates and, again, make it easier for people to get access to the credit they need to get through this.
MR. GREGORY: All right, we've defined our terms a little bit, now let's talk about the big news this week, your plan to help save the banks. The bank stabilization plan. We've come up with an example here and we'll role-play a little bit, because I think this is the easiest way to explain this. So here's how a transaction would work. Bank USA, we're calling it, has a loan, a toxic asset, and it's valued on their books for $100 million. And it's for sale, right? So there's going to be an auction here and investors like me could come in, and I'm going to come in and I've got--my highest bid is for $70 million, OK? That's the price for the $100 million loan that I'm actually going to pay. Now, here's how the transaction actually works, right? I'm the investor, I put in $5 million. You, the Treasury Department--you're really the taxpayer--put in $5 million, and then the government in the form of the FDIC is going to provide 60 million at very good terms, going to guarantee that loan. So the government's on a hook for a lot of this. That's called leverage, right? How does it work and what's the upside?
SEC'Y GEITHNER: David, let me just step back for one second. Part of what's, what's causing this problem in our financial system is banks made a bunch of bad loans, many of them backed by real estate; residential, commercial real estate. Those loans are now sitting on the books of the financial system and they're taking up room, preventing banks from extending new credit on the scale they need. And we have two choices in this context. We can leave it as it is, hope banks will earn their way out of this process over time, and I am certain that will create the risk of a deeper, longer recession. Again, the classic lesson in financial crises, if governments wait to act, they wait too late and that means more damage to the economy, higher deficit in the future, greater cost to the taxpayer. We're not prepared to take that approach.
Another approach many people advocate is that the government itself come in...
MR. GREGORY: Right.
SEC'Y GEITHNER: ...and buy these assets, take on all the risk itself. The government would set a price for the assets and bear all the losses and all the costs in that context. Our judgment is that would be much more expensive for the taxpayer, create much greater risk for the taxpayer, and we're not prepared to take that approach.
MR. GREGORY: And the point in our model, if we can just put that slide up again, where you see investor puts in five million, Treasury puts in five million, the FDIC guarantees it at $60 million in terms of providing the loan. There's upside there. In other words, if the value of that loan goes up, the taxpayer wins, the investor wins.
SEC'Y GEITHNER: Right. The investors are taking risk. Their money is at risk and at stake. They're the ones that set the price for which this transactions will take place. So using their self-interest to get the price better, better than what the government would do in that context.
MR. GREGORY: Right.
SEC'Y GEITHNER: We're using their expertise to help manage these assets. And the--and as you said, the taxpayer will share in the upside. This is a relatively conservative structure. It's not very different from when your family buys a house. It's a more conservative structure than a bank typically operates. But the key thing is it allows the government to work with the private investor to help get through this crisis.
MR. GREGORY: Hm.
SEC'Y GEITHNER: That we don't want the government taking on all the risk and all the losses.
MR. GREGORY: Right.
SEC'Y GEITHNER: We need to work with the private sector to help get this, get this recovery going again.
MR. GREGORY: All right, but here's the key point. The investor presumably is on board because, you know, they stand to gain a lot. The government wants to get all of these toxic assets off the banks' balance sheets. It's been estimated between $1.5 and $3 trillion of bad stuff out there. But will the banks participate? And here's my question based on our example. Hundred million dollar loan, but the auction price is $70 million. Well, if you're the bank and you say, 'Hey, wait a minute. This is really worth $90 million or $80 million. I'm not going to sell that for $70 million and take that loss on my books.' Are you going make them sell?
SEC'Y GEITHNER: Banks already hold reserves against that $100 million. So the gap is not between 100 and 70, for example, it's a narrower gap. Now, banks are going to have an incentive because they want to raise, go raise private capital from the markets. And it's going to be easier for them to do that if they can show their investors a cleaner balance sheet. And that'll help improve the incentive for banks to participate.
MR. GREGORY: But you can't make them sell, can you?
SEC'Y GEITHNER: Well, you can make it compelling and economic for them to sell. And again, if you think about the markets today, if you had to sell your house tomorrow, in a market where no one can get a mortgage, then the price you would get if you sold in that market would be a tiny fraction of its basic value in a more normal. And our markets are not working today. People, in effect, in these securities markets, can't raise financing. And there is a very good case in that context for the government to provide financing on appropriate terms to help provide a market for these assets. And by doing that, we're going to make it more likely that interest rates come down and, and the financial system has the capacity to provide the credit, the oxygen.
MR. GREGORY: Mm-hmm.
SEC'Y GEITHNER: That economies need to grow.
MR. GREGORY: Isn't the government on the hook here for a lot of risk? Isn't there a lot more risk here for the government than there is for that investor?
SEC'Y GEITHNER: David, the choice we face is whether to have the government take on all the risk in solving this, which we don't want to do. So if you compare this to the classic alternative, which is again, the government sits back, hopes the market solves this, which would be much more damaging to the economy, or the government takes on all the risk, buys all the assets itself, makes up a price, would risk overpaying, provide a much greater subsidy, this proposal is a much better approach to solving this problem.
MR. GREGORY: Paul Krugman, Nobel laureate, New York Times columnist, been very critical of this plan. He and others have said this is effectively a transfer of wealth from the banks' balance sheets to the government's balance sheets. A bailout for the banks, trash for cash. You've heard all of these terms. And in fact, Krugman writes in a column last Sunday that your approach is very similar to your predecessor's in the Bush administration, Hank Paulson. This is what he writes. I want to have you respond to it: 'The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks' books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn't be in trouble. And so the plan is to use taxpayer funds to drive the prices of bad assets up to `fair' levels. Mr. Paulson proposed having the government buy the assets directly. Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. ... The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down,' and again, these are all mortgage backed, 'the investors can walk away from their debt. So this isn't really about letting markets work. It's just an indirect, disguised way to subsidize purchases of bad assets.' Respond, please.
updated 11:58 a.m. ET, Sun., March. 29, 2009
MR. DAVID GREGORY: Our issues this Sunday: Crisis management at the White House.
(Videotape)
PRES. BARACK OBAMA: It took many years and many failures to lead us here, and it will take many months and many different solutions to lead us out.
Story continues below ↓advertisement | your ad here
(End videotape)
MR. GREGORY: At the height of a global recession, the administration unveils a detailed plan to shore up the country's financial system and get the banks lending again.
(Videotape)
SEC'Y TIMOTHY GEITHNER: To address this will require comprehensive reform. Not modest repairs at the margin, but new rules of the game.
(End videotape)
MR. GREGORY: With us this morning, in his first live Sunday morning interview, the man at the helm of the administration's efforts to combat the recession and save the banking system, the secretary of the Treasury, Timothy Geithner.
Then, a leading Republican voice in the Senate, the GOP's presidential candidate in 2008 and their ranking member of the Senate Armed Services Committee, Senator John McCain of Arizona. What does President Obama's former opponent think of the bank rescue plan and the president's new strategy in Afghanistan? We'll ask him in an exclusive interview. Geithner and McCain, only on MEET THE PRESS.
But first, here live is Treasury Secretary Timothy Geithner.
Welcome to MEET THE PRESS.
SEC'Y GEITHNER: Thank you, David. Good to be here.
MR. GREGORY: Thank you. I want to start with some basic terms here. Can you explain as simply as you can why increasing bank lending is so important to the economy?
SEC'Y GEITHNER: Absolutely, David. Economies require banks because they require credit. Credit is like the blood, it's like the oxygen of any economy. And for us to get the economy growing again, we need to make sure there's going to be credit available to businesses and families across the country so that businesses can meet payroll, so that they can expand, so that families can put their kids through college, can borrow to finance purchase of a car or a new house. That's, that's why financial systems matter, and there is now way to get this economy back on track unless we have a financial system that's working with the recovery rather than against recovery.
MR. GREGORY: My mother out in California, I presume, is watching this morning. She's like a lot of Americans, worried about her job and wondering why not just bank lending, but something called nonbank lending, securitization--what is that, and why does that matter to her?
SEC'Y GEITHNER: We, we came through a period where people borrowed too much and we let our financial system take on much too much risk. And the consequences of those choices, made over years, were--was a huge boom. And that boom--the air is now coming out of that, and that's causing enormous damage. And financial crises are, are brutally indiscriminate in the pain they--and suffering they cause. The burden falls not just on people who took too much risk, but on people who were careful and responsible in their business. That's why it's so unfair. That's why Americans are so frustrated and angry And that's why it's so important that your government act very aggressively to help contain the damage.
MR. GREGORY: But I want to go back to what--I want to understand the terms here. What is securitization, and why does that matter?
SEC'Y GEITHNER: In our system we have banks--community banks, large banks, small banks--that provide credit to businesses and families. But in our markets we also have these securitization markets where--which, which match investors directly with borrowers through the capital markets. We need both those to work. Both are not doing enough now. They're not working, doing the kind of job they need to do to get credit going again. And so to fix this mess we're in, the mess we inherited, need to make sure banks are strong enough...
MR. GREGORY: Right.
SEC'Y GEITHNER: ...but we also need to make sure these credit markets are working again.
MR. GREGORY: And let me--on that point, on the nonbank lending, the securitization market is where actually most of the lending goes on right now. Is that right?
SEC'Y GEITHNER: Well, well, typically in, in our financial system, somewhat less than half of lending for businesses and consumers comes from those markets. So we need to get those markets going again just as we need to fix our banking system. And the programs we put in place are already having some effect in helping unfreeze those markets. So just as an example, last week the Fed announced--the Fed put in place a program with the Treasury, very powerful program that led to about $9 billion in new issuance of automobile loans and credit card loans. That was more than you saw in the past four months combined.
MR. GREGORY: Mm-hmm.
SEC'Y GEITHNER: That will help bring down interest rates and, again, make it easier for people to get access to the credit they need to get through this.
MR. GREGORY: All right, we've defined our terms a little bit, now let's talk about the big news this week, your plan to help save the banks. The bank stabilization plan. We've come up with an example here and we'll role-play a little bit, because I think this is the easiest way to explain this. So here's how a transaction would work. Bank USA, we're calling it, has a loan, a toxic asset, and it's valued on their books for $100 million. And it's for sale, right? So there's going to be an auction here and investors like me could come in, and I'm going to come in and I've got--my highest bid is for $70 million, OK? That's the price for the $100 million loan that I'm actually going to pay. Now, here's how the transaction actually works, right? I'm the investor, I put in $5 million. You, the Treasury Department--you're really the taxpayer--put in $5 million, and then the government in the form of the FDIC is going to provide 60 million at very good terms, going to guarantee that loan. So the government's on a hook for a lot of this. That's called leverage, right? How does it work and what's the upside?
SEC'Y GEITHNER: David, let me just step back for one second. Part of what's, what's causing this problem in our financial system is banks made a bunch of bad loans, many of them backed by real estate; residential, commercial real estate. Those loans are now sitting on the books of the financial system and they're taking up room, preventing banks from extending new credit on the scale they need. And we have two choices in this context. We can leave it as it is, hope banks will earn their way out of this process over time, and I am certain that will create the risk of a deeper, longer recession. Again, the classic lesson in financial crises, if governments wait to act, they wait too late and that means more damage to the economy, higher deficit in the future, greater cost to the taxpayer. We're not prepared to take that approach.
Another approach many people advocate is that the government itself come in...
MR. GREGORY: Right.
SEC'Y GEITHNER: ...and buy these assets, take on all the risk itself. The government would set a price for the assets and bear all the losses and all the costs in that context. Our judgment is that would be much more expensive for the taxpayer, create much greater risk for the taxpayer, and we're not prepared to take that approach.
MR. GREGORY: And the point in our model, if we can just put that slide up again, where you see investor puts in five million, Treasury puts in five million, the FDIC guarantees it at $60 million in terms of providing the loan. There's upside there. In other words, if the value of that loan goes up, the taxpayer wins, the investor wins.
SEC'Y GEITHNER: Right. The investors are taking risk. Their money is at risk and at stake. They're the ones that set the price for which this transactions will take place. So using their self-interest to get the price better, better than what the government would do in that context.
MR. GREGORY: Right.
SEC'Y GEITHNER: We're using their expertise to help manage these assets. And the--and as you said, the taxpayer will share in the upside. This is a relatively conservative structure. It's not very different from when your family buys a house. It's a more conservative structure than a bank typically operates. But the key thing is it allows the government to work with the private investor to help get through this crisis.
MR. GREGORY: Hm.
SEC'Y GEITHNER: That we don't want the government taking on all the risk and all the losses.
MR. GREGORY: Right.
SEC'Y GEITHNER: We need to work with the private sector to help get this, get this recovery going again.
MR. GREGORY: All right, but here's the key point. The investor presumably is on board because, you know, they stand to gain a lot. The government wants to get all of these toxic assets off the banks' balance sheets. It's been estimated between $1.5 and $3 trillion of bad stuff out there. But will the banks participate? And here's my question based on our example. Hundred million dollar loan, but the auction price is $70 million. Well, if you're the bank and you say, 'Hey, wait a minute. This is really worth $90 million or $80 million. I'm not going to sell that for $70 million and take that loss on my books.' Are you going make them sell?
SEC'Y GEITHNER: Banks already hold reserves against that $100 million. So the gap is not between 100 and 70, for example, it's a narrower gap. Now, banks are going to have an incentive because they want to raise, go raise private capital from the markets. And it's going to be easier for them to do that if they can show their investors a cleaner balance sheet. And that'll help improve the incentive for banks to participate.
MR. GREGORY: But you can't make them sell, can you?
SEC'Y GEITHNER: Well, you can make it compelling and economic for them to sell. And again, if you think about the markets today, if you had to sell your house tomorrow, in a market where no one can get a mortgage, then the price you would get if you sold in that market would be a tiny fraction of its basic value in a more normal. And our markets are not working today. People, in effect, in these securities markets, can't raise financing. And there is a very good case in that context for the government to provide financing on appropriate terms to help provide a market for these assets. And by doing that, we're going to make it more likely that interest rates come down and, and the financial system has the capacity to provide the credit, the oxygen.
MR. GREGORY: Mm-hmm.
SEC'Y GEITHNER: That economies need to grow.
MR. GREGORY: Isn't the government on the hook here for a lot of risk? Isn't there a lot more risk here for the government than there is for that investor?
SEC'Y GEITHNER: David, the choice we face is whether to have the government take on all the risk in solving this, which we don't want to do. So if you compare this to the classic alternative, which is again, the government sits back, hopes the market solves this, which would be much more damaging to the economy, or the government takes on all the risk, buys all the assets itself, makes up a price, would risk overpaying, provide a much greater subsidy, this proposal is a much better approach to solving this problem.
MR. GREGORY: Paul Krugman, Nobel laureate, New York Times columnist, been very critical of this plan. He and others have said this is effectively a transfer of wealth from the banks' balance sheets to the government's balance sheets. A bailout for the banks, trash for cash. You've heard all of these terms. And in fact, Krugman writes in a column last Sunday that your approach is very similar to your predecessor's in the Bush administration, Hank Paulson. This is what he writes. I want to have you respond to it: 'The common element to the Paulson and Geithner plans is the insistence that the bad assets on banks' books are really worth much, much more than anyone is currently willing to pay for them. In fact, their true value is so high that if they were properly priced, banks wouldn't be in trouble. And so the plan is to use taxpayer funds to drive the prices of bad assets up to `fair' levels. Mr. Paulson proposed having the government buy the assets directly. Mr. Geithner instead proposes a complicated scheme in which the government lends money to private investors, who then use the money to buy the stuff. ... The Geithner scheme would offer a one-way bet: if asset values go up, the investors profit, but if they go down,' and again, these are all mortgage backed, 'the investors can walk away from their debt. So this isn't really about letting markets work. It's just an indirect, disguised way to subsidize purchases of bad assets.' Respond, please.
Sunday, April 19, 2009
interview: Hayek on Statistics & Macroeconomic Explanation
Via Taking Hayek Seriously
interview: Hayek on Statistics & Macroeconomic Explanation: "This post was written by Greg Ransom on April 19, 2009
Posted Under: Biography, Explanation, Probability Theory, Statistics
Below I’ve posted a conversation between Friedrich Hayek and Leo Rosen from 1978 in which Hayek presents some of his conclusions about the relationships between statistics, probability theory, and macroeconomic explanation.
Note well when reading the following that Friedrich Hayek’s first job as an economist had Hayek up to his eyeballs in the collection and statistical analysis of economic data. And ditto Hayek’s second job as lead economist for the Austrian Institute of Trade Cycle Research. So statistics analysis and economic data collection were a central part of Hayek’s early life as a working economist.
ROSTEN: Dr. Hayek, I’m interested in your impressions of the empirical work that was being done by American economists. When you came here, it must have struck you rather forcibly — the stuff that was being done at the National Bureau, stuff on business cycles, in which I think you were interested at one point.
HAYEK: Well, I got interested by my visit to the United States. You see, when I came here as a young man in ‘23, I found they had nothing here to learn in economic theory. The American economic theorists had a great reputation at that time, but by the time I arrived, the few who were surviving were old men. And current teaching wasn’treally interesting from a theoretical point of view. I was actually attached to New York University, but I gate-crashed into Columbia [University] . Then I was working in the New York Public Library on the same table with Willard Thorp and other people from the National Bureau. I was drawn into that circle, and I learned a great deal about descriptive statistical work; in fact, I owe part of my later career to the fact that I learned the technique of time-series analysis at that time and was the only person in Austria who knew it. So I became director of that new institute of business-cycle research.
ROSTEN: This was in Vienna?
HAYEK: That was in Vienna, yes. Information about current affairs is very valuable; the expectation that you will learn much for the explanation of events is largely deceptive. You cannot build a theory on the basis of statistical information, because it’s not aggregates and averages which operate upon each other, but individual actions. And you cannot use statistics to explain the extremely complex structures of society. So while I will use statistics as information about current events, I think their scientific value is rather much more limited than the American economists of the last thirty or forty years have believed.
ROSTEN: I’ve left you at one point. If you say that the description of aggregates and the uses of statistics don’t help you much to explain things, and if you say that they help with contemporary events, they cease to be con- temporary very soon.
HAYEK: Oh, yes.
ROSTEN: You have built up a body of data: now, how important are those data?
HAYEK: Well, they give you an indication of what has probably happened in society during the last six months, [laughter].
ROSTEN: Do you see any more optimistic possibility for the application of statistics?
HAYEK: Not really, in economics. Demography, yes. In all fields we have to deal with true mass phenomena, but economics has not to deal with mass phenomena in the strict sense. You know where you have a sufficiently large number of events to apply the theory of probability, and proper statistics begins where you have to deal with probabilities .
ROSTEN: Well, all the sciences begin with that amassing of what might seem to be formless data. Would you tell us a little more about why you think this is not true in economics? Do you really think that most of economics takes place in discrete, isolated events, decisions, judgments?
HAYEK: Well, this leads very deeply into methodological issues; but the model of science — physical science, in the original form–has relatively simple phenomena, where you can explain what you observe as functions of two or three variables only. All the traditional laws of mechanics can be formulated as functions of two or three variables. Now, there is another extreme field, mass phenomena proper, where you know you cannot get the information on the particular events, but you can substitute probabilities for them. But there is, unfortunately, an intermediate [type of] event, where you have to deal with complex phenomena, which, on the one hand, are so complex that you cannot ascertain all the individual events, but, [on the other] , are not sufficiently mass phenomena to be able to substitute probabilities for information on the individual events. In that field I’m afraid we are very limited.
We can build up beautiful theories which would explain everything, if we could fit into the blanks of the formulae the specific information; but we never have all the specific information. Therefore, all we can explain is what I like to call “pattern prediction.” You can predict what sort of pattern will form itself, but the specific manifestation of it depends on the number of specific data, which you can never completely ascertain. Therefore, in that intermediate field — intermediate between the fields where you can ascertain all the data and the fields where you can substitute probabilities for the data–you are very limited in your predictive capacities.
This really leads to the fact, as one of my students once told me, that nearly everything I say about the methodology of economics amounts to a limitation of the possible knowledge. It’s true; I admit it. I have come to the conclusion that we’re in that field which someone has called organized complexity, as distinct from disorganized complexity.
ROSTEN: Warren Weaver.
HAYEK: Yes, exactly. Warren Weaver spoke about this. Our capacity of prediction in a scientific sense is very seriously limited. We must put up with this. We can only understand the principle on which things operate, but these explanations of the principle, as I sometimes call them, do not enable us to make specific predictions on what will happen tomorrow.
I was just listening to the wireless here, where people were speaking about the inevitable depression. Oh, yes, I also know a depression will come, but whether in six months or three years I haven’t the slightest idea. I don’t think anybody has. [laughter]
ROSTEN: Yes, life is a terminal disease. [laughter] But could you give me some examples of questions to which you — I mean about economics, or in economics — questions to which you would like answers, or to which you do not have any satisfactory –
HAYEK : Oh, any price movement of the future. I have no way of predicting them. Well, that’s exaggerating. There are instances where you can form a shrewd idea of what’s likely to happen, but in that case, of course, the price movements which you anticipate, which you expect, are already anticipated in current prices, and they are no longer true. The only interesting things are the unforeseen price movements, and they, by definition, you cannot foresee. [laughter]
ROSTEN : You were expressing your respect for Frank Knight, and once he said with great exasperation that the difference between the physical sciences and the social sciences is that in the physical sciences they don’t care what you say about them, but in the social sciences you affect the subject matter by talking about it. Now, to the degree to which people in government think they can affect economic policy, whether fine-tuning, to use that old phrase, or large-scale changes, by either changes in money supply or attempts to influence credit or so on, do you feel that we know enough to be able to make any of that kind of prediction plausible?
HAYEK: I’m sure not. I don’t think all this fine-tuning — Well, you see, that really comes back to my basic approach to economics: economic mechanism is a process of adaptation to widely dispersed knowledge, which nobody can possess as a whole. And this process of adaptation to knowledge, which people currently acquire in the course of events, must produce results which are unpredictable. The whole economic process is a process of adaption to unforeseen changes which, in a sense, is self-evident, because we could never have planned how we would arrange things once and for all and could just go on with our original plans.
ROSTEN: You mean, if those who knew, really knew, and acted upon what they knew. Are you saying that the social sciences, particularly economics, as an example, are much more complicated than the physical sciences?
HAYEK: Well, not the sciences; it’s the subject that’s much more complicated, simply in the sense that any [economic] theory would have a larger number of data to insert than any physical theory. As I said a moment ago, all the formulae of mechanics have only two or three variables in them. Of course, in real life you can use this to explain an extremely complex phenomenon, but the
underlying theory is of a very simple character. With us, you can’t have a theory of perfect competition without at least having a few hundred participants. And you would have to be informed about all their knowledge in order to arrive at a specific prediction. The very definition of our subject is that it’s built up of a great many distinct units, and it wouldn’t be a subject of that order if the elements weren’t so numerous. You cannot form a theory of competition with only three elements in it.
ROSTEN: You could certainly have a theory.
HAYEK: Well, it would be wrong, because it wouldn’t be competition with only three acting persons in it.
ROSTEN: Well, just explain that. What about four?
HAYEK: No, I don’t think it’s the approach. But you have to have a number where it’s impossible for any one of them to predict the action of the others, and there must be a sufficient number of others for the one to be unable to predict it.
ROSTEN: You say that’s in the order of a hundred, or hundreds, or thousands, and so on.
HAYEK: Yes.
ROSTEN: It’s a startling theory, and I’ve not heard it put quite this way.
HAYEK: But, you know, the whole market is due to the fact that people are aiming at satisfying needs of people whom they do not know, and use for their purposes facilities provided by people of whom they also have no information. It’s a coordination of activities where the individual can, of necessity, be only a small part of it — any individual, not only the participating individuals but even any outsider. The mistaken conception comes from a very curious use of the term data. The economists speak about data, but they never make clear to whom these data are given. They are so unhappy about it that occasionally they speak even in a pleonasm about “given data,” just to reassure themselves that [the data] are really given. But if you ask them to whom they are given, they have no answer. [laughter]
ROSTEN: You mean “revealed”?
HAYEK: They are fictitiously assumed to be given to the explaining theorists. If the data were such and such, then this would follow. But of course the data are not really given either to them or to any one other single person, They are the widely dispersed knowledge of hundreds of thousands of people, which can in no way be unified; so the data are never data.
ROSTEN: It’s almost as if you were talking about nuclear physics and the difficulty, or impossibility, of talking about an atom and how it’s going to behave.
HAYEK: Yes. It’s a different argument. You see, in nuclear physics, up to a point, you can substitute information about individual elements by probability calculations. There the numbers are big enough for the law of large numbers to operate. In economics they are not. They are too big to know them individually and not big enough to be described by probability calculations.
ROSTEN: Do you think that this is a permanent and unbreakable prison?
HAYEK: Yes. I don’t think we can ever get beyond that.
ROSTEN: –because earlier you had said something about the processes of proof and the fact that you couldn’t prove anything. And I was reminded of the work, of which I know very little and which I know you know a great deal about, of Caddel, at Princeton [University].
HAYEK: Yes.
ROSTEN: — on the terrible, to me tragic, built-in trap that he has discovered in the uses of logic, and in what
you earlier had talked about as the uses of reason.
HAYEK: You see, I became aware of all this not by my work in economics but–I don’t know whether you know that I once wrote a book on psychology.
ROSTEN: No, I did not know.
HAYEK: On physiological psychology–a book called The Sensory Order –in which I make an attempt to provide at least a schema for explaining how physiological processes can generate this enormous variety of qualities which our senses represent. [The schema is] called “the sensory order.” [The book] ends up with the proof that while we can give an explanation of the principle on which it operates, we cannot possibly give an explanation of detail, because our brain is, as it were, an apparatus of classifi cation. And every apparatus of classification must be more complex than what it classifies; so it can never classify itself. It’s impossible for a human brain to explain itself in detail …
.. [Work on The Sensory Order] taught me a great deal on the methodology of science, apart from the special subject. What I later wrote on the subject, the theory of complex phenomena, is equally the product of my work in economics and my work in psychology.
ROSTEN: And you had not then been working in statistics.
HAYEK: No, although I’ve nearly all my life had the title of Professor of Economics and Statistics, I’ve never really done any statistical work. I did do practical statistics as the chief of that Austrian Institute of Trade Cycle Research …
ROSTEN: The work that you started on business cycles, I assume, was not unlike the work later done by [Simon] Kuznets and his group at the institute.
HAYEK: Well, again, you see, it was an abstract schema without much empirical work. I had some very elementary data boom there was an excessive development of production of capital goods, much of which afterwards turned out to be mistaken. And I didn’t need many more facts for my purpose to develop a theory which fits this, and which exclusively shows us, [using] other accepted data, that a credit expansion temporarily allows investment to exceed current savings, and that it would lead to the overdevelopment of capital industries. Once you are no longer able to finance a further increase of investment by credit expansion, the thing must break down. It becomes more complicated in conditions when the credit expansion is no longer done for investment by private industry but very largely by government. Then you have to modify the argument, and our present booms and depressions are no longer explicable by my simple scheme.
But the typical nineteenth- and early- twentieth-century [phenomena], I think, are still adequately explained by my theory — but not adequately to the statisticians, because, again, all I can explain is that a certain pattern will appear. I cannot specify how the pattern will look in particular, because that would require much more information than anyone has. So, again, I limit the possible achievement of economics to the explanation of a type – One of my friends has explained it as a purely algebraic theory.
ROSTEN: An algebraic theory?
HAYEK: Yes, you get an algebraic formula without the constants being put in. Just as you have a formula for, say, a hyperbola; if you haven’t got the constants set in, you don’t know what the shape of the hyperbola is — all you know is it’s a hyperbola. So I can say it will be a certain type of pattern, but what specific quantitative dimensions it will have, I cannot predict, because for that I would have to have more information than anybody actually has."
interview: Hayek on Statistics & Macroeconomic Explanation: "This post was written by Greg Ransom on April 19, 2009
Posted Under: Biography, Explanation, Probability Theory, Statistics
Below I’ve posted a conversation between Friedrich Hayek and Leo Rosen from 1978 in which Hayek presents some of his conclusions about the relationships between statistics, probability theory, and macroeconomic explanation.
Note well when reading the following that Friedrich Hayek’s first job as an economist had Hayek up to his eyeballs in the collection and statistical analysis of economic data. And ditto Hayek’s second job as lead economist for the Austrian Institute of Trade Cycle Research. So statistics analysis and economic data collection were a central part of Hayek’s early life as a working economist.
ROSTEN: Dr. Hayek, I’m interested in your impressions of the empirical work that was being done by American economists. When you came here, it must have struck you rather forcibly — the stuff that was being done at the National Bureau, stuff on business cycles, in which I think you were interested at one point.
HAYEK: Well, I got interested by my visit to the United States. You see, when I came here as a young man in ‘23, I found they had nothing here to learn in economic theory. The American economic theorists had a great reputation at that time, but by the time I arrived, the few who were surviving were old men. And current teaching wasn’treally interesting from a theoretical point of view. I was actually attached to New York University, but I gate-crashed into Columbia [University] . Then I was working in the New York Public Library on the same table with Willard Thorp and other people from the National Bureau. I was drawn into that circle, and I learned a great deal about descriptive statistical work; in fact, I owe part of my later career to the fact that I learned the technique of time-series analysis at that time and was the only person in Austria who knew it. So I became director of that new institute of business-cycle research.
ROSTEN: This was in Vienna?
HAYEK: That was in Vienna, yes. Information about current affairs is very valuable; the expectation that you will learn much for the explanation of events is largely deceptive. You cannot build a theory on the basis of statistical information, because it’s not aggregates and averages which operate upon each other, but individual actions. And you cannot use statistics to explain the extremely complex structures of society. So while I will use statistics as information about current events, I think their scientific value is rather much more limited than the American economists of the last thirty or forty years have believed.
ROSTEN: I’ve left you at one point. If you say that the description of aggregates and the uses of statistics don’t help you much to explain things, and if you say that they help with contemporary events, they cease to be con- temporary very soon.
HAYEK: Oh, yes.
ROSTEN: You have built up a body of data: now, how important are those data?
HAYEK: Well, they give you an indication of what has probably happened in society during the last six months, [laughter].
ROSTEN: Do you see any more optimistic possibility for the application of statistics?
HAYEK: Not really, in economics. Demography, yes. In all fields we have to deal with true mass phenomena, but economics has not to deal with mass phenomena in the strict sense. You know where you have a sufficiently large number of events to apply the theory of probability, and proper statistics begins where you have to deal with probabilities .
ROSTEN: Well, all the sciences begin with that amassing of what might seem to be formless data. Would you tell us a little more about why you think this is not true in economics? Do you really think that most of economics takes place in discrete, isolated events, decisions, judgments?
HAYEK: Well, this leads very deeply into methodological issues; but the model of science — physical science, in the original form–has relatively simple phenomena, where you can explain what you observe as functions of two or three variables only. All the traditional laws of mechanics can be formulated as functions of two or three variables. Now, there is another extreme field, mass phenomena proper, where you know you cannot get the information on the particular events, but you can substitute probabilities for them. But there is, unfortunately, an intermediate [type of] event, where you have to deal with complex phenomena, which, on the one hand, are so complex that you cannot ascertain all the individual events, but, [on the other] , are not sufficiently mass phenomena to be able to substitute probabilities for information on the individual events. In that field I’m afraid we are very limited.
We can build up beautiful theories which would explain everything, if we could fit into the blanks of the formulae the specific information; but we never have all the specific information. Therefore, all we can explain is what I like to call “pattern prediction.” You can predict what sort of pattern will form itself, but the specific manifestation of it depends on the number of specific data, which you can never completely ascertain. Therefore, in that intermediate field — intermediate between the fields where you can ascertain all the data and the fields where you can substitute probabilities for the data–you are very limited in your predictive capacities.
This really leads to the fact, as one of my students once told me, that nearly everything I say about the methodology of economics amounts to a limitation of the possible knowledge. It’s true; I admit it. I have come to the conclusion that we’re in that field which someone has called organized complexity, as distinct from disorganized complexity.
ROSTEN: Warren Weaver.
HAYEK: Yes, exactly. Warren Weaver spoke about this. Our capacity of prediction in a scientific sense is very seriously limited. We must put up with this. We can only understand the principle on which things operate, but these explanations of the principle, as I sometimes call them, do not enable us to make specific predictions on what will happen tomorrow.
I was just listening to the wireless here, where people were speaking about the inevitable depression. Oh, yes, I also know a depression will come, but whether in six months or three years I haven’t the slightest idea. I don’t think anybody has. [laughter]
ROSTEN: Yes, life is a terminal disease. [laughter] But could you give me some examples of questions to which you — I mean about economics, or in economics — questions to which you would like answers, or to which you do not have any satisfactory –
HAYEK : Oh, any price movement of the future. I have no way of predicting them. Well, that’s exaggerating. There are instances where you can form a shrewd idea of what’s likely to happen, but in that case, of course, the price movements which you anticipate, which you expect, are already anticipated in current prices, and they are no longer true. The only interesting things are the unforeseen price movements, and they, by definition, you cannot foresee. [laughter]
ROSTEN : You were expressing your respect for Frank Knight, and once he said with great exasperation that the difference between the physical sciences and the social sciences is that in the physical sciences they don’t care what you say about them, but in the social sciences you affect the subject matter by talking about it. Now, to the degree to which people in government think they can affect economic policy, whether fine-tuning, to use that old phrase, or large-scale changes, by either changes in money supply or attempts to influence credit or so on, do you feel that we know enough to be able to make any of that kind of prediction plausible?
HAYEK: I’m sure not. I don’t think all this fine-tuning — Well, you see, that really comes back to my basic approach to economics: economic mechanism is a process of adaptation to widely dispersed knowledge, which nobody can possess as a whole. And this process of adaptation to knowledge, which people currently acquire in the course of events, must produce results which are unpredictable. The whole economic process is a process of adaption to unforeseen changes which, in a sense, is self-evident, because we could never have planned how we would arrange things once and for all and could just go on with our original plans.
ROSTEN: You mean, if those who knew, really knew, and acted upon what they knew. Are you saying that the social sciences, particularly economics, as an example, are much more complicated than the physical sciences?
HAYEK: Well, not the sciences; it’s the subject that’s much more complicated, simply in the sense that any [economic] theory would have a larger number of data to insert than any physical theory. As I said a moment ago, all the formulae of mechanics have only two or three variables in them. Of course, in real life you can use this to explain an extremely complex phenomenon, but the
underlying theory is of a very simple character. With us, you can’t have a theory of perfect competition without at least having a few hundred participants. And you would have to be informed about all their knowledge in order to arrive at a specific prediction. The very definition of our subject is that it’s built up of a great many distinct units, and it wouldn’t be a subject of that order if the elements weren’t so numerous. You cannot form a theory of competition with only three elements in it.
ROSTEN: You could certainly have a theory.
HAYEK: Well, it would be wrong, because it wouldn’t be competition with only three acting persons in it.
ROSTEN: Well, just explain that. What about four?
HAYEK: No, I don’t think it’s the approach. But you have to have a number where it’s impossible for any one of them to predict the action of the others, and there must be a sufficient number of others for the one to be unable to predict it.
ROSTEN: You say that’s in the order of a hundred, or hundreds, or thousands, and so on.
HAYEK: Yes.
ROSTEN: It’s a startling theory, and I’ve not heard it put quite this way.
HAYEK: But, you know, the whole market is due to the fact that people are aiming at satisfying needs of people whom they do not know, and use for their purposes facilities provided by people of whom they also have no information. It’s a coordination of activities where the individual can, of necessity, be only a small part of it — any individual, not only the participating individuals but even any outsider. The mistaken conception comes from a very curious use of the term data. The economists speak about data, but they never make clear to whom these data are given. They are so unhappy about it that occasionally they speak even in a pleonasm about “given data,” just to reassure themselves that [the data] are really given. But if you ask them to whom they are given, they have no answer. [laughter]
ROSTEN: You mean “revealed”?
HAYEK: They are fictitiously assumed to be given to the explaining theorists. If the data were such and such, then this would follow. But of course the data are not really given either to them or to any one other single person, They are the widely dispersed knowledge of hundreds of thousands of people, which can in no way be unified; so the data are never data.
ROSTEN: It’s almost as if you were talking about nuclear physics and the difficulty, or impossibility, of talking about an atom and how it’s going to behave.
HAYEK: Yes. It’s a different argument. You see, in nuclear physics, up to a point, you can substitute information about individual elements by probability calculations. There the numbers are big enough for the law of large numbers to operate. In economics they are not. They are too big to know them individually and not big enough to be described by probability calculations.
ROSTEN: Do you think that this is a permanent and unbreakable prison?
HAYEK: Yes. I don’t think we can ever get beyond that.
ROSTEN: –because earlier you had said something about the processes of proof and the fact that you couldn’t prove anything. And I was reminded of the work, of which I know very little and which I know you know a great deal about, of Caddel, at Princeton [University].
HAYEK: Yes.
ROSTEN: — on the terrible, to me tragic, built-in trap that he has discovered in the uses of logic, and in what
you earlier had talked about as the uses of reason.
HAYEK: You see, I became aware of all this not by my work in economics but–I don’t know whether you know that I once wrote a book on psychology.
ROSTEN: No, I did not know.
HAYEK: On physiological psychology–a book called The Sensory Order –in which I make an attempt to provide at least a schema for explaining how physiological processes can generate this enormous variety of qualities which our senses represent. [The schema is] called “the sensory order.” [The book] ends up with the proof that while we can give an explanation of the principle on which it operates, we cannot possibly give an explanation of detail, because our brain is, as it were, an apparatus of classifi cation. And every apparatus of classification must be more complex than what it classifies; so it can never classify itself. It’s impossible for a human brain to explain itself in detail …
.. [Work on The Sensory Order] taught me a great deal on the methodology of science, apart from the special subject. What I later wrote on the subject, the theory of complex phenomena, is equally the product of my work in economics and my work in psychology.
ROSTEN: And you had not then been working in statistics.
HAYEK: No, although I’ve nearly all my life had the title of Professor of Economics and Statistics, I’ve never really done any statistical work. I did do practical statistics as the chief of that Austrian Institute of Trade Cycle Research …
ROSTEN: The work that you started on business cycles, I assume, was not unlike the work later done by [Simon] Kuznets and his group at the institute.
HAYEK: Well, again, you see, it was an abstract schema without much empirical work. I had some very elementary data boom there was an excessive development of production of capital goods, much of which afterwards turned out to be mistaken. And I didn’t need many more facts for my purpose to develop a theory which fits this, and which exclusively shows us, [using] other accepted data, that a credit expansion temporarily allows investment to exceed current savings, and that it would lead to the overdevelopment of capital industries. Once you are no longer able to finance a further increase of investment by credit expansion, the thing must break down. It becomes more complicated in conditions when the credit expansion is no longer done for investment by private industry but very largely by government. Then you have to modify the argument, and our present booms and depressions are no longer explicable by my simple scheme.
But the typical nineteenth- and early- twentieth-century [phenomena], I think, are still adequately explained by my theory — but not adequately to the statisticians, because, again, all I can explain is that a certain pattern will appear. I cannot specify how the pattern will look in particular, because that would require much more information than anyone has. So, again, I limit the possible achievement of economics to the explanation of a type – One of my friends has explained it as a purely algebraic theory.
ROSTEN: An algebraic theory?
HAYEK: Yes, you get an algebraic formula without the constants being put in. Just as you have a formula for, say, a hyperbola; if you haven’t got the constants set in, you don’t know what the shape of the hyperbola is — all you know is it’s a hyperbola. So I can say it will be a certain type of pattern, but what specific quantitative dimensions it will have, I cannot predict, because for that I would have to have more information than anybody actually has."
Sunday, February 1, 2009
Everything anyone ever needed to know about trading
Rudyard Kipling
If
If you can keep your head when all about you
Are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or, being lied about, don't deal in lies,
Or, being hated, don't give way to hating,
And yet don't look too good, nor talk too wise;
If you can dream - and not make dreams your master;
If you can think - and not make thoughts your aim;
If you can meet with triumph and disaster
And treat those two impostors just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to broken,
And stoop and build 'em up with wornout tools;
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on";
If you can talk with crowds and keep your virtue,
Or walk with kings - nor lose the common touch;
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds' worth of distance run -
Yours is the Earth and everything that's in it,
And - which is more - you'll be a Man my son!
If
If you can keep your head when all about you
Are losing theirs and blaming it on you;
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
Or, being lied about, don't deal in lies,
Or, being hated, don't give way to hating,
And yet don't look too good, nor talk too wise;
If you can dream - and not make dreams your master;
If you can think - and not make thoughts your aim;
If you can meet with triumph and disaster
And treat those two impostors just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to broken,
And stoop and build 'em up with wornout tools;
If you can make one heap of all your winnings
And risk it on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on";
If you can talk with crowds and keep your virtue,
Or walk with kings - nor lose the common touch;
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much;
If you can fill the unforgiving minute
With sixty seconds' worth of distance run -
Yours is the Earth and everything that's in it,
And - which is more - you'll be a Man my son!
Economy so bad divorce market is drying up
Divorce Gets Harder as Recession Ends Jobs, Cuts Asset Values
By Patricia Hurtado and Laurel Brubaker Calkins
Jan. 23 (Bloomberg) -- Irene Georgakis, a housewife in Queens, New York, thought she’d hit bottom on Valentine’s Day 2007 when she learned her husband of 24 years had a girlfriend, a discovery that led to her filing for divorce.
Then the economy nosedived, and things got worse. Georgakis, 54, said her husband, George, 64, owner of five New-York-based companies, is balking at paying support and using the recession to claim poverty after making millions during their marriage.
“He’s the ultimate stonewaller,” Georgakis said in an interview. “It’s galling.”
The Georgakises are among couples in broken marriages fighting the economy in addition to each other as they try to divvy up assets from homes to artworks that have plunged in value. Couples bent on splitting estates have had to redo the math when asset values proved less than they had counted on to split up.
By Patricia Hurtado and Laurel Brubaker Calkins
Jan. 23 (Bloomberg) -- Irene Georgakis, a housewife in Queens, New York, thought she’d hit bottom on Valentine’s Day 2007 when she learned her husband of 24 years had a girlfriend, a discovery that led to her filing for divorce.
Then the economy nosedived, and things got worse. Georgakis, 54, said her husband, George, 64, owner of five New-York-based companies, is balking at paying support and using the recession to claim poverty after making millions during their marriage.
“He’s the ultimate stonewaller,” Georgakis said in an interview. “It’s galling.”
The Georgakises are among couples in broken marriages fighting the economy in addition to each other as they try to divvy up assets from homes to artworks that have plunged in value. Couples bent on splitting estates have had to redo the math when asset values proved less than they had counted on to split up.
AXP: Update
AXP Dynamically hedging their credit exposure. Capital One claims do be doing the same. I'm still not convinced. As deflation persists nominal consumers debts will grow in real terms as unemployment rises bankruptcy will prove a better option for many than paying back Ken.
AXP since I got long vol last week
Your Money - American Express Watched Where You Shopped - NYTimes.com
American Express Kept a (Very) Watchful Eye on Charges
AXP since I got long vol last week
Your Money - American Express Watched Where You Shopped - NYTimes.com
You probably know that credit card companies have been scrutinizing every charge on your account in recent years, searching for purchases that thieves may have made. Turns out, though, that some of the companies have been suspicious of your own spending, too.
In recent months, American Express has gone far beyond simply checking your credit score and making sure you pay on time. The company has been looking at home prices in your area, the type of mortgage lender you’re using and whether small-business card customers work in an industry under siege. It has also been looking at how you spend your money, searching for patterns or similarities to other customers who have trouble paying their bills.
In some instances, if it didn’t like what it was seeing, the company has cut customer credit lines. It laid out this logic in letters that infuriated many of the cardholders who received them. “Other customers who have used their card at establishments where you recently shopped,” one of those letters said, “have a poor repayment history with American Express.”
It sure sounded as if American Express had developed a blacklist of merchants patronized by troubled cardholders. But late this week, American Express told me that wasn’t the case. The company said it had also decided to stop using what it has called “spending patterns” as a criteria in its credit line reductions.
“The letters were wrong to imply we were looking at specific merchants,” said Susan Korchak, a company spokeswoman. The company uses hundreds of data points in making its decisions, she said, adding that the main factor in determining credit lines “has always been and still is the overall level of debt, relative to the card member’s financial resources.”
The company will still have plenty of other data to judge your creditworthiness, though. American Express executives have spoken candidly to investors and analysts about its deep dives into your data.
A spokesman for Citigroup says that it is using some mortgage data to help it make credit decisions, but it is not using specific store data or looking at types of merchandise purchased. A spokeswoman for Capital One said that geography was one of many factors it considered and that it, too, did not make decisions based on where people shop.
Bank of America and Chase declined to comment on precisely how their underwriting works, though it’s safe to assume that they and other companies are looking at more data more carefully than they ever have before.
In the grave new world of the ever-worsening economy, lenders of all sorts are grasping for any sort of information that may shield them from ruin. In recent investor presentations, American Express executives have noted how much better the company’s data-mining capabilities are than they were during the last two downturns.
As technological advances give banks better tools and exponentially more information on who their customers are and what they do all day, they no longer have to wait long to tweak their formulas. “We have clients changing risk policies daily, depending on what they see in the marketplace,” said Dennis Dixon, the president of Zoot, a technology company in Four Corners, Mont., that helps banks and others make credit decisions.
The question, then, is how much of the data they can use before spooking their customers. Kevin D. Johnson, a 29-year-old Atlanta resident who runs a marketing and communications firm, received a letter from American Express last October saying that his credit limit was being lowered. One reason was that other customers who had used their cards at places where he had shopped were late in paying their bills.
The company couldn’t — or wouldn’t — tell him which charges had met with its disapproval. Frustrated, he told his story to the local newspaper and on “Good Morning America.” He also began documenting his experience on newcreditrules.com, where he posted the names of all the merchants he patronized, in the hope that other American Express customers would cross-check his list with theirs and solve the mystery.
When I queried the company this week, before it changed its policy, I noted that if it wouldn’t tell people which establishments were suspect, people would have no choice but to guess. The truly paranoid, presumably, would stop using American Express cards altogether.
But American Express couldn’t possibly go public with such a list. If it did, the merchants on the list, who generally pay the company a lot of money to accept its cards, would have a fit and hurl their Amex terminals into the nearest body of water.
Now, the company says that there never was such a list. So what about the language in its letters to cardholders, which calls out particular “establishments” where cardholders had shopped, I asked. Well, apparently that was all just a big misunderstanding, despite the number of people who must have been in on drafting the notes in the first place.
American Express wouldn’t have been the first company to try cordoning off certain industries. Last year, CompuCredit, a subprime lender, got in trouble with the Federal Trade Commission for failing to disclose that it could reduce customers’ credit lines for using their cards at various establishments.
What was on CompuCredit’s no-go list? Marriage counselors, tire retreading and repair shops, bars and nightclubs, pool halls, pawnshops and massage parlors, among others.
Robert Manning, a longtime critic of the industry and the author of “Credit Card Nation,” also pointed out that American Express ran the risk of discouraging a lot of virtuous behavior. “If someone shops at the Dollar Store, he’s a prudent steward of his financial resources, but the blunt instruments at Amex suggest that he’s changing his financial behavior,” he said. “There’s this ecological fallacy that if I suddenly make a charge at Wal-Mart, my line of credit would get bumped down.”
But while American Express has pulled back from snooping on your shopping, it’s still paying attention to other ways you spend. In one presentation to analysts, it noted that people with multiple residences and multiple mortgages used to be a good bet. Now, the reverse is true.
The company is also using credit reports to identify your mortgage lender. If it’s a subprime lender or one that has gone bankrupt, that could affect the size of your credit line. Borrowers do not necessarily have a say in determining who ends up owning or servicing their mortgage, though. Ms. Korchak, the American Express spokeswoman, said that customers should call the company if they think there is any confusion about the identity of their original lender.
American Express has also been looking at the health of the industries where its small-business cardholders work. If you’re a dentist, say, you may have less trouble with the card company than if you work in construction or finance. Al Kelly, the company’s president, said in a presentation in August that it had made changes in credit limits “by looking at industries that are facing, or might face, incremental stress.” The “might face” could encompass all sorts of industries of the company’s choosing.
So if you want to keep your credit unchanged, it now makes sense to actively manage your credit portfolio and look at it even more frequently than you do your investments.
If a card company lowers your credit limit, for instance, it can hurt your credit score, since one factor in your creditworthiness is how much of your available credit you’re using at any given time. You want that percentage to be as low as possible, so you may have to pay down debt or use your cards less.
That said, if you have a high credit limit, that may make you a target, too. American Express has said it is keeping a particularly close eye on those customers.
If it feels as if you simply can’t win here, remember that you do have choices. You can avoid credit cards in most instances. Or you can join a credit union or look to smaller banks, where better deals may be available.
Card companies presume that you’ll suck it up and pay more or adjust your spending if they change their terms on you. But because they deploy such different tactics, you have the opportunity to leave one company and patronize another.
BXP next FAIL first?
I just heard Mort Zuckerman say on Bloomberg Radio that Manhattan was a supply constrained real estate market and that being focused on the high end of the market they should insulated. I am not sure if Mr. Zuckerman was just putting on a a brave face or if he really believes this, either way, i'll be putting on a net long volatility position in BXP to compliment one I already have in Simons Property Group. With bank bonuses a thing of the past Manhattan real estate is going down, hard.
Bloomberg.com: News
Zuckerman Loss Makes Sam Zell Master of Real Estate (Update2)
Bloomberg.com: News
Zuckerman Loss Makes Sam Zell Master of Real Estate (Update2)
By Bob Ivry
Jan. 30 (Bloomberg) -- Billionaire Mortimer Zuckerman just learned a hard lesson from billionaire Sam Zell.
Zuckerman’s Boston Properties Inc. said this week that three Manhattan skyscrapers it bought in May lost about $165 million of value in seven months. Zell exited the office property market in February 2007, selling Equity Office Properties Trust and its more than 500 buildings to Blackstone Group LP for $39 billion in debt and equity, the largest leveraged buyout at the time. It was the peak of the market.
“After that, the world changed,” said Dan Fasulo, managing director at real estate data provider Real Capital Analytics.
Boston Properties disclosed the writedowns as it reported its first quarterly net loss in at least eight years. Zuckerman bought the three office towers from developer Harry Macklowe, who was forced to sell because he had to repay short-term loans he used to buy eight buildings from Zell in February 2007.
Financial companies, battered by more than $1 trillion of writedowns and credit-market losses since 2007, have tightened commercial real estate lending. U.S. sales of office buildings plunged 88 percent since the second quarter of 2007, according to New York-based Real Capital Analytics. In midtown Manhattan, the location of the three buildings, 6.7 percent of commercial space was vacant in February 2007, according to data from Colliers ABR. In December, vacancies climbed to 10.2 percent.
General Motors Building
Blackstone wrote down the value of its real estate by 10 percent in the third quarter of 2008, according to a filing with the U.S. Securities and Exchange Commission. The value will be updated when the New York-based investment firm announces fourth-quarter results next month. Blackstone spokesman Peter Rose said he had no further comment.
Boston Properties took impairment charges on 540 Madison Avenue, 2 Grand Central Tower and 125 West 55th Street. The shares fell 96 cents, or 2.2 percent, to $43.30 at 4 p.m. in New York Stock Exchange composite trading. The stock dropped 51 percent in the past 12 months.
The tower that Boston Properties bought in May that kept its value was the General Motors Building, the $2.8 billion skyscraper on Fifth Avenue adjacent to Central Park.
“You can’t fault Mort Zuckerman for buying the single best property in the U.S., the GM Building,” New York real estate billionaire Richard LeFrak said in an interview. “If you’re going to overpay for something, you overpay for that. Today it sounds like a high price, but 10 years from now they’ll be yelling, ‘Maestro! Genius! Take a bow!’”
‘Smart Guy’
Lawrence Fiedler, president of JRM Development Enterprises Inc. in New York and a real estate professor at New York University, said he thought a $165 million writedown didn’t sound like a lot of money. He praised Zell and Zuckerman.
“Mort Zuckerman is a smart guy,” Fiedler said. “Did he pay too much? Everybody who bought property when he bought property paid too much.”
Zuckerman, in an interview, blamed mark-to-market accounting rules that require publicly traded companies to declare the value of their assets every three months.
“We do expect to get somewhat less rent in those buildings than we thought we would, but it doesn’t mean the buildings are worth less,” said Zuckerman, who’s chairman of Boston Properties. “There are a whole set of assumptions that has to meet the standards of your public accountant. We wouldn’t sell these buildings for this price. We would buy them.”
In a February 2007 interview, Zuckerman called Zell “one of the authentic geniuses of real estate.”
Terry Holt, a spokeswoman for Zell, said he declined comment.
“Zell sold the buildings at the right price at the right time,” Zuckerman said yesterday in the interview. “Nobody’s ever perfect, though. You end up buying a newspaper business.” Zuckerman owns the New York Daily News tabloid newspaper.
Last month, less than a year after Zell bought Tribune Co., owner of the Chicago Tribune, and took it private, the media company sought bankruptcy protection with $13 billion of debt.
To contact the reporter on this story: Bob Ivry in New York at bivry@bloomberg.net.
Monday, January 26, 2009
Told you so: AmEx Earnings Drop 79% - WSJ.com
AmEx Earnings Drop 79% - WSJ.com
Earlier:
"Double, double toil and trouble; Fire burn and cauldron bubble. Cool it with a baboon's blood, Then the charm is firm and good. O well done! I commend your pains; And every one shall share i' the gains; And now about the cauldron sing, Live elves and fairies in a ring Enchanting all that you put in. By the pricking of my thumbs, Something wicked this way comes."
- William Shakespeare, "Macbeth", Act 4 scene 1
With disaster unfolding at Capital One one has to wodner how AXP is going to weather this storm. AXP reports earnings monday at 5:00pm it could be ugly. I'll be net buying volatility in AXP on monday. You've gotta figure when Ken Chenault turned AXP into a bank and took $3.5bn in TARP funds that he saw something ugly looming on the horizon.
Earlier:
Amex next to enter the fail?
"Double, double toil and trouble; Fire burn and cauldron bubble. Cool it with a baboon's blood, Then the charm is firm and good. O well done! I commend your pains; And every one shall share i' the gains; And now about the cauldron sing, Live elves and fairies in a ring Enchanting all that you put in. By the pricking of my thumbs, Something wicked this way comes."- William Shakespeare, "Macbeth", Act 4 scene 1
Sunday, January 25, 2009
Implied Volatility and the allegory of the cave
The Options Market is Mispriced (more on this later... maybe)
From the Matrix:"Morpheus : The Matrix is everywhere. It's all around us, even in this very room. You can see it when you look out your window or when you turn on your television. You can feel it when you go to work, when you go to work, when you pay your taxes.The Matrix is the world that has been pulled over your eyes, to blind you from the truth.Socrates And now, I said, let me show in a figure how far our nature is enlightened or unenlightened:, Behold! human beings living in an underground den, which has a mouth open towards the light and reaching all along the den; here they have been from their childhood, and have their legs and necks chained so that they cannot move, and can only see before them, being prevented by the chains from turning round their heads. Above and behind them a fire is blazing at a distance, and between the fire and the prisoners there is a raised way; and you will see, if you look, a low wall built along the way, like the screen which marionette players have in front of them, over which they show the puppets.Glaucon I see.Socrates And do you see, I said, men passing along the wall carrying all sorts of vessels, and statues and figures of animals made of wood and stone and various materials, which appear over the wall? Some of them are talking, others silent.Glaucon You have shown me a strange image, and they are strange prisoners.Socrates Like ourselves, I replied; and they see only their own shadows, or the shadows of one another, which the fire throws on the opposite wall of the cave?Glaucon True, he said; how could they see anything but the shadows if they were never allowed to move their heads?Socrates And of the objects which are being carried in like manner they would only see the shadows?Glaucon Yes, he said.Socrates And if they were able to converse with one another, would they not suppose that they were naming what was actually before them?Glaucon No question, he replied.Socrates To them, I said, the truth would be literally nothing but the shadows of the images.Glaucon That is certain.Socrates And now look again, and see what will naturally follow if the prisoners are released and disabused of their error. At first, when any of them is liberated and compelled suddenly to stand up and turn his neck round and walk and look towards the light, he will suffer sharp pains; the glare will distress him, and he will be unable to see the realities of which in his former state he had seen the shadows; and then conceive some one saying to him, that what he saw before was an illusion, but that now, when he is approaching nearer to being and his eye is turned towards more real existence, he has a clearer vision,, what will be his reply? And you may further imagine that his instructor is pointing And when to the objects as they pass and requiring him to name them, will he not be perplexed? Will he not fancy that the shadows which he formerly saw are truer than the objects which are now shown to him?Glaucon Far truer.Socrates And if he is compelled to look straight at the light, will he not have a pain in his eyes which will make him turn away to take refuge in the objects of vision which he can see, and which he will conceive to be in reality clearer than the things which are now being shown to him?Glaucon True, he said.Socrates And suppose once more, that he is reluctantly dragged up a steep and rugged ascent, and held fast until he is forced into the presence of the sun himself, is he not likely to be pained and irritated? When he approaches the light his eyes will be dazzled, and he will not be able to see anything at all of what are now called realities?Glaucon Not all in a moment, he said.Socrates He will require to grow accustomed to the sight of the upper world. And first he will see the shadows best, next the reflections of men and other objects in the water, and then the objects themselves; then he will gaze upon the light of the moon and the stars and the spangled heaven; and he will see the sky and the stars by night better than the sun or the light of the sun by day?Glaucon Certainly.Socrates Last of all he will be able to see the sun, and not mere reflections of him in the water, but he will see him in his own proper place, and not in another; and he will contemplate him as he is.Glaucon Certainly.Socrates He will then proceed to argue that this is he who gives the season and the years, and is the guardian of all that is in the visible world, and in a certain way the cause of all things which he and his fellows have been accustomed to behold?Glaucon Clearly, he said, he would first see the sun and then reason about it.Socrates And when he remembered his old habitation, and the wisdom of the den and his fellow-prisoners, do you not suppose that he would felicitate himself on the change, and pity them?Glaucon Certainly, he would.Socrates And if they were in the habit of conferring honors among themselves on those who were quickest to observe the passing shadows and to remark which of them went before, and which followed after, and which were together; and who were therefore best able to draw conclusions as to the future, do you think that he would care for such honors and glories, or envy the possessors of them? Would he not say with Homer,Glaucon Yes, he said, I think that he would rather suffer anything than entertain these false notions and live in this miserable manner.Socrates Imagine once more, I said, such a one coming suddenly out of the sun to be replaced in his old situation; would he not be certain to have his eyes full of darkness?Glaucon To be sure, he said.Socrates And if there were a contest, and he had to compete in measuring the shadows with the prisoners who had never moved out of the den, while his sight was still weak, and before his eyes had become steady (and the time which would be needed to acquire this new habit of sight might be very considerable), would he not be ridiculous? Men would say of him that up he went and down he came without his eyes; and that it was better not even to think of ascending; and if any one tried to loose another and lead him up to the light, let them only catch the offender, and they would put him to death.Glaucon No question, he said.Socrates This entire allegory, I said, you may now append, dear Glaucon, to the previous argument; the prison-house is the world of sight, the light of the fire is the sun, and you will not misapprehend me if you interpret the journey upwards to be the ascent of the soul into the intellectual world according to my poor belief, which, at your desire, I have expressed, whether rightly or wrongly God knows. But, whether true or false, my opinion is that in the world of knowledge the idea of good appears last of all, and is seen only with an effort; and, when seen, is also inferred to be the universal author of all things beautiful and right, parent of light and of the lord of light in this visible world, and the immediate source of reason and truth in the intellectual; and that this is the power upon which he who would act rationally either in public or private life must have his eye fixed.Glaucon I agree, he said, as far as I am able to understand you.Socrates Moreover, I said, you must not wonder that those who attain to this beatific vision are unwilling to descend to human affairs; for their souls are ever hastening into the upper world where they desire to dwell; which desire of theirs is very natural, if our allegory may be trusted.Glaucon Yes, very natural.Socrates And is there anything surprising in one who passes from divine contemplations to the evil state of man, when they returned to the den they would see much worse than those who had never left it. himself in a ridiculous manner; if, while his eyes are blinking and before he has become accustomed to the surrounding darkness, he is compelled to fight in courts of law, or in other places, about the images or the shadows of images of justice, and is endeavoring to meet the conceptions of those who have never yet seen absolute justice?Glaucon Anything but surprising, he replied.Socrates Any one who has common sense will remember that the bewilderments of the eyes are of two kinds, and arise from two causes, either from coming out of the light or from going into the light, which is true of the mind's eye, quite as much as of the bodily eye; and he who remembers this when he sees any one whose vision is perplexed and weak, will not be too ready to laugh; he will first ask whether that soul of man has come out of the brighter life, and is unable to see because unaccustomed to the dark, or having turned from darkness to the day is dazzled by excess of light. And he will count the one happy in his condition and state of being, and he will pity the other; or, if he has a mind to laugh at the soul which comes from below into the light, there will be more reason in this than in the laugh which greets him who returns from above out of the light into the den.Glaucon That, he said, is a very just distinction.Socrates But then, if I am right, certain professors of education must be wrong when they say that they can put a knowledge into the soul which was not there before, like sight into blind eyes?Glaucon They undoubtedly say this, he replied.Socrates Whereas, our argument shows that the power and capacity of learning exists in the soul already; and that just as the eye was unable to turn from darkness to light without the whole body, so too the instrument of knowledge can only by the movement of the whole soul be turned from the world of becoming into that of being, and learn by degrees to endure the sight of being, and of the brightest and best of being, or in other words, of the good.Glaucon Very true.Socrates And must there not be some art which will effect conversion in the easiest and quickest manner; not implanting the faculty of sight, for that exists already, but has been turned in the wrong direction, and is looking away from the truth?Glaucon Yes, he said, such an art may be presumed.Socrates And whereas the other so-called virtues of the soul seem to be akin to bodily qualities, for even when they are not originally innate they can be implanted later by habit and exercise, the virtue of wisdom more than anything else contains a divine element which always remains, and by this conversion is rendered useful and profitable; or, on the other hand, hurtful and useless. Did you never observe the narrow intelligence flashing from the keen eye of a clever rogue, how eager he is, how clearly his paltry soul sees the way to his end; he is the reverse of blind, but his keen eye-sight is forced into the service of evil, and he is mischievous in proportion to his cleverness?Glaucon Very true, he said.Socrates But what if there had been a circumcision of such natures in the days of their youth; and they had been severed from those sensual pleasures, such as eating and drinking, which, like leaden weights, were attached to them at their birth, and which drag them down and turn the vision of their souls upon the things that are below, if, I say, they had been released from these impediments and turned in the opposite direction, the very same faculty in them would have seen the truth as keenly as they see what their eyes are turned to now.Glaucon Very likely.Socrates Yes, I said; and there is another thing which is likely, or Neither rather a necessary inference from what has preceded, that neither the uneducated and uninformed of the truth, nor yet those who never make an end of their education, will be able educated ministers of State; not the former, because they have no single aim of duty which is the rule of all their actions, private as well as public; nor the latter, because they will not act at all except upon compulsion, fancying that they are already dwelling apart in the islands of the blest.Glaucon Very true, he replied.Socrates Then, I said, the business of us who are the founders of the State will be to compel the best minds to attain that knowledge which we have already shown to be the greatest of all, they must continue to ascend until they arrive at the good; but when they have ascended and seen enough we must not allow them to do as they do now.Glaucon What do you mean?Socrates I mean that they remain in the upper world: but this must not be allowed; they must be made to descend again among the prisoners in the den, and partake of their labors and honors, whether they are worth having or not.Glaucon But is not this unjust? he said; ought we to give them a worse life, when they might have a better?Socrates You have again forgotten, my friend, I said, the intention of the legislator, who did not aim at making any one class in the State happy above the rest; the happiness was to be in the whole State, and he held the citizens together by persuasion and necessity, making them benefactors of the State, and therefore benefactors of one another; to this end he created them, not to please themselves, but to be his instruments in binding up the State.Glaucon True, he said, I had forgotten.Socrates Observe, Glaucon, that there will be no injustice in compelling our philosophers to have a care and providence of others; we shall explain to them that in other States, men of their class are not obliged to share in the toils of politics: and this is reasonable, for they grow up at their own sweet will, and the government would rather not have them. Being self-taught, they cannot be expected to show any gratitude for a culture which they have never received. But we have brought you into the world to be rulers of the hive, kings of yourselves and of the other citizens, and have educated you far better and more perfectly than they have been educated, and you are better able to share in the double duty. That is why each of you, when his turn comes, must go down to the general underground abode, and get the habit of seeing in the dark. When you have acquired the habit, you will see ten thousand times better than the inhabitants of the den, and you will know what the several images are, and what they represent, because you have seen the beautiful and just and good in their truth. And thus our State, which is also yours will be a reality, and not a dream only, and will be administered in a spirit unlike that of other States, in which men fight with one another about shadows only and are distracted in the struggle for power, which in their eyes is a great good. Whereas the truth is that the State in which the rulers are most reluctant to govern is always the best and most quietly governed, and the State in which they are most eager, the worst.Glaucon Quite true, he replied.Socrates And will our pupils, when they hear this, refuse to take their turn at the toils of State, when they are allowed to spend the greater part of their time with one another in the heavenly light?Glaucon Impossible, he answered; for they are just men, and the commands which we impose upon them are just; there can be no doubt that every one of them will take office as a stern necessity, and not after the fashion of our present rulers of State.Socrates Yes, my friend, I said; and there lies the point. You must contrive for your future rulers another and a better life than that of a ruler, and then you may have a well-ordered State; for only in the State which offers this, will they rule who are truly rich, not in silver and gold, but in virtue and wisdom, which are the true blessings of life. Whereas if they go to the administration of public affairs, poor and hungering after their own private advantage, thinking that hence they are to snatch the chief good, order there can never be; for they will be fighting about office, and the civil and domestic broils which thus arise will be the ruin of the rulers themselves and of the whole State.Glaucon Most true, he replied.Socrates And the only life which looks down upon the life of political ambition is that of true philosophy. Do you know of any other?Glaucon Indeed, I do not, he said.Socrates And those who govern ought not to be lovers of the task? For, if they are, there will be rival lovers, and they will fight.Glaucon No question.Socrates Who then are those whom we shall compel to be guardians? Surely they will be the men who are wisest about affairs of the state.
Neo : What truth?
Morpheus : That you are a slave, Neo. Like everyone else, you were born into bondage, born into a prison that you cannot smell or taste or touch. A prison...for your mind.... Unfortunatly, no one can be... told what the Matrix is... you have to see it for yourself. This is your last chance. After this, there is no turning back.....You take the blue pill, the story ends. You wake up and believe...whatever you want to believe. You take the red pill.....you stay in wonderland...and I show you just how deep the rabbit hole goes."
The Allegory of the Cave (The Republic , Book VII)
And suppose further that the prison had an echo which came from the other side, would they not be sure to fancy, when one of the passers-by spoke that the voice which they heard came from the passing shadow?
Better to be the poor servant of a poor master, and to endure anything, rather than think as they do and live after their manner?
Amex next to enter the fail?
"Double, double toil and trouble; Fire burn and cauldron bubble. Cool it with a baboon's blood, Then the charm is firm and good. O well done! I commend your pains; And every one shall share i' the gains; And now about the cauldron sing, Live elves and fairies in a ring Enchanting all that you put in. By the pricking of my thumbs, Something wicked this way comes."
- William Shakespeare, "Macbeth", Act 4 scene 1
- William Shakespeare, "Macbeth", Act 4 scene 1
With disaster unfolding at Capital One one has to wodner how AXP is going to weather this storm. AXP reports earnings monday at 5:00pm it could be ugly. I'll be net buying volatility in AXP on monday. You've gotta figure when Ken Chenault turned AXP into a bank and took $3.5bn in TARP funds that he saw something ugly looming on the horizon.
Thursday, January 22, 2009
DECISION MAKING UNDER KNIGHTIAN UNCERTAINTY
"The theorist not having definite assumptions clearly in mind in working out the 'principles,' it is but natural that he, and still more the practical workers building upon his foundations, should forget that unreal assumptions were made, and should take the principles over bodily, apply them to concrete cases, and draw sweeping and wholly unwarranted conclusions from them. The clearly untenable and often vicious character of such deductions naturally works to discredit theory itself."
–F. H. Knight
–Benjamin Graham
THE NATURE OF KNIGHTIAN UNCERTAINTY:
There is no such thing as "value". To understand how I have reached this seemingly ridiculous conclusion I must walk you through my analysis. I apologize for the length of what will follow but it is necessary due to the imbeded assumptions which under pin economic theory (of which I am quite critical).
I would refer you, reader, to the works of F.H. Knight, Karl Popper, John Law, Benoît Mandelbrot, George Soros, Daniel Bernoulli and Ed Thorp as a counter point. I would suggest that you apply Popper's test of falsifiability to the underlying assumptions of both Keynsian and Austrian economics. The assumption of "rational" self interest is not testable and can always be asserted as an explanation for any behavior post hoc. It is from this poisonous tree that fruit of asset price appreciation is harvested. It is on the back of Bernoulli's theory of marginal utility that all economics bases its assumption for rational behavior. However, the implicit assumption is that individuals can predict their own utility function with certainty or with known maximum and minimum bounds(or that this utility function is stable though unknown to the actor). While this assumption holds when making decisions with respect to a discrete selection of alternatives on a finite time interval in reality there are an infinite combinations and permutations of alternatives. The binomial to normal approximation of the rational expectational decision tree does not work.
What George Soros calls reflexivity and Mandelbrot recursive self affinity is the process by which people make assumptions and as those assumptions hold people increase the size of their investment in those assumptions. Using normally distributed prices as their presumption people decrease their expectation of variance as observations of prices within an interval increase. They begin to borrow money to increase the rate of their return. The problem comes when variance exceeds the maximum expectation. Lenders lose confidence in their ability to collect their principal and raise the cost of capital accordingly sellers are forced to reduce leverage to meet this cost and are forced into sell assets in the process, the fall in prices created by delevering triggers lenders to become more concerned still; and they raise their cost of capital further and the cycle repeats itself. This is what is commonly known as the credit cycle. The net effect is that prices of assets are not, never were and never will be normally distributed they overact to the upside in good times and overact to the down side in bad times. Further, this process is scale invariant as well as recursive. It is precisely when one has made a consistent rate of return in an investment that they are often most at risk, because they begin reduce their expectation of the rate of the rate of change in prices, or the acceleration of price changes if you will. For this reason, because people usually make steady amounts of money over medium length time periods and then go broke very quickly, that one cannot asses the performance of an investor based on how much money they have made in the past. While they may be a "competent investor" They may also be exposed to instantaneous volatility and be bankrupt in two weeks, it is impossible to tell.
DECISION MAKING UNDER KNIGHTIAN UNCERTAINTY.
Let us return for a moment to Mr. Bernoulli. While it is possible that value does not exist at all, risk with respect investment is a matter definition, for surely there is risk in the world. However, I will argue that the only acceptable definition of expectation in investing should be deductive mathematical expectation. Qualitative measurement of expectations are notoriously unreliable and since only a few % points difference in returns determine whether an investment is acceptable or rejected the necessary confidence interval can never be achieved. Which is to say, the margin of error for qualitative analysis is greater than the difference in returns between which the analysis would presume to distinguish.
While this may seem impractical, in practice it merely means restricting investments to those which can be synthetically replicated (statically) using different instruments by taking long and short offsetting positions; in short (pun intended) arbitrage.
Here we may incorporate Bernoulli's idea of marginal return to maximize the geometric mean rate of return for our investments. You must never invest in situation where the maximum loss and minimum payout are not calculable, with certainty. The expected payout must always be twice chance of winning. In practice this means that the waited average payout of all of your investment must be greater than zero from the moment you enter into the investment.
The answer to what causes losses to be more than expected is as discussed earlier. The change in expectation vs. your assumption when you entered into your investment. When I invest, I invest assuming only that the market price is wrong. I assume I have no idea what stocks are worth, as with Lehman Brothers, they could go to zero or they could go to 1infinity, I have no idea AND I want to make money either way. That is my only assumption that the market price is wrong. But rather than simply pulling out of the market, I want to make money on my knowledge that the market price is wrong.
To solve how to invest under these very restrictive conditions I will employ a bit of information theory. The impulse response of the an investment portfolio price or the change in the rate of change of an instruments price is its "convexity" which can be seen as a distortion of the linearity of its change with respect to its underlying (be they cash flows with a bond or stock with an option or what have you). This distortion from linearity can be modeled using the dirac delta function. Further, by identifying the inflection point of the price the "distortion" can be eliminated by the purchase of instruments with offsetting characteristics. Then the new portfolio can be analyzed in the same manner until the distortion is eliminated. This can all be done in one signal construction, statically rather than "dynamically" as the binomial process discussed earlier would suggest. Any time this process can be completed including total transaction costs and achieve a 2:1 pay off then an investment can be considered sufficiently profitable.
TO SUM UP
My basic assumptions are as follows.
Prices have infinite variance due to recursive self affinity in the behavior of market participants. As Mandelbrot demonstrated in 1962, prices are Levy distributed. The market fails to price in infinite instantaneous volatility and therefore volatility is always two cheap. Therefore I am a buyer volatility, through the use of synthetic volatility swaps on the companies that have the most difficult business to understand.
1) DOWN is UP
2) UP is DOWN
3 )The Market is a Ponzi Scheme, so is the dollar, so is gold.
4) Take as little risk with as much pay off as possible and only when the risk can be defined deductively rather than from statistical inference.
"Thus the professional investor is forced to concern himself with the anticipation of impending changes, in the news or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced. This is the inevitable result of investment markets organised with a view to so-called “liquidity”. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity, the doctrine that it is a positive virtue on the part of investment institutions to concentrate their resources upon the holding of “liquid” securities. It forgets that there is no such thing as liquidity of investment for the community as a whole. The social object of skilled investment should be to defeat the dark forces of time and ignorance which envelop our future. The actual, private object of the most skilled investment to-day is “to beat the gun”, as the Americans so well express it, to outwit the crowd, and to pass the bad, or depreciating, half-crown to the other fellow.
This battle of wits to anticipate the basis of conventional valuation a few months hence, rather than the prospective yield of an investment over a long term of years, does not even require gulls amongst the public to feed the maws of the professional; — it can be played by professionals amongst themselves. Nor is it necessary that anyone should keep his simple faith in the conventional basis of valuation having any genuine long-term validity. For it is, so to speak, a game of Snap, of Old Maid, of Musical Chairs — a pastime in which he is victor who says Snap neither too soon nor too late, who passes the Old Maid to his neighbour before the game is over, who secures a chair for himself when the music stops. These games can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.
Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees."
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