Friday, September 23, 2011

Dialog with a A RealEconomist(tm)

The Unknown Economist!
I had a really interesting e-mail exchange with a "famous" economist (although he would, no doubt, dispute the epithet) on the logic behind the Republican Party's lunatic economic policies.  In order to preserve his privacy, I'm not going to reveal his name, but here is the substantive parts of our discussion.

I'm just staggered by the ongoing failure of policy in Washington. How did we get to a place where facts don't matter and ideology rules over all? America has become like a Kafka novel, only scarier.

Someone, somewhere, is making money at this somehow and I don't get how. But as "Deep Throat" said in All the President's Men, "Follow the money!"


A RealEconomist(tm):
Well, there's money in proving that a guy who inherited money is a self-made man. And if you tax that guy, you are interfering with one of the key components of the economy.
Other than ego for the supposed "self-made man," how does that make him money? I get that the ridiculous chants of "class war" by the millionaires is all about taxes (nobody making more than $100,000/year should be allowed to use the phrase "class war"), but that's wealth preservation, not wealth creation. What does destabilizing the global economy do to make people money?

Is there not something more nefarious at work here? Disruption and disassembly of the Federal government (especially agencies like the EPA and the FDA) and the commensurate lessening for regulations across a broad range of product spaces represents a big opportunity. The carbon extraction industry is especially interested.

I'm not normally a paranoid person (believe it or not), and I generally laugh at conspiracy theories (the "truthers" in particular) but I really, really, really think they're out to get us. All of us.

Wouldn't it be depressing if the survivalists were right all along???


A RealEconomist(tm):
In my experience, you can never underestimate the power of ego. Yes, there are financial benefits (worth paying for) to getting people to explain why getting to dump coal ash in the neighboring preschool is a good idea. But in the end, a lot of what happens in life depends on luck and on where one started. (Even the "self-made billionaires" like Bill Gates and Warren Buffett come from wealthy families.) But it bothers a lot of people to no end that they aren't viewed as having made it themselves.

I have a friend - a liberal Democrat. His father is worth in the neighborhood of $100 million. His father actually is self made, as in, coming from a middle class upbringing. He will also tell you that he was extremely lucky - a fledgling client of the small engineering firm he started couldn't afford to pay its bills and gave him a share of the business instead. Eventually he sold his piece of [a company you've heard of], about $40 from the all time high. My friend actually didn't want to work for his father's company, afraid people wouldn't see him as being his own man. I kept telling him, "the only reason I don't go to work for my Dad's company is that my Dad doesn't have a company. Screw what other people think."

My wife has a friend whose father started a company (I won't name it, but I guarantee you know the company as does every other sentient adult in the US and my guess is about 10% of the rest of the world's population would recognize the name too). She's Vice Chair of the company. But she just upped and left to NYC to start her own business. People who have enough money to have the freedom to think about it start to think that other people don't look up to them unless they're self made. The hard way is to up and leave and start on your own. The easy way is to pay for someone tell the right story. (I've noticed that the liberals that I know that fall into that category go off and start their own bus, the conservatives follow in their predecessor's footsteps and pay for the right story to be told.)
Ego is the powerful force destroying the global economy (well, at least the US economy)... Wow.  Most of the liberals I know recognize the force of luck and coincidence in their success, being at the right place at the right time, knowing the right person or reading the right sequence of papers and achieving a scientific breakthrough.  Most conservatives seem to believe that they are solely responsible for their success, the "self-made man" who conquers obstacles (like the EPA) in their quest for greatness.  Elizabeth Warren put that idea to bed quite handily.  "Nobody got rich on his own..."

Ego.  It's all about ego.

This article in Scientific American, How Math Whizzes Helped Sink the Economy, an excerpt from the book The Quants by Scott Patterson (a reporter for the Wall Street Journal), gives us another excruciating example of ego destroying the markets.  The book spins a tale of hubris, ego and math.  The Quants shows how a small cabal of "smart guys," known collectively as "quants" for their quantitative analytic capabilities, trashed the world economy:
The quants created a name for the Truth, a name that smacked of cabalistic studies of magical formulas: alpha. Alpha is a code word for an elusive skill certain individuals are endowed with that gives them the ability to consistently beat the market. It is used in contrast with another Greek term, beta, which is shorthand for plain-vanilla market returns anyone with half a brain can achieve.

To the quants, beta is bad, alpha is good. Alpha is the Truth. If you have it, you can be rich beyond your wildest dreams.

The notion of alpha, and its ephemeral promise of vast riches, was everywhere in the hedge fund world. The trade magazine of choice for hedge funds was called Alpha. A popular website frequented by the hedge fund community was called Seeking Alpha. Several of the quants in the room had already laid claim, in some form or another, to the possession of alpha. Asness named his first hedge fund, hatched inside Goldman in the mid-1990s, Global Alpha. Before moving on to Morgan in 1992, Muller had helped construct a computerized investing system called Alphabuilder for a quant farm in Berkeley called BARRA. An old poster from a 1960s film noir by Jean-Luc Godard called Alphaville hung on the walls of PDT's office in Morgan's midtown Manhattan headquarters.

But there was always a worry haunting the beauty of the quants' algorithms. Perhaps their successes weren't due to skill at all. Perhaps it was all just dumb luck, fool's gold, a good run that could come to an end on any given day. What if the markets weren't predictable? What if their computer models didn't always work? What if the truth wasn't knowable? Worse, what if there wasn't any Truth?

[Q]uants, such as Griffin, Asness, Muller, Weinstein, Simons, and the rest of the math wizards who had taken over Wall Street, had helped tame the market's volatility. Out of chaos they had created order through their ever-increasing knowledge of the Truth.

For providing this service to society, the quants were paid handsomely. But who could complain?
Then the bubble popped and everyone... everyone lost.
Amazingly, not one of the quants, despite their chart-topping IQs, their walls of degrees, their impressive Ph.D.'s, their billions of wealth earned by anticipating every bob and weave the market threw their way, their decades studying every statistical quirk of the market under the sun, saw the train wreck coming.

How could they have missed it? What went wrong?

A hint to the answer was captured centuries ago by a man whose name emblazoned the poker chips the quants wagered with that night: Isaac Newton. After losing £20,000 on a vast Ponzi scheme known as the South Sea Bubble in 1720, Newton observed: "I can calculate the motion of heavenly bodies but not the madness of people."
Ugh, we're so screwed.

No comments:

Post a Comment