Money and Finance
- Hussman Weekly Market Comment: The Grand Superstition
In general, the larger the events, the more important the events are to survival, and the closer in proximity those events occur, the more likely an organism is to believe those events are tied together by cause and effect. This makes the 2008-2009 credit...
- Clouds Seen In Regulators’ Crystal Ball For Banks
Five years ago, the financial regulators of the United States — and more broadly the world — didn’t see the storm coming. Would they if a new one were brewing now? The answer to that is far from clear. The regulators have more information now, and...
- Cornercap Special Report: The Aftermath Of 2008 - A Look At The Lasting Impact Of The Credit Crisis
The panic of 2008 is still among us, judging from investor behavior. Most investors are putting a premium on safety at almost any price. This article looks at the lasting impact of the credit crisis: Does it mean we are in a different investment era?...
- Jeremy Grantham's 1q Letter: My Sister's Pension Assets And Agency Problems (the Tension Between Protecting Your Job Or Your Clients' Money)
The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last...
- Confessions Of A Risk Manager
Why did banks become so overexposed in the run-up to the credit crunch? A risk manager at a large global bank—someone whose job it was to make sure that the firm did not take unnecessary risks—explains in his own words...The pressure on the risk department...
Money and Finance
Tweedy, Browne's Semi-Annual Report
In a fascinating new book, A Demon of Our Own Design, author Richard Bookstaber, a “Wall Streeter” with over 20 years of quantitative trading experience, contends that financial innovation, complexity and globalization have combined to make our markets more crisis prone. He uses biology as a frame of reference for economic behavior, and contrasts the cockroach and the furu, a small perch-like fish, in a case study of risk management. He finds the survival of the cockroach over millions of years quite remarkable, especially in light of what he describes as their “coarse and sub-optimal behavior” when it comes to risk management. In essence, the cockroach has a rather simple defense mechanism: moving away from slight puffs of air. It completely ignores a wide range of other information and risks “…that one would think an optimal risk management system would take into account.”
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He contrasts the sub-optimal behaving cockroach to the finely tuned and optimizing behavior of the furu, a once dominant, small, perch-like fish that survived in Africa’s Lake Victoria for thousands of years. The furu, over the centuries, became highly adapted to its environment, evolving into some 300 species and developing a myriad of skills, which allowed it to thrive and flourish in its habitat, rivaling “the finches that Darwin studied in the Galapagos.” It unfortunately fell victim to extinction when the Nile Perch was introduced by a Kenyan game fisheries officer into the lakes of Central Africa. Bookstaber points out that their “extinction was not the result of natural selection based on fitness in the usual sense; they were diverse and suited for almost every conceivable element of the Lake Victoria ecology.…Its path toward extinction was just a result of dumb luck that someone had introduced an alien species into its waters.”
He contrasts the sub-optimal behaving cockroach to the finely tuned and optimizing behavior of the furu, a once dominant, small, perch-like fish that survived in Africa’s Lake Victoria for thousands of years. The furu, over the centuries, became highly adapted to its environment, evolving into some 300 species and developing a myriad of skills, which allowed it to thrive and flourish in its habitat, rivaling “the finches that Darwin studied in the Galapagos.” It unfortunately fell victim to extinction when the Nile Perch was introduced by a Kenyan game fisheries officer into the lakes of Central Africa. Bookstaber points out that their “extinction was not the result of natural selection based on fitness in the usual sense; they were diverse and suited for almost every conceivable element of the Lake Victoria ecology.…Its path toward extinction was just a result of dumb luck that someone had introduced an alien species into its waters.”
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Bookstaber concludes that “the cockroach and the furu are just two of many examples I can cite in biology to illustrate the benefits of coarse behavior and the perils of finely-tuned behavior in reacting to a broad range of natural uncertainty.”
Bookstaber concludes that “the cockroach and the furu are just two of many examples I can cite in biology to illustrate the benefits of coarse behavior and the perils of finely-tuned behavior in reacting to a broad range of natural uncertainty.”
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To carry Bookstaber’s biological case study into the capital markets, Benjamin Graham and Warren Buffett are perhaps the “cockroaches” of the investment world, eschewing leverage and demanding a substantial margin of safety in each investment they made. Their simple and elegant defense mechanism against the vast uncertainty of financial markets was a cheap entry price supported by collateral value. By avoiding leverage, they were not likely to ever be untethered from their ownership of real and growing assets.
To carry Bookstaber’s biological case study into the capital markets, Benjamin Graham and Warren Buffett are perhaps the “cockroaches” of the investment world, eschewing leverage and demanding a substantial margin of safety in each investment they made. Their simple and elegant defense mechanism against the vast uncertainty of financial markets was a cheap entry price supported by collateral value. By avoiding leverage, they were not likely to ever be untethered from their ownership of real and growing assets.
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The furu, on the other hand, is akin to today’s highly leveraged investor seeking to eradicate risk by fine tuning portfolios using probability theory in an attempt to ferret out and nullify any and all conceivable risks. Portfolios of high alpha generating, non-correlated assets are put together in a mosaic that is supposed to enhance return and lower volatility. With risk so theoretically constrained, investors are free to use leverage to exploit small market inefficiencies, allowing them to proverbially and safely “pick up dimes in front of steamrollers.” With massive amounts of individual and institutional capital having moved into these finely-tuned and highly leveraged strategies, Bookstaber contends that our capital markets will from time to time be confronted with liquidity shocks that could accelerate into full blown crises. Such was the case with the credit crunch in August.
The furu, on the other hand, is akin to today’s highly leveraged investor seeking to eradicate risk by fine tuning portfolios using probability theory in an attempt to ferret out and nullify any and all conceivable risks. Portfolios of high alpha generating, non-correlated assets are put together in a mosaic that is supposed to enhance return and lower volatility. With risk so theoretically constrained, investors are free to use leverage to exploit small market inefficiencies, allowing them to proverbially and safely “pick up dimes in front of steamrollers.” With massive amounts of individual and institutional capital having moved into these finely-tuned and highly leveraged strategies, Bookstaber contends that our capital markets will from time to time be confronted with liquidity shocks that could accelerate into full blown crises. Such was the case with the credit crunch in August.
- Hussman Weekly Market Comment: The Grand Superstition
In general, the larger the events, the more important the events are to survival, and the closer in proximity those events occur, the more likely an organism is to believe those events are tied together by cause and effect. This makes the 2008-2009 credit...
- Clouds Seen In Regulators’ Crystal Ball For Banks
Five years ago, the financial regulators of the United States — and more broadly the world — didn’t see the storm coming. Would they if a new one were brewing now? The answer to that is far from clear. The regulators have more information now, and...
- Cornercap Special Report: The Aftermath Of 2008 - A Look At The Lasting Impact Of The Credit Crisis
The panic of 2008 is still among us, judging from investor behavior. Most investors are putting a premium on safety at almost any price. This article looks at the lasting impact of the credit crisis: Does it mean we are in a different investment era?...
- Jeremy Grantham's 1q Letter: My Sister's Pension Assets And Agency Problems (the Tension Between Protecting Your Job Or Your Clients' Money)
The central truth of the investment business is that investment behavior is driven by career risk. In the professional investment business we are all agents, managing other peoples’ money. The prime directive, as Keynes knew so well, is first and last...
- Confessions Of A Risk Manager
Why did banks become so overexposed in the run-up to the credit crunch? A risk manager at a large global bank—someone whose job it was to make sure that the firm did not take unnecessary risks—explains in his own words...The pressure on the risk department...