Designing better futures

Chanos on China & Krugman on Asia 1994 & USSR 1960

Arguably the world's most successful and well known short seller, Jim Chanos has some strong opinions on China's urban real estate bubble.  Regardless of your opinion on the matter, his debate and argument is worthwhile watching in regards to macro China.  In regards to China, I have deep concerns and am nervous about the global ramifications of a half awakened giant stumbling.

This video has poor audio and lasts an hour but provides insight into the thought process of short specialists thinking processes, a useful bit of education.

98% of the time the average Western person can ignore sovereign debt and the Chinese economies.  That may not be true in the near future. 

In the video Chanos says the best essay he has ever read on emerging markets is by Paul Krugman written in 1994 before the Thai Bahtulism etc. unfolded in 1997.  Regardless of your opinion on Krugman, his thoughts in this "The myth of Asia's Miracle, a fable" are worth weighing in the current context.  The opening of Krugman's paper:

Once upon a time, Western opinion leaders found themselves both impressed and frightened by the extraordinary growth rates achieved by a set of Eastern economies. Although those economies were still substantially poorer and smaller than those of the West, the speed with which they had transformed themselves from peasant societies into industrial powerhouses, their continuing ability to achieve growth rates several times higher than the advanced nations, and their increasing ability to challenge or even surpass American and European technology in certain areas seemed to call into question the dominance not only of Western power but of Western ideology. The leaders of those nations did not share our faith in free markets or unlimited civil liberties. They asserted with increasing self-confidence that their system was superior: societies that accepted strong, even authoritarian governments and were willing to limit individual liberties in the interest of the common good, take charge of their economies, and sacrifice short-run consumer interests for the sake of long-run growth would eventually outperform the increasingly chaotic societies of the West. And a growing minority of Western intellectuals agreed.

The gap between Western and Eastern economic performance eventually became a political issue. The Democrats recaptured the White House under the leadership of a young, energetic new president who pledged to "get the country moving again--a pledge that, to him and his closest advisers, meant accelerating America's economic growth to meet the Eastern challenge.

The time, of course, was the early 1960s. The dynamic young president was John F. Kennedy. The technological feats that so alarmed the West were the launch of Sputnik and the early Soviet lead in space. And the rapidly growing Eastern economies were those of the Soviet Union and its satellite nations.....read more

Checklists, hedge funds and human behaviour

Checklists are not sexy, but their results are.  I just finished the Checklist Manifesto by Atul Gawande.  I am sold and you should be as well. Checklists save lives, make money and make life less stressful.

Outperformance seems to be associated with repeat process and efficient group communication. Checklists allow for managing individual and team processes for better outcomes.  The book gives a great overview of how, where and for whom checklists work. How to design and apply a checklist for super-ordinate goals is an emerging science/art.

As a hedge fund guy and anthropologist, I am fascinated.  Checklist dynamics applied correctly could be a hugely important innovation in group dynamics and increasing human potential.  As a tool for facilitating group activity they appear to be incredibly effective.  Read the book to understand how they work.  It involves, group dynamics, social interactions, reducing cognitive load and a host of other things.

Checklists allow for efficiency of semi-structured tasks and better individual and group behaviour goal directed behaviour.  Effective checklists are finely tuned for effectiveness, brevity and looseness.  Looseness is required for creativity to come in.

Great design of a bridge, airplane, product or service comes from the understanding of a goal and the design problems constraints.  Checklists seem to work the same way but in a behavioural real time way.  By providing cognitive, behavioural and group constraints, individuals are freed to contribute more effectively when need be collaboratively. 

The Checklist manifesto is a great book and gripping read.  Converting process into gripping human drama is no easy feat, but this thing reads like an action movie.  My copy of this book is already on loan request to a friend who is a risk manager for multi-billion $ Fund of Funds.  

See and here a check list in action saving lives as Sully lands in the Hudson river and saves lives.  The video is a also described in the book.

Here is Mohnish Prabai's value investor checklist.  He only gives a bit away. 

How Mohnish Pabrai Uses Checklists

View more presentations from MShareS.

I am working on a Charlie Munger type approach to the investing problem.  Charlie preaches inversion as a way to solve problems.  So here is an inversion technique to build a value investing checklist, find some great sounding investments that failed or companies that disappeared from an industry and then list why they failed.   That causal list becomes your checklist.  You can start with firms or experiences that didn't work out.  After collecting data on 30-50 a few patterns should emerge.

Group the failure points or weaknesses into clusters, management, competitive loss, industry type etc.  you could even group according to Porters 5 forces etc.  That becomes your checklist.  Each industry has its own subtleties and the key is to identify the moats in each one and then run checklists around them. 

If you succeed you will end up with a few key rules or heuristics that makes groups able to makes decisions and act, faster, better and safer.  As a hedge fund you might try organizing into teams either by sector/asset class or specialty.  Instead of a beverage analyst, auto, tech etc. how about forensic accounting specialist, emerging threat specialist, regulatory specialist, organizational psychologist to analyze corporate culture etc. to analyze impact for a firm, oh and an anthropologist to capture major cultural trends that may be fading or rising.  This approach is probably cheaper and more effective than trying to find all those skills in one person.

One more note on process and safety: as many other have called for, I wish we had an economic/policy NTSB (national transportation safety board) to do post mortems on accidents.  Ideally the crash board, would have better resources than a university and be independent of industry and congress.  Seeing bubbles after the fact is easy, determining true causation isn't.

Keynes vs. Hayek, throwdown video

Farnam street may be the best econoblog you never heard of.  Farnam Street's emphasis on common sense, ethics and behaviour is fantastic and highly educational.

Here is the latest find, see video below. For the record, I am a bigger fan of Hayek, but both are more schools of philosphy than arbiters of a true science. 

Keynes stimulus is nice in theory but most centralized distributions of wealth provide below reasonable returns due to political allocators at the switch. Keynes also appeals to the desire for control in crisis and the need to "do something".  This isn't necessarily a good thing.

Those interested in learning more about the Austrian school of thought might look at the Ludwig von Mises Institute.

In some scenarios, stimuloss (sic) crowds out true economic actors.  This limits or damages true sustainable economic growth.  Govt' sponsored weeds crowding out true green shoots isn't a good thing.  

In truly dire cases politicians gain far too much power by controlloing and directing massive flows of wealth.  Japan and construction is a good case in point.  Check out the resource curse phenomenon in some countries to understand this feedback loop at its worst.

James Montier: refreshingly honest about Finance as mostly junk

James Montier doesn't wear ties or suits etc.  He doesn't look smooth or polished.  He isn't the type you would put in a line-up of likely bankers, and yet he is refreshingly honest and knowledgeable about investing. 

Montier is an economist and global equity strategist at Dresdner Kleinwort Wasserstein, a German-owned investment bank. 

Montier has common sense and the ability to sum up some basic arguments very well.  If you are interested in investments, looking at an MBA etc. you find this video very interesting.

A Fast Company bio is here.

James also doesn't scream or yell seeking to be a personality, he just has a very honest voice.

There are some excellent points made in this video.  Well worth the time.

Some Quotes from the video:  "We intentionally screw people.  We have become marketing bitches.  Even Fama and French don't believe in the Efficient Market Hypothesis."

oh and Montier's synthesis of economic data with leading-edge behavioral research got him named London's "best global strategist" last year.

losses of 58% projected in NYC real estate

Losses of up to 58% predicted in NYC commercial real estate in 2011.  Article in Jan 8,2010 New York Times.

Readers of Designing Better Futures would have known about the potential for  this since Feb 4, 2009.  Article Tarp for Trump 60% declines for Manhattan Real Estate.  The decline estimates were for residential real estate which still has room to go, but the methodology is the same and the outcome will most likely be similar.

My assessments of gold and forex lead to +90% gains for some accounts in 09 and managed to return +45% on capital at risk in 07-08 combined for value based hedge fund. 

Value based investing is the core approach using multiple mental models a la Munger and Buffet with a little quant stuff for empirical testing.  Small capital was deployed. Common sense and patience seemed vital.

An experiment with high frequency trading this year was disastrous.  Maybe I am a better value and macro guy.

Sector knowledge:

• Forex
• Commodities
• FMCG
• Structured Finance &  Bond Insurance
• Telecoms
• Technology
• Renewable Energy
• Consumer services
• Broad international experience

Black Swan Goggles

So the holiday season is here and you have just received a pair of Black Swan goggles.  These allow you to spot Financial black swans safely from any distance.  Unfortunately  due to the warranty restrictions you aren't allowed to profit from your new super powers.

Now imagine you could also travel back in time with your swanky swan goggles.  What could you do to prevent the crisis?

Think about it.

It is the regulators dilemma in retrospect.  But imagine you are a quant, professor, CEO, banker, legislator etc. 

What role could you play?  How far would you go to prevent the current problems. 

When would you start?  and whom would you need to convince to change behaviour, rules etc.? 

Over $6 Trillion in "wealth" was being "made" by a freight train of "winners" and before that home ownership was slowly seen as a right that all were entitled to via tax breaks, incentives etc.

So who will you be with the stylish shades to change things for the better?

Those advocating better models, or tighter thinking are indirectly posing such a conjecture.  So what would you do and when would you do it? 

If you want you can continue the conversation at the Linkedin BlackSwan Group.

Bad bonds auctions & SIC code identity politics?

The 30 Year bond auction was a bit disappointing. According to Bloomberg:

Treasury 30-year bonds declined after a record $16 billion sale of the debt, the last of this week’s three offerings totaling $81 billion, drew the weakest demand since May.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.26, the least since May and below an average of 2.39 at the last 10 auctions. The bonds drew a yield of 4.469 percent, higher than the forecast of 4.424 percent in a Bloomberg News survey of five of the Federal Reserve’s 18 primary dealers.

The fact remains that the US has roughly a 4 year debt duration with north of 40% due to mature within a year is a serious issue.  The worlds bond markets aren't quite used to the $100b in auctions week in and week out.  This figure is equivelent to $5.1 trillion for nexts years issuance.  This supply could seriously challenge the demand for more US debt.

Current US cultural behaviours and beliefs strongly indicate that more economic trouble will beget more stimulus etc.  The flawed stimulus doom loop will keep going until the world decides to stop funding the party. 

Shock and awe no longer accompany domestic bailouts, stimulouts etc.  Every new announcement of federal activity seems to create the belief in the public that we all need a bailout so get in line.  The rhetoric is capitalism is for the other guy.  I am a victim. 

The new Identity politics is defined by SIC code .

Trained as anthropologist, I treat economics as a bounded belief system.

The US is now challenged as many actors in the culture are rapidly adopting defeatist and self defeating beliefs.  Accountability and a sense of responsibility go out the window. The dangerous doom loop thinking goes like this:

I am a member of industry/group X. I am important or at least my local representative tells me this when I fund his/her campaign.

Everyone else got bailed out, why not me.  Soon the positive feedback loop will accelerate as people feel "cheated" for not being stimulated.  I am a victim.

The heart of the Keynesian argument for counter cyclical injections of liquidity and stimulus is based on loose assumptions of the multiplier effects.

In my opinion The Keynesian stimulus thesis rests on one of two flawed assumptions.

1. Officials are expert at stimulating or allocating efficiently.

2. It doesn't matter where liquidity goes as it will multiply and create demand.

The only paper I trust these days is either labeled Charmin or produced by the Norwegian central bank, good luck with those insured muni's the fun isn't going to stop at the federal level, it could bubble up as well.  MBIA, AMBAC etc. bond insurance may not be a backstop, of course the state of New York can help out.

Good Senate Risk Commentary you may have missed

Nassim in some more focused presesntations before congress. Comments on Stimulus and free markets: Ht: Rocky Chen

Here is Rick Bookstabers Testimony on VaR, which is a very good introductory read.

My own opinion is that the best way to measure financial risk is to assume it is a function of concentration of opinion or belief. The more people, models, institutions etc. all believe the same thing to be true the greater the risk.

There is no "truth" in finance it is a social phenomenon, not a physical reality like physics, the laws of economics are plastic. Homogeneity in opinion leads to homogeneity in action and reaction.

It isn't the models, ratings agencies, regulators, traders or banks that cause financial catastrophes it is the fact that sometimes their opinions through mania, legislation or fate all converge leading to mania, panics and crashes.

Concentrations of opinion/belief are a form of collective myopia that is part of the human condition. We are social, we group, agree, act and propagate risk. The bubbles, actors and rationalizations change, but the ultimate causes of risk don't, we are all too human.

My own opinion is that the greatest current systemic risks outstanding are:

The dollar as safe currency, example last years lesson via the flight to quality leads to the maginot line behavior of today as the USD is now the darling of the carry trade.

Basel II implementations leading to a "unified" framework for global banking risk.