Wednesday, February 01, 2012

Charles Murray Reiterates Willpower


I really liked Tierney and Baumeister's book Willpower. Their argument is that willpower is a very useful skill, one that like a muscle tires when used, but can be strengthened through repetition. We should all practice daily acts of self-control to become more productive.

Charles Murray's latest book Coming Apart addresses the same theme, noting that society is splitting up into classes based on their abilities, which are highly driven by bourgeois values. Over the past 50 years, the working class have lost their industriousness, honesty, religion, and respect for marriage, and he presents a bunch of data to bolster this argument (eg, less than 5% of college educated white women have children out of wedlock, but 40% of white women without college do). This book is a straightforward extension of the main arguments in his two prior best sellers, where in Losing Ground he argued that the Welfare State is destructive to productivity and ethical development, and in The Bell Curve that society is sorting itself into a meritocratic class structure. By focusing on white people and that portion of individual skill amenable to environment--willpower--he tries to avoid issues of genetics and racial politics that were a large part of The Bell Curve commentary.

Murray argues the well-off should set a better example by not apologizing for their squareness, but rather, by advocating their lifestyle and scorning those who fail to live up to it—we need more of what is usually called 'blaming the victim'. Murray singles out the modern welfare state as the key instigator for our moral squalor, but I rather think our lack of faith in bourgeois values in general was the first mover here. Surely enlarging the dole increases the size of its patronage pool, but I still think policy is more symptomatic than causal.

Consider that in the 19th century novelists popularized the idea that cultural constraints or expectations were often arbitrary and led to seemingly needless shame and psychological problems (eg, The Scarlet Letter, The Brother's Karamazov, Jane Eyre). A slew of social scientists picked up the vibe, especially Freud or the Frankfurt School (Adorno, Horkheimer, Marcuse), and the Marxists. For example, in Freud's view sexual urges were viewed as having a powerful biological basis, while traits such as responsibility, dependability, orderliness, guilt, and the delay of gratification, are imposed by a repressive, pathology-inducing society, often a mere 'transference' from some guilt-trip inspired by traumatic potty-training or one's desire to have sex with one's mother. A bourgeois conscience became a hang-up that prevents you from realizing your authentic self (note the importance of 'self-actualization' in mid 20th century books like The Invisible Man). It never occurred to them that having no constraints or conscience has worse problems.

The subversive agenda of these writers was to pathologize traditional Western norms such as those celebrated by Puritans, Quakers, and Calvinists. Such norms were rarely perfectly achieved but nonetheless seen as unambiguously good, and so aspirational. It's useful for anyone but especially children to have clear goals as to what is the 'good life', and an important point to remember in this arena is that we should not let the perfect be the enemy of the good, especially in comparison with the untried.

After the Frankfurt school infested America, the beatnik idea that we should all 'tune in, turn on, and drop out' was a logical extension, supposedly an incredibly profound insight on how 'to be' (as usual, expertise was confounded common sense, as any family with an addict will tell you such a drug-induced stupor is the opposite of ennobling). Traditional parent-child relations, though popular on TV at the time, were being sullied in the academy as involving the suppression of human nature, and so the cause of domination and authoritarianism, which led to the Hitler (really, read The Authoritarian Personality). A healthy individual, meanwhile, does whatever he feels, which should involve rejecting their parent's strictures.

The end result was not total consciousness and keen insights about truth and beauty, but rather, nihilism and depression. The 'Greatest Generation' built things like Hoover dam and created a country of unprecedented prosperity and universal education; then, as if to prove that failure is endogenous, raised the greatest generation of naive, self-absorbed whiners in the History of Man.

My parents graduated college when such progressive ideas were intellectually dominant. They considered discipline, such as that required by drilling exercises, to be deeply destructive, and education was simply about figuring out how to release the genius that exists in all of us (this probably explains a little of why I liked Willpower so much, because I see very clearly how these principles would have been helpful for my upbringing). This naive zeitgeist reached its intellectual apogee, unfortunately, right about when and where I was born (1960's California) and turned that beautiful Eden into a failed state, a suicide New Yorker intellectuals might not notice from the gated community that is Manhattan (median home price a cool $1.4MM).

Scribes have always been jealous of the wealthy and powerful, thinking that an elite set of navel-gazing intellectuals such as themselves would be more efficient, as if they wouldn't turn into illiberal tyrants in short order (see what became of young intellectuals Trotsky, Mao, Ho Chi Min, and Mugabe). They convince themselves prior attempts along these lines were co-opted, but that's purely self-serving confabulation. Unfortunately, these same people dominate the media and academia by their very nature (wordsmiths), so it will be hard for modern mores to change because people wise enough to see it's wrong will tend to simply succeed off the grid, without reconciling their success theoretically in a treatise.

Currently there existis a dominant coalition of the lumpen-proletariat and their patronizing, indulgent, but highly status-oriented advocates who aspire to lead the new reverse dominance hierarchy. The leaders will argue that we should expropriate if not imprison the rich and their like because 1) mass redistribution will always win a referendum and 2) such a process needs leaders, and who better than those most articulate and faithful to the hive?

Subsequent to the anti-nuclear family claptrap within modern literature and sociology departments, psychologists have found that children will accept high levels of parental controls, but only if the relationship with the parents is positive. The key is having moral authority that comes from demonstrated competence and consistency. So too will the lower classes accept judgment from the upper classes if they think such observations come from those who believe what they say and say something true and important. Currently, they simply hear about how great it is to be a victim, how noble it is to be poor, powerless, or discriminated; to be wronged is the ultimate in righteousness. This simply isn't true and the poor know it. Suffering does have meaning when it cannot be controlled, and in such times a stoic attitude is truly heroic, often taken out of a higher duty to one's neighbors and family. But simply suffering low status because one does not have a job, stopped paying their mortgage, is in jail, or did not learn a trade, is usually the result of simple sloth and shortsightedness, and all their friends and family know it.

Alas, successful people are ashamed to assert they have better genetics, values, and habits--even though they quietly believe it to be true--and so are content to let the media and intellectuals push the delusional idea that success is like when Paris Hilton had sex on a digital camera and built a career out of it: luck, connections, and chutzpah, but no discipline, ingenuity, and perseverence. With such examples it becomes defensible to suggest most of the rich are like that--mere lucky hacks in the game of life. The flip side is that those who are unsuccessful are suffering for no fault of their own.

Thus, every day we see people championing the pathetic in journalistic essays: a scared mother of four on food stamps, or her selfless Community Activist advocate. No one champions the simple strivers, those who take care of themselves and in the process alleviate society of one more charity case, and along the way create wealth via 'gains from trade' implicit in market transactions. A simple prosperous mensch who does not hypocritically claim he primarily works for others is off the radar, implicitly insulting to any intellectual making considerably less than him.

The kind of change Murray is talking about will not happen until productive, successful people again feel pride in their distinguishing learned characteristics, including the willingness to shame people who do not have them. Consider that at the height of America's growth, the most popular form of fiction lionized were Horatio Alger stories, which lionized initiative and material prosperity. On the bright side, the ideas of Freud, Marxists, the Frankfurt school, and their destructive spawn are on the decline, mainly because they were never sciences they aspired to be, rather, intellectual fads once plausible but no longer (eg, no trendy writer is going impress his readers by giving his subjects Freudian complexes the way Norman Mailer did). Children of beatnik-influenced parents like me are not doubling down on the manifest failures in that philosophy. On the other side, failed big governments like Argentina, Brazil, and India highlight that countries are not like companies, they do not have to transform to survive when they go bankrupt. I wish people would valorize bourgeois virtues, but I don't see a catalyst around the corner, especially with 1/6 of Americans getting some kind of welfare.

Monday, January 30, 2012

Fama on EconTalk

Eugene Fama is interviewed by Russ Roberts over at EconTalk. Most of the time they talk about the Efficient Markets Hypothesis, and the mortgage crisis, but 'risk premiums' were mentioned in this little exchange:
Roberts: What are the lessons for me that finance has learned that are important? [bla bla]...
Fama: [blah bla] ... I think we've learned a lot about risk and return. Some of it is intuitive. But there is a lot of stuff on which stocks are more or less risky. A lot of stuff on international markets...[bla bla]
That was quite the elision! Risk is ubiquitious in modern finance as an explanation, as Robert Merton says: 'Risk is not an add-on … it permeates the whole body of thought.' Yet it receives only a minor mention that passes so quickly here, as if not to dwell on it long enough to elicit any follow up, such as "which stocks are riskier than than others?" If it's value stocks, why do they have lower betas and volatility than growth stocks? If it's small-cap stocks, in what way are they risky, other than having higher-than-average returns? If it's equities in general, why is the CAPM a failure cross-sectionally? It is, after all, the main focus of his oeuvre, so I think he's unconsciously signalling he's on the defensive here.

An interesting point is that the Efficient Markets Hypothesis (which I defend here), is something that started out without much enthusiasm, but over time has grown stronger, led mainly by the obvious fact that it is very difficult to make abnormal returns in the market. Fama gets a lot of flack for it since day 1, but it has been his most enduring idea (clearly, a group effort with Working, Samuelson, and Muth). The risk premium, however, started off as a fait accompli around the same time, though the risk factor is like a Freudian's Oedipal complex, something that started out with supposedly clear empirical support but later was simply assumed. This is because the risk premium is a direct consequence of the most fundamental assumption of economics: a von Neuman-Morgenstern utility function, one that increases in wealth at a decreasing rate. Given that, risk premiums exist, so for most economists, one doesn't need proof. This is nice because we don't have any other than the supposed equity risk premium, which even if it is 3.5% as most experts think, should generalize to something other than the difference in return between equities and bonds (eg, cross sectionally, over time, across futures, currencies, bonds, etc).

Sunday, January 29, 2012

What if Returns Don't Reach 7%?

A review in the WSJ on the book The Hedge Fund Mirage by Simon Lack notes:
The return-on-investment targets of 7% to 8% that are structured into pension plans are beyond reach in today's artificial environment. To redeem their promises to retiring teachers, firemen and the like, managers are risking more money with hedge funds in hope of yields higher than those on safer investments.

And so it is, as I read subsequently that:
Just five years ago, it was illegal for South Carolina's public pension plan to invest in hedge funds, private equity and other complicated bets.

Now, nearly half its assets are in such investments. That is way too much for the state treasurer, who is charged with squeezing the most out of the $26 billion pension fund.

Unfortunately, hedge funds are doing worse than ever:
The "Global Macro" trading strategy, one of seven tracked by the Dow Jones Credit Suisse "Core Hedge Fund Index," finished last year down over 10%, worse than the entire index, which fell 7.4%.

This isn't going to end well. The risk premium of 5% that everyone expects is not going to happen, and this failure will act as positive feedback in the upcoming fiscal disaster; when the pension funds all under perform and need more money, it will be the nail in the coffin. I think the tinder will be inflation, which the central banks seem to think is the cure for their GDP ills (and those of underperforming pensions), so they will push until it comes back.

Wednesday, January 25, 2012

Is Arithmetic Return Bias Basis of Low Vol Anomaly?


I created an index of the highest beta stocks from 1962 to present. Every 6 months I took those 100 highest beta stocks, excluding the lowest 20% in market cap (to get rid of dumb stocks you can't trade). The results are in the chart above, and summary data are as follows:

The top line, "AnnReturn", is the arithmetic return, and here the monthly returns for the high beta stocks are about 0.14% higher than the S&P500, which when multiplied by 12 is a 1.7% difference. But looking at the chart which shows a total return chart, and the geometric annualized return, we see a very different picture, with the high beta stocks underperforming by 3.5% annually.

The basis for this is the difference between geometric and arithmetic returns, which is

Geometric Return =Arithmetic Return - Variance/2

Thus, the differential annualized variance (in this case, 12% vs. 2%), generates the differential annualized return. Interestingly, the return rankings for these data are different depending on the horizon!

Mutual funds and individual investor holding horizons average about 1 year, and I think that's a good assumption for an investment horizon. It seems that 1 year would be the obvious horizon to apply data against, but the problem is there is so little of it. There's like twelve times as much monthly data! A simple fix would be to use log returns, but this doesn't always happen, and I think those who still find the Security Market Line to have a positive slope in general are looking at monthly percent return data, and this is why they see what they do.

Insurance and Pooling Equilibria

In the bad old days, insurance was a way to smooth cash flows from improbable but large expenses: fire, health, auto mishaps. Through repetitious metonymy, 'health care insurance' and health care are now synonymous.

I was struck by Obama's mention last night that:
I will not go back to the days when health insurance companies had unchecked power to cancel your policy, deny your coverage, or charge women differently than men.

Emprically, women use more health care, they cost more, estimates are around 35%. Some of this is childbearing, but a lot of it comes from the simple fact they go to the doctor more often (notice women see their gynecologists rather regularly, whereas men have no comparable service). So now charging women more for something they use more of is illegal because it discriminates.

Interestingly, in the 1970's there was a law passed so that upon retirement, the annual payments to female retirees had to be the same as for male retirees even though women live longer, statistically. That is, the present value of their retirement packages, by law, are larger for women than men.

Government seems to be doing more and more to make it difficult to prevent 'pooling equilibria', cases where different types of applicants get into a pool, eventually pushing out the 'better' or 'lower cost' people who don't want to subsidize the other group. For example, due to legal rulings, it is now very difficult to give job applicants explicit aptitude tests, even though this would be very useful, and avoid the charade from those Microsoft/Google IQ tests given verbally. Interestingly, Nobel Laureate and prominent Big Government advocate Joe Stiglitz's most famous paper relates to an inefficiency from a pooling equilibrium, and his take-away was that markets were inefficient because of this problem. In practice, government encourages pooling equilibrium where it was never a problem before by preventing rational discrimination based on projected costs/benefits based on observable characteristics.

While the equilibrium efficiency loss in Stiglitz-Weiss is abstract, it usually creates something pretty simple, as if you can imagine what would happen to insurance if it could not price based on risk and allowed people to opt out: healthy people would leave in droves, which is why Obama-care made insurance mandatory. Think about the lawsuits on disparate impact for mortgage lending in the 1990s, where whites were rejected less often than blacks, and this was presumed discriminatory (in an evil way), and so the only way to make unequal groups equal is to stop making distinctions that differentiate them, which led to simply the idea that down payments and having a job were unnecessary underwriting criteria.

It's rather funny that Stiglitz's main theoretical contribution to the academic literature is so starkly in contrast to not just his politics but his obsession, which is increasing the size and scope of government which prioritizes preventing firms from rationally discriminating. Remember that in Stiglitz's model, like everything else in this literature (he didn't invent it), failure to discriminate types somewhat known by participants is what causes all the problems, the 'bad equilibria.' I guess that highlights no one takes these models very seriously--change one assumption here or there, different result.

Sunday, January 22, 2012

Modern Robin Hoods

My Sunday opinion section had a commentary piece arguing why we should tax the rich more. It ends with this:
Am I envious, Mr. Romney? You bet I am. But I'm also angry at the stark injustice of it all.
The author is the 'vice president of the Institute for Local Self-Reliance.'

Wednesday, January 18, 2012

Wikipedia Black Out Working

Many of my favorite websites (Fark, Wikipedia) staged a protest against some intellectual property legislation coming down the pike, and it seems to have been successful. For example, Florida Senator Marco Rubio made this confession:
In a frank statement posted to his Facebook page on Wednesday, Rubio hinted at a Beltway truth that many other wavering Protect IP and SOPA supporters have been hesitant to admit: More than one lawmaker signed on to the legislation without understanding its technical workings and potential problems, believing it to be an uncontroversial, bipartisan bill that would support American industries.
Of course, this highlights that often senators vote for legislation without understanding its technical workings and potential problems.

Tuesday, January 17, 2012

MIT Economists Running Central Banks

Bloomberg Magazine has a piece on the MIT economists who dominate central banking today. If you ask them why, they will say it's because of their particular blend of theory and practice (as if the idea of theory AND practice is really an outside-the-box idea).

I think it's more a matter of this was a group of smart kids who were really interested in macro, because in the 1970's they were still optimistic about its ability to be useful. A small group like that can create a positive feedback loop pretty easily, because having a recommendation from other successful macro economists is very important.

Yet, given the recently released Fed minutes from 2006, we see these Cambridge macro savants are a lot like the world's leading psychoanalysts all being from Vienna in 1930--experts to be sure, just not at actually helping people. Here's what US central bankers were saying about Greenspan when he left in 2006
For the Fed 2006 began with the departure of Mr. Greenspan, who presided in January over his final meeting as Fed chairman and was then widely regarded as the epitome of a central banker, a master who had guided the American economy through almost 20 years of remarkably consistent growth.
...
Ms. Yellen said: “It’s fitting for Chairman Greenspan to leave office with the economy in such solid shape. The situation you’re handing off to your successor is a lot like a tennis racquet with a gigantic sweet spot.”

If they didn't see our greatest recession since the great depression coming, why should we expect them to see inflation before it's too late?