Thursday, November 13, 2008

Billionaires, not Geniuses

Watching Hedge Fund billionaires testify in front of congress was rather illuminating. They weren't nearly as impressive as their fortunes might suggest, though with the threat of litigation and legislation I can empathize with their being terse. Yet some said enough to make you understand they do not have an understanding of the current situation much deeper than Thom Friedman's latest thumbsucker on 'why we just can't sit down and work this out'. Not that they sounded as emotional and uninformed as some members of congress, but Griffith sounds like your average 40 year-old businessman. He was the only one that commented on Burton Malkiel's suggestion, that CEO's be paid with option that last well after they leave their firm mitigate moral hazard, with the very forceful objection that this would inhibit essential 'risk taking'. Of course, moral hazard is 'excessive risk taking' created by bad incentives, so Griffith left undefined exactly how getting options that might last 5 or 10 years after their tenure, as opposed to 1 year, inhibits risk taking. The whole point of moral hazard is if the horizon is short enough, lots of risk taking is imprudent though rational, thus the longer timelines. I have difficulty understanding why giving people insanely short horizons is so important. I especially do not like it when anyone selling a financial product who's risk has a weighted average life of 7 or 10 years, gets an option with anything less than 7 or 10 years. That's just dumb.

In general, Griffith was least impressive as to his insights. Paulson was rather boring and circumspect, and Falcone pretty much said nothing not written by his lawyer.

Simons didn't say much, but like a math genius, had a highly particular intelligence. He stated it was very important to step in and stop people from getting kicked out of their homes. It was a sop to legislators looking for support for something radical, and reflects a superficial understanding of the current mortgage problem (which is unrelated to his firm's activities), as the current homeowners who are not paying their bills are hardly sympathetic, and prolonging the length of time before the bank repossess the house causes more rot and decrepitude, but Simons has this intuition of an undergrad, of hard-working people who just 'fell behind' in these bad times. Lengthening the duration of the foreclosure process merely lengthens this crisis.

Then there's Soros, a true rich businessman crank. Like many successful businessmen, he has a good understanding of the real world. But also like many successful businessmen, he thinks this is a profound, academic understanding. It is not. Many wise people have a great understanding of life, but that's different than a theoretical, academic understanding, because a scientific understanding is very specific. It is very parsimonious and testable (when good). The number one characteristic of an older person (ie, over 25) learning statistics or modeling is they add too many parameters to their models. Their intuition is brimming with reality, which is insanely multidimensional.

Thus, Soros propounded his theory of 'reflexivity' to the committee, and even though he did not define it, because it profoundly changes the way we look at financial markets, it implies we must replace Basel 2 with Basel 3. If you google 'reflexivity' and 'soros', see if it makes any sense. I have no doubt that Soros is a smart man with great investing ideas, they just aren't the basis of 'theories' or Basel 3. This is why relatively uninspiring men in academia can do so well, because their field is quite different than in business: proving things, creating models to build upon. Often quite useless, they are analytical tools, much more so than the wise advice of some old relative that, while more profound, can't be systematized.


Anonymous said...

Eric, if you believe that markets work, isn't Soros much much smarter than you? Just kidding.
There's something to be learned from Soros. He survived the Nazis by working for the Nazis. His choice was death or assist murder: pretty disturbing world.
He survived and eventually prospered. What does that say about moral absolutism? The nature of the universe? I'm not implying anything here. I'd like to know.

Anonymous said...

Would you say that your PhD education helped or hindered you as an investor?

karl k said...

Soros is the exemplar of the particular strip of liberal/leftist hypocrite, who is in the end, fascist in their sensibility: he decries instability, but will not hesitate in a second to profit from it.

But if you gave him the choice -- a fascistic stability imposed by guys "who know better" and the kind of messy freedom of market players, he'd pick the former in a nanosecond.

Eric Falkenstein said...

I think ignorance is helpful to a businessman only in that it makes him more bold, which means, it makes him takes more risk than he 'should'. Thus, it is probable that many very successful investors are 'lucky fools', and their wild success partly a result of winning the lottery, in effect. But ex ante, one would still consider such risk taking rash, so I can't say I regret not taking foolish risks out of ignorance, any more than I regret not spending more money on lottery tickets.

Soros, I think, has some very good intuition on various investment opportunities, but I do not think they rise to the level of a general theory.

Mean Mister Mustard said...

Eric, once again, you have faithfully served your purpose as one of the world's top sources of middlebrow tripe. In fact, I would say you have an academic understanding of middlebrow tripe.