Monday, 29 September 2014

Ayn Rand v Wishful Thinking

As you may have gathered from his previous ramblings, The Spear generally leans to the political right.  And, being the human that he is, The Spear tends to read things which he knows he will find agreeable.  Thus he is 9/10 of the way through Ayn Rand’s ‘Atlas Shrugged’.

Ok, The Spear knows what you’re thinking, it is either:
a)      Ayn Rand?, who the hell is that?
b)      Ayn Rand?, you disgust me. Or
c)       Ayn Rand?, don’t you mean ‘Jesus’.

To those in camp (a), Google it.  The Spear would like to think he does not belong in either of the other two categories.

Given her experiences in soviet Russia, it shouldn’t come as a surprise that Rand’s writing is fiercely anti-communist, as with other writers from the former USSR including Arthur Koestler (Darkness at Noon amongst others) and Friedrich Hayek (Road to Serfdom).  Indeed, she and her family suffered first-hand all that the grim reality of communism entails; the property seizures, the displacement, the purges, the desperation.  It is only natural that her position was in favour of the American-style laissez-faire capitalism under which she made her name.

What does come somewhat unexpectedly for a first-time reader of Rand is her style of storytelling.  Subtlety is a tool that has seemingly been sacrificed by Rand to make sure that her message to readers comes through loud and clear.  This in-your-face style of writing has the effect of enthralling supporters and enraging detractors.  It is a shame, really, as there is much to be taken away from this half novel, half philosophy lecture, if one is able to get past the woefully one-dimensional characters it relies upon.

Although one is never fully able to believe that such hyperbolic characters could be real, their traits, in themselves, are accurate representations of the underlying forces at play, which are often hard to grasp and elucidate.

While there may never be someone as totally destructive as James Taggart, or as superhumanly competent as John Galt, if one looks at them instead as allegorical attitudes or characteristics, Rand does as a great job at describing the mindset and value system required to make each possible.

She explores in great detail what value system is required to justify the renunciation of rational thought and self-interest at the behest of a moral debt to an unknowable God or the subjective ‘greater good’; the former which demands sacrifices in return for rewards in the after-life, and the latter which demands sacrifices for promises of a bright but always distant future.  Both require that people feel guilty about enjoying themselves during the present, and idolise ‘need’ over ability.

She also highlights the great hypocrisy of the wishful thinkers who want to have their cake and eat it too; the non-thought of those who want to reap the benefits of something whilst denouncing its means, who want to deny reality by getting something for nothing.
These aren’t just theoretical traits of characters in a novel.  These non-thoughts are held by those close to The Spear.  The Spear knows people who on the surface appear like normal, rational human beings, but who are yet able to extoll these ultimately destructive ‘good ideas’ in the name of ‘morality’ and ‘heart’. 

‘You are heartless’, they say to The Spear.  ‘Don’t you care?’ they say to The Spear.  ‘You are selfish.  All you care about is money’ they say, as if good intentions and ‘heart’ alone allow them to live lives of relative luxury or do anything but hug those in need.

‘Government should be about helping people’ they say, without any thought to the source of this benevolence, or any limit to it.  Meanwhile, productive business, the ultimate creator of all the government’s wealth, is viewed as base commercial enterprise, to be regulated and taxed, but not admired.  A government that only puts in place the services necessary for people to effectively look after themselves is not wanted.

What is wanted is the land of the milk and the honey, but without any of the incentive mechanisms necessary to achieve it; i.e. they are after ‘heaven on earth’, the ever-elusive, forever in the future utopia, that shall one day be achieved if only the people were to sacrifice more for the greater good.  If only the people were made to sacrifice more for the greater good, at the point of a gun if necessary.  It’s for their own good...  The end justifies the means…

Before you label The Spear as a lunatic, all he can say is beware.  Be vigilant.  It may sound hard to believe but THIS HAS ACTUALLY HAPPENED.  This seemingly crazy line of thought has actually overtaken entire countries for decades at a time.  And once it has, it’s the most ruthless who rise to the top.  That’s why people like Rand and Koestler and Hayek and Orwell wrote their books.  They are reminders – reminders to the people of the future – never to be conned by the line of thinking which, yes, sounds like a good idea, but ultimately leads to nothing but death and destruction.

So thanks, Ayn Rand, for another reminder.

Sunday, 21 September 2014

The Photo Shoot

E1 = Employee 1
E2 = Employee 2
P = Photographer

Two men enter dressed in white-collar work wear.  The room is set up for a photo-shoot; there is a large background screen with industrial/construction images on it, a couple of spot-lamps and reflectors and typical photography gear.

E1 = How did we get roped into this?

E2 = I don’t know; the boss said they needed a couple of guys for some new promotional material and I guess they decided that we were the most photogenic.

E1 = I would have done my hair this morning if I knew my mug was going to end up on a billboard.

E2 = I wouldn’t get your hopes up, I doubt we’re going to end up on the cover of Time or anything.  Knowing our company we’ll probably end up on those ads above the urinals in airports.

E1 = (sarcastic) Great.  Like all I need is random dudes associating their dicks with my face.

E2 = Cause you’d get enough of that on the weekends as it is wouldn’t you.

E1 = Yeah  it’s like -… Oh ha ha.  It’s good to see you keep pushing the boundaries of comedy with your insightful witticisms.  We are all truly in your debt oh hilarious one (mock flourish).

E2 = You’re welcome.

E1 = So, have you ever done anything like this before?

E2 = Do mug-shots count?

E1 = Nnnnno.

E2 = Then no, I haven’t.

E1 = When I was six my mother took me and my sisters to a modelling agency for a few photos to see if she could make some money out of us.  Turns out she couldn’t.  Apparently we didn’t have ‘it’.

E2 = That’s a shame. 

E1 = Yeah, I think it broke her heart, having to come to the realisation that we wouldn’t be able to pay for our own upbringing… What poor little bastards we were.

E2 = Oh well, you know what they say…?

E1 = What?

E2 = It’s not who you know, it’s who you bl..

Enter a Frenchman in a black turtleneck and beret.

P = Ah!  Here are my two superstars!  My two little Fabergé eggs!

E2 =  (aside) Here we go…

E1 = So, are you gonna make us famous or what?

P =  Famous?  Famous?  No, fine messieurs, no!  By the time Pierre De Bagnolet is finished with you, you will be infamous!     

E1 = Infamous?  Isn’t that the same thing?

P = Fame is fleeting – Infame is infinite!  No!  If Pierre De Bagnolet has his way, there shall not be a urinal in all of the nation which does not bear your faces!

E2 = Told ya.

E1 = Oh man!  And we're not even getting paid for this!

P = Do not underestimate the art of the u-ri-nal!  With urination comes relief, and with relief comes ‘appiness!  You, my friends, will be the archangels of ‘appiness!

E2 = Archangels of jock-itch more like it.

P = Enough!  Let us begin the magic of the lens!  (He puts on some pop music and starts prancing around with his handheld camera) You!  Over ‘ere (pointing to a spot in front of the camera).

E1 = Here?

P =  No!  Over ‘ere (physically moving E1 about two inches to the left). You!  Over ‘ere!  (E2 shuffles into position reluctantly).  Now, show me your ‘appy faces!

(E1 and E2 put on forced smiles, P looks through his lens at them but does not take a photo)

P = ‘appy!  Think ‘appy thoughts!

E1 = (through clenched teeth) It’s a bit hard…

E2 = (through clenched teeth) Kill me now….

P = A challenge!  Never fear.  I would not have it any other way.  The easy mistress is not worth wooing!

E2 = Speak for yourself.

P = No!  You two are the refined, elegant beauty who will not give up her flower easily.  But I promise, no matter what it takes, Pierre De Bagnolet will find a way to deflower your soul!

E1 = And I just had mine pruned last week.

P = Props!  We need props!  You! Hold this piece of paper (he hand E1 a large schematic).  You! Put on this ‘ard ‘at (he hands E2 a hard hat.  The two handle the props uncertainly).

E1 = What do you want us to do?

P = Read!  Read it like you have never read before!

(E1 unrolls the plan and the two start looking at it in a quizzical manner.)

P = (looks through camera) No, no, no, no, no!  WHY so serious?

E2 = He fights crime by night…

P = ‘e can fight crime on ‘is own time!  You need to leave your stress behind, and live in the moment!  You need to believe!

E1 = Believe what?

P = Look around you!  See ze cranes.  See ze buildings.  See ze sky-scra-pers!  You are men!  Men at work!  Become one with the machines!  Become one with the metal!

(The two employees look around each other and slowly become more rigid in appearance)

P = Better!  Now, I need you, in the ‘ard ‘at, to point.  Point at the paper and believe!

(E1 points at the paper)

P = Believe!

(The paper starts vibrating noticeably in E1 hands)

P= Yes!  Yes! That’s it!  That’s it!

E1&E2 = Ahhhh! (The paper is by now shaking violently in E1 hands as the pressure of the moment builds),

P = Believe!  Believe!  Believe!

E1&E2 = Ahhhh! (E1 pokes a whole through the paper ripping it in two.  The two employees collapse in exhaustion)

P = Excellent!  Excellent!  Pierre De Bagnolet strikes again!  (He lights a cigarette and turns the music off).  That will be all for today.  Here’s my card (he throws his card at them and walks out.  The two employees sit on the ground regaining their breath).

E1 = I think he took my flower!

Thursday, 11 September 2014

The Insanity of Repetition

The Spear has noticed in the past few months several (what he thinks are homeless) individuals of his city engaging in odd behaviour.  ‘Odd?’ you say, ‘but why that is to be expected from vagrants’.  However, what brings the behaviour to The Spear’s attention in this case is not so much the oddness of the behaviour, but rather the impeccable regularity with which it is undertaken.
The first is the case of the Silent Stander.  The Silent Stander, as the Spear has dubbed him, is a man who simply stands in the same spot every day, looking into the distance and looking rather worried about something.  Every afternoon as The Spear walks past a certain square, the man is to be seen standing up straight as a rod in his spot facing the centre of the square, his arms at his sides, shifting his weight uneasily from foot to foot, and repeatedly clasping and unclasping his hands, as if concentrating very hard and nervously waiting for somebody to appear.  He doesn’t speak or hassle passers-by (which are many as he is in the main thoroughfare).  He simply stands and looks rather worried.

The second is the Screaming Sitter.  In great contrast with the Staring Stander, the Screaming Sitter is an ageing lady who sits on the same city bench every night, yelling profanities at everybody, but at nobody in particular.  She yells and yells about the hardships of her life, and the wicked ways of the world, while seemingly waiting for the bus.  She can be heard up and down the street, but perversely it is the excessiveness of her ranting which grants her as little attention from passers-by as the Stander’s silence.  

At first The Spear was slightly concerned by the odd behaviour of these clearly disturbed folk.  But, having now seen them on a regular basis, their harmless antics have simply become part of the landscape, forming part of The Spear’s own routine. 

Indeed, a certain safety and comfort is endowed by repetition.  The comfort of the known, even if it is utterly insane, is sometimes still preferable to the fear of the unknown.  Better the devil you know, right?

However, it has also been said that insanity is doing the same thing over and over again and expecting different results.  While this may not take the form of standing in odd places with a look on our face implying we’ve just shat our pants, The Spear thinks we can all be a little guilty of that.

Lotto tickets week after week.  Getting wasted every Saturday night.  New years eve parties.  Online dating.  Tinder.  Insanity isn’t just the playground of the vagrants.

The Spear isn’t sure what results these ‘crazy’ people he keeps seeing are hoping for, but he hopes that they can find whatever it is they want and move on.  Likewise, if things aren’t working out for you doing the same old routine, perhaps it is not the world, but you, who should start doing things differently.

Monday, 18 August 2014

Misbehaving supermodels: She ain't so pretty after all

“Beauty is a form of Genius--is higher, indeed, than Genius, as it needs no explanation…It cannot be questioned. It has divine right of sovereignty. It makes princes of those who have it.” - Oscar Wilde. 

One does not usually associate supermodels with those in the risk management profession.  While the term ‘models and bottles’ has long been associated with high-flying investment bankers, their middle-office brethren, the risk managers, have always played the nagging house-wife to the bread-winners of high finance.  Yet those in the middle office, while far removed from the limelight of the catwalk, have taken to supermodels of a different kind; models whose beauty is defined by mathematically elegant expressions of risk.

The financial supermodels of risk managers are numerous, and their creators often achieve a form of celebrity status amongst fellow academics and industry practitioners.  Markowitz’s Modern Portfolio Theory, the ensuing Capital Asset Pricing Model and the Black-Scholes-Merton Options Pricing model are all prime examples where the model’s creators were deemed (perhaps foolishly?) worthy of Nobel Prizes.  A notable exception to this honour-roll, however, is the widely used (and Basel regulated) Value at Risk (VaR) metric.

Perhaps because of its practical development from within industry, as opposed to the white-glove environment of academia, VaR is seen as more of an every-day risk management tool, rather than a feat of ground-breaking intellectual rigor.  Essentially, it summarises risk to a single number; the dollar amount of mark-to-market losses on a portfolio that should not be exceeded within a certain time frame at certain high level of confidence.  But it is this supposedly simple nature of VaR, combined with the exposure of risk managers to it every day, which makes this unassuming supermodel potentially the most dangerous.

Nassim Taleb, author of Fooled by Randomness (2001) and The Black Swan (2007), has been one of the fiercest critics of VaR as a risk management tool.  One of Taleb’s primary criticisms is that models of uncertainty are too precise, given the condensation of complex factors necessary to produce a single-figure risk measure for a large portfolio.  He argues that such undue precision enables investors and managers to be lulled into a false sense of security, breeding contempt for risk and a false sense of control.

Yves Smith is similarly scathing of VaR as an effective risk management tool in her book Econned (2010).  Aside from arguing that the degree of abstraction necessary for the production of a VaR discards important information about the behaviour of the underlying systems, she directly devalues what a VaR estimate is really worth.  By adopting confidence levels of 95-99%, which are relatively good at predicting day-to-day risk, she argues that VaR does not focus on what is really important to risk managers, namely what lies in the remaining 1-5% of the loss tails.

Indeed, VaR is silent with regard to what lies beyond the chosen confidence level, and this silence can prove deadly.  Hull (2012), details how undesirable risk-taking can be inadvertently encouraged when VaR is used to try and limit the risks taken by a trader.  In essence, traders who like taking high risks in the hope of realising high returns (and fat bonuses) are able to structure trades that satisfy VaR limits imposed by a bank while simultaneously exposing the bank to massive losses in the silent tail, utilising a return distribution that is anything but normal.

Defenders of VaR, such as industry practitioners and authors Eric Falkenstein and Suna Reyent, point to more recent methods of estimating the tail risks, such as Extreme Value Theory, Expected Shortfall and Conditional VaR.  Importantly, they note that most firms don’t rely solely on VaR, but supplement this measure with other methods such as stress-testing and Monte Carlo simulation.  Yet detractors such as Smith and Taleb argue that all of these approaches send broadly similar signals, and do nothing much to solve the problem of reliance on historical data.

The very nature of historically-based volatility estimation methods upon which VaR is based, such as GARCH modelling, certainly seem to imply the adoption of pro-cyclical capital policies by financial institutions.  By encouraging banks to hold less capital in good times and dictating they hold more capital in times of market turbulence, they encourage build-ups of leverage followed by a rush to the exits and the freezing of credit markets.

Sadly, given the cut-throat nature of the global capital markets, management’s hands are often effectively tied when deciding which risk metrics to push.  It doesn’t take much imagination to envision competitive pressures forcing the hand of management to adopt capital-light risk metrics during times of low volatility, of which Basel regulated VaR classifies as a prime candidate (the upcoming Basel III is an attempt to rectify this).  While the risk managers may have their stress-tests and methods for estimating tail risks, anecdotal evidence from the GFC overwhelmingly points to the sacrifice of long-term risk management on the altar of next quarter’s results; the nagging wife losing out again to the breadwinner of the household.

This race to the bottom of minimally regulated capital requirements in order to remain competitive and satisfy shareholders has the effect of focusing the attention of risk management on the numbers.  Similarly, where profitable risk-taking by utilising high levels of leverage can be justified by focusing on the numbers and ‘black boxes’, as with Long Term Capital Management and other so called ‘scientific’ hedge funds, the focus inevitably remains on the justifiable metrics, rather the nature of the assets under management.

This approach is diametrically at odds with the value-based investment strategy of arguably the world’s most successful investor, Warren Buffett (a long time critic of VaR and Modern Portfolio Theory).  Rather than focusing on statistically definitive volatility as a measure of risk, Buffett’s value investment approach relies instead on a hard-headed analysis of an investment’s prospects rather than its price movements.  Unfortunately, these types of business judgements and valuation skills are not easily taught, and are ugly and vague when compared to mathematically beautiful models and claims of scientific justification.

Thus, while VaR and other quantitative risk measures are known to have significant shortfalls, management seeking justification for myopic risk taking and regulators seeking a hard, enforceable rule, are seemingly destined to focus on the simplified, backwards-looking numbers, which are worth almost nothing when it comes to estimating anything other than day-to-day risks; the very risks which least require sophisticated risk-estimation tools.

Although the beauty of risk management’s supermodels may indeed have divine sovereignty, to quote once again Oscar Wilde, “The truth is rarely pure and never simple.”  While Basel lll may prevent history from repeating, continued reliance on supermodels like VaR will make sure it rhymes.

Friday, 15 August 2014

Problems of the Rich & Famous

Being rich and/or famous has its own unique set of problems, as The Spear recently saw first-hand.

As The Spear drove along his street this morning, he looked in his rear view mirror to spy none other than the car of the richest household in the neighbourhood (if the sizes of mansions are any indication).   Easily identifiable by its custom plates, the convertible Mercedes Benz was being driven by the jewel-burden woman of the household with one of her old-money friends for company in the passenger seat, and a brand new Persian rug poking up in a roll from the back. 

There was only one problem with this image of sundry wealth: it was pouring rain.  The size of the Persian rug had prevented the duo from raising the hood on their convertible, leaving the pair as drenched as the Merc’s leather upholstery.

The Spear remained dry in his second-hand Mazda.

While most people seem to like the idea of being rich and famous, this may be because they have never been exposed to the problems which only the rich and famous are subject to.  People may question how someone as famous and successful as Robin Williams could consider taking their own life, but the reality is these most of these people could never know just what problems that level of success can bring.

Sunday, 27 July 2014

The Opportunity Cost of Talent

There is an implicit cost that comes with the possession of talent of one sort or another: the inability to use that talent for more than one thing at a time.

The notion of Opportunity Cost, widely used throughout the world of economics and finance, is defined by Investopedia as:

The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

In the realm of capital budgeting - which is a largely analogous to how a person decides which projects they will undertake - the opportunity cost, otherwise termed the ‘discount rate’, is the term on the denominator of the equation of the present value of the project.  Thus, the higher the discount rate (opportunity cost), the lower the value any particular future benefits from the project become.

A relatively talented individual under normal circumstances is often confronted with a relatively good set of options, or potential projects.  For instance, those who score highest in their tertiary entrance exams will be able to choose from any course in any university.  Likewise, very good looking people are generally inundated with a plethora of potential suitors.

Therein arises the problem of the relatively talented.  Because they are faced with a multitude of options, deciding which option is best becomes a hard task.  When the opportunity cost of any action is so high, the relative value of one seemingly good option over another becomes marginal, and given the number of variables usually in play, it is hard to determine which course of action is actually best.

Imagine a genius like Leonardo da Vinci.  If he were alive today, he probably would have been sent to a special school for the especially gifted, and put on the fast track to the inevitable PhD in mathematics.  Would he have been happy with that?  Seeing as left to his own devices he ended up a painter, sculptor, architect, musician, mathematician, engineer, inventor, anatomist, geologist, cartographerbotanist, and writer, it is plausible that he would have felt some angst over his wide-ranging talents within being so narrowly applied.

He doesn't look too happy

For the relatively untalented, the path of action is normally much more straightforward.  As with increasing the relative returns on a project by reducing the discount rate, those with a low opportunity cost often know when they are presented with a good deal: a well-paid job v minimum wage/unemployment, a trip abroad v no holiday at all, anybody v isolation.  Beggars can’t be choosers.

So, if instead of taking what you can get, you find yourself asking if you’re getting all you can take, welcome, friend of The Spear, to the land of the relatively talented.

Monday, 14 July 2014

Specifying Specificity

Once upon a time The Spear wrote specifications as part of his job.  What he quickly came to realise, without really giving it much thought, was that there were essentially two very different ways of specifying requirements, each with their own strengths and weaknesses.  We use both every day.

The first is an outcome-based, or ‘top-down’ specification.  It focuses on what is trying to be achieved, without giving much detail as to how it is to be achieved.  For instance, ‘the shirt must be cleaned,’ is a form of top down specification. 

Outcome based specifications are often used when the specifier is short on time or technical expertise, where the process used to achieve the outcome is not deemed to be critical.  They are a kind of ‘catch-all’ that cannot fail to capture the want. 

Due to the often qualitative nature of the fulfillment of top down specifications (all projects must be accepted at some stage by a human being who gives the ‘OK’), it is typical that such a specification comes with a qualitative acceptance clause such as ‘to the satisfaction of X’.  Contractors and those seeking to satisfy specs hate this ambiguity as it is hard to quantify (i.e. cost).

Their lack of detail gives the person receiving the specification leeway to satisfy the want as they see best.  While this can be a way of efficiently performing the task, it may however introduce unwanted, unspecified side effects.  A shirt may be cleaned, but it may be wrinkled in the process.  It has positively fulfilled a specification which failed to detail undesirable negatives.  As there are infinitely more things that the specifier does not want to happen to the shirt, it is impossible to capture them all in a general top-down specification.

This hunt for exactness leads to process-based, or ‘bottom-up’ specifications.  After stating that only the specification as it is detailed it to be followed, a bottom-up spec aims to detail, item by item, step by step, the process of creating the final output in as much detail as possible.  For example, ‘a shirt consisting of type A white, intertwined cotton fibres of 1.2 microns in diameter, sanitised for 35 minutes in 18L of grade 315 bleach at 66 degrees celcius in an air-tight chamber’ is a bottom-up spec.

These detailed specs are used when the writer has technical expertise in the area of specification and where the process requires a high degree of control, such as in an experiment or high-end manufacturing.  So, whereas a top-down spec may be made by an end-user, a bottom-up spec is more likely to be written by a third-party specialist. 

While infinite detail is impossible to achieve, small ‘catch-alls’ are embedded in the main specification to try and tie up any loose ends, such as ‘to manufacturer’s specifications’ or ‘to the principles of X’, in the effort to at least provide direction to those seeking more information as to how to fulfill the finest details of the spec.

While bottom-up specs are great for the person trying to fulfill the spec because their satisfaction of the spec is mostly free from ambiguity, their very rigidity may prevent the satisfaction of the desired outcome in the most efficient way, or even at all.

If a bottom-up specifier does not know what they are doing, or is not up with the latest developments in the field, a detailed specification may be nothing but a very length recipe for disaster, or the loss of a lot of money.

This is why The Spear, when making his own professional specifications, tended to cover his arse with top-down specifications in any instances where he doubts his own ability to adequately bottom-up specify on a subject.  While generally specifying detail, he would use outcome-based catch-alls wherever he thought the risk of mis-specification was too great.

He wants his shirt to be machine washed with warm water with standard detergent, to his satisfaction.