Quote of the Day: Experience is a continuous exit exam

Experience is not much of a teacher; it is, rather, a continuous exit exam. For we are not very good at "learning" from events.

- You are told that experience is accumulated knowledge when it is largely a survival filter, a fitness test. Those we call "experienced" are simply those who had the traits that allowed them to survive in a given function in order to be able do it for a long time: what we call on this forum absence of fragility.

- This confusion is similar to mistaking the Lamarckian for the Darwinian. There is some direct learning (Lamarckian) in experience, but it has to coexist with a stiff selection test.

- The consequence is that "experienced" people should limit their teaching to avoidance of fragility.

- And our preferences show that we get the point (intuitively): we tend worship old people when they are successful, and despise (and neglect) them when they are ordinary. Yet both have, technically, the same "experience".

This is from my favorite iconoclast theorist, mathematician-philosopher and author Nassim Nicolas Taleb at his Facebook page

I think that this "experience is not a teacher" observation seems highly relevant to the stock market industry. 

Many (if not most) "experienced" industry participants (veterans) never really seemed to have learned from their "experience". They are often swayed by other matters, particularly social influence (status signaling) or industry interest (principal-agent problem). 

While they have "survived" the sharp vacillations of the marketplace over the years (experience), their survival "filter test" must have come or emanated from other means or source for them to disregard or become oblivious to the lessons of their previous episodes of life. In short, they lack the skin in the game.

And yes, in general, the public loves winners or the "visible" and almost completely disregards the "unseen" alternatives. That's because the survivorship bias, which aside from the innate impulse to adhere to the law of least efforts has largely been ingrained to us by media. 

Survivorship bias effuses an aura, or even a delusion of hope. Such hope feeds on the optimistic 'feel good' bias of the general public.

Unfortunately much of the optimism channeled via the survivalship bias are bereft of real circumstances. And this is why superhero themes (one or a few protagonists saving the world) have constantly been a bestseller whether in the movies or in politics. Superhero themes embodies the visible, emotive values and short term gratification.

Note: I made additions (in italics) to my original comment

The Myth of the Surveillance Cameras

Mainstream media continues to inculcate upon the public of the supposed public safety expediencies from surveillance cameras.

Steve Chapman at the Reason.org puts into perspective its efficacies.

One cherry picking of instances doesn’t imply effectiveness

There is no doubt that the cameras were a big help this time. But that doesn't mean they are generally a good idea -- much less a crucial tool in fighting terrorism and crime.

Surveillance cameras were originally touted as a strong deterrent, scaring away bad guys fearful of being caught on tape. But these devices have a disappointing record in action. In some places, they noticeably reduce crime. In others, they have the same effect as a potted plant.

In the Boston bombings, the cameras utterly failed in their preventive function. Not only did the bombings occur; they occurred in perhaps the most heavily photographed spot in America that day. Besides the permanent video cameras in operation, hundreds of spectators with cellphones were eagerly capturing the scene.

I’d say that mainstream media has been engaged in deceitful framing or applying selective influence or manipulation of the public through survivorship bias or through selective reporting. In other words, the positive effects from the use of surveillance cameras are being broadcasted, but its negative effects have not been shown. 

The implied goal seems designed to reduce people’s resistance from being monitored.

Security expert Bruce Schneier also shares this view stating that “Pervasive security cameras don't substantially reduce crime”

Next, since cameras are economic goods, they are subject to diminishing returns.

Again Mr. Chapman

Putting video gear in areas that are obvious potential terrorist targets is one thing. Putting them on every corner of an entire city is another. Some places are enviably safe without surveillance, which means any cameras installed there should be color-coordinated, since they will be primarily decorative.

They will fall victim to the law of diminishing returns. If you put out a couple of mousetraps, you may catch some mice. If you put out dozens, you may not catch many more. The second 10,000 cameras won't add nearly as much crime-fighting value as the first 10,000 -- or possibly even the first 1,000.

Of course, once aware, fugitives are likely to move activities away from where these cameras are located, or that they may use various forms of concealment. 

In short, surveillance cameras works from an element of surprise. Take the surprise away, the camera losses its effectiveness. Again human action.

The next is opportunity costs or tradeoff from use of scarce resources.

One drawback is that taxpayers are not composed of cash. Buying a camera costs money; so does maintaining it and monitoring the images it generates. A dollar spent on surveillance video is a dollar that can't be spent on foot patrols, police training, DNA tests or streetlights.

Then there is the issue of the invasion of privacy.

Another is that cameras contribute greatly to the steady erosion of personal privacy. Americans are generally oblivious to this phenomenon because they are oblivious to the multitude of unblinking eyes watching them in the course of a day. If each of us had a little alarm that went off every time we came into camera range, we might be less agreeable to the monitoring.

This is not really just an American thing, but also applies elsewhere as it does the Philippines.

 

Finally promoting surveillance cameras as furtive ploys to establish the Orwellian “big brother’ state that destroys civil liberties.

Cameras may also soften us up for even deeper intrusions. If video feeds are so great, why not add audio? If you can stand being watched whenever you leave home, surely you won't mind if every word is heard as well. And how about a tiny drone hovering over your front door, round the clock -- for the rest of your life?

Enthusiasts for electronic surveillance may say: If you have nothing to hide, you have nothing to fear. But there's a reason people don't live in glass houses.

There is really nothing wrong with the private sector’s use of surveillance cameras, what is wrong is having to politicize them and use these as tools to advance despotism in the name of public safety.

Video: The Power of the Undervalued $10 Trillion Informal Economy

Author Robert Neuwirth of Stealth of Nations: The Global Rise of the Informal Economy makes a great talk at the TED anent the vastly underrated informal or shadow economy

The TED introduces Mr. Neuwirth for his "out-of-the-box" thinking, or as challenging

“the conventional thinking by examining the world's informal economy close up. To do so, he spent four years living and working with street vendors and gray marketers, to capture its scope, its vigor--and its lessons. He calls it “System D” and argues that it is not a hidden economy, but a very visible, growing, effective one, fostering entrepreneurship and representing 1.8 billion jobs worldwide.

Mises Institute’s Jeff Riggenbach quotes Mr. Neuwirth’s definition of the informal economy based on his book…

This "informal economy," he writes, "produces, cumulatively, a huge amount of wealth.… It is how much of the world survives, and how many people thrive." And he has a name for it: System D.

"System D," he quickly explains, “is a slang phrase pirated from French-speaking Africa and the Caribbean. The French have a word that they often use to describe particularly effective and motivated people. They call them débrouillards. To say a man (or woman) is a débrouillard(e) is to tell people how resourceful and ingenious he or she is. The former French colonies have sculpted this word to their own social and economic reality. They say that inventive, self-starting, entrepreneurial merchants who are doing business on their own, without registering or being regulated by the bureaucracy and, for the most part, without paying taxes, are part of 'l'economie de la débrouillardise.' Or, sweetened for street use, 'Systeme D.' Thisessentially translates as the ingenuity economy, the economy of improvisation and self-reliance, the do-it-yourself or DIY economy.

The video from TED Ideas Worth Spreading (hat tip Professor Mark Perry)

Some highlights:

-“Something like this is totally open, it’s right there for you to find. All of this is happening openly and above board there is nothing underground about it. It is our prejudgment that it is underground”

-Governments dislike this

-“We are all focused on the luxury economy” ($1.5 trillion per year)

-“It excludes two-third of the workers of the world, 1.8 billion people work in an economy that is unregulated and informal”

-It is where employment is

-It engenders a more egalitarian world

In reality, the so called “prejudgment” of the informal economy has been part of orchestrated government campaign propaganda to derogate them, for the simple reason that the existence of the informal economy diminishes the importance of the role of governments.

More significantly, the informal economy represents the stark account of government failure

As John Sullivan of the Huffington Post writes,

The informal sector -- those businesses and entrepreneurs who work outside of the formal market economy -- is huge and largely undocumented in most developing economies. Almost everywhere, the root cause is the same: cumbersome, unresponsive, unfair, and overwhelmingly status quo-driven bureaucracy. People simply cannot get through the wall of red tape or the maze of regulations to gain access to the formal economy.

Moreover, author Robert Neuwirth points to the survivorship bias by public of focusing on the “luxury” economy (euphemism for consumption economy) which has been much smaller than the informal economy.

Again this represents the indoctrination by the mouthpieces of government conduits particularly through mainstream media.

Take the Philippines, hardly any serious study dwells with the informal economy. Every news exaggerates on the contributions of OFWs to the economy whose remittances accounts about 10% more or less of the economy.

When it comes to the informal economy, even when we deal with them or see them daily as a fact of life, they become a vacuum in mainstream’s eyes

The following excerpt is an example of one distorted perspective relative to OFW’s contribution to property development, the Global Property guide writes,

Overseas Filipinos’ remittances are powering the low-end to mid-range residential property market. They are snapping up housing projects and mid-scale subdivisions in regions near Metro Manila such as Cavite, Batangas and Laguna Provinces, while the expansion of the upper residential market, including the luxury market, is due to increased housing demand from BPO employees and expatriates, according to the World Bank.

Overseas Filipino Workers (OFW).account for around 17% to 18% of residential sales of Ayala Land, one of the country’s major developers. In the next five years Ayala Land President Antonio Aquino expects to double this, by branching out to the affordable and low-end market segment.

If OFWs account for say 20% of the housing or property demand, so what happened to the 80%? Which is mathematically bigger 20% or 80%? Since when has 20% become a dominant factor?

Let me add that OFWs also contributes to the informal economy, that is if the recipient families engage in unregulated or untaxed commerce.

This is why I have been repeatedly pointing out that for a country, whom according to mainstream has supposedly been living in Third World and has been allegedly 'poor', the Philippines hosts three of the largest malls in the world (Forbes 2008). Yet these malls, have not been like those ghost malls in China, as they have near full occupancy (which means profitable retail enterprises)

Further, the thrust of mall development in the Philippines has been spreading to the rural area which I recently argued, as suggesting of the deepening role of decentralization and of signs of the plateauing or the reversal of urbanization.

All these can HARDLY be supported by consumption spending by OFWs alone (or even if you add exports, which has been the favorite source of Keynesian influenced media).

The fact is that the informal economy has far been a larger contributor to the Philippines’ economic growth than has been projected.

Remember since the informal economy has been largely undocumented thus statistical estimates will bear significant errors.

Despite the survivalship bias practiced by the mainstream, Mr. Neuwirth’s putting into perspective of the real state and of the potentials of the informal economy appears to have been indirectly acknowledged by the World Bank,

the shadow economy has reached a remarkably large size with a weighted (unweighted) average value of 17.2 (33.1)% of official GDP. However, equally important is the clear negative trend of the size of the shadow economy over time. The unweighted average size of the 162 countries decreased from 34.0% of official GDP in 1999 to 31.0% in 2007; for the 21 transition countries from 36.9% in 1999 to 32.6% in 2007.

While the World Bank says the trend has been slowing, this has, I think, has mostly been a result of recent trends of globalization and economic freedom which tend to increase participation of the some erstwhile segments of the informal sector to the formal sector.

But such dynamics should not be construed as past performance determining future outcome. If the informal or shadow economy has signified as the public’s response to the politicization of the markets, then increased politicization means the tendency to shift economic activities towards the informal sector.

A quote from this Forbes article nails it…

“These are not really people oppressed by poverty,” says writer Stewart Brand. “They are getting out of poverty as fast as they can.” This isn’t to say that cellphones are about to save the world. But they have become the tool of choice for people who are determined to save themselves.

The informal economy, thereby represents free trade in motion and has been about people’s natural recourse to survival.

As the distinguished Austrian economist Percy Greaves Jr. once said,

For men, life is a series of choices by which we seek to exchange something we have for something we prefer. We know what we prefer. No other man or bureaucrat is capable of telling us what we prefer. Our preferences are our values. They provide us with a compass by which we steer all our purposeful actions. Because few people fully understand this, we have some serious economic problems…

Anything that raises cost or hinders the free and voluntary transactions of the market place must keep human satisfactions from reaching their highest potential. Today the greatest obstructions to the attainment of higher human satisfactions are the well-meaning but futile political interferences with the mutually beneficial transactions of a free market economy.

So any obstacles placed against activities which facilitates people’s survival will intuitively lead to the informal economy.

This is common sense.

Unfortunately common sense has been unavailable to politically brainwashed mindsets.

Quote of the Day: The Seen and Unseen

If one-sidedness is the other side of literature’s emphatic concreteness, emphatic awareness of strangers’ pains and pleasures is the unexpected other side of economists Gradgrindian detachment. Consider rent control. The beneficiaries are plain to see: they are the tenants when the rent-control law is adopted. The victims are invisible: they are the future would-be tenants, who will face a restricted supply of rental housing because landowners will have a diminished incentive to build rental housing and owners of existing apartment buildings will prefer to sell rather than rent the apartments in them. Economics brings these victims before the analyst’s eye…. A jurisprudence of empathy can foster short-sighted substantive justice because the power to enter imaginatively into another person’s outlook, emotions, and experiences diminishes with physical, social, and temporal distance.

That’s from Richard Posner’s 1995 Overcoming Law (as quoted by Professor Don Boudreaux).

Markets Ignore US SEC-Goldman Sachs Tiff, More Political Dirty Dancing

``Popular opinion ascribes all these evils to the capitalistic system. As a remedy for the undesirable effects of interventionism they ask for still more interventionism. They blame capitalism for the effects of the actions of governments which pursue an anti-capitalistic policy.” Ludwig von Mises, Interventionism an Economic analysis

Adding more arbitrary laws or “regulations”, which are usually founded upon noble goals, have been used as the main pretext for expanding political power by the incumbents.

This unfortunately is what people refuse to see yet has been a critical cause of much of today’s ills.

For the political economy, regulations can unilaterally skew the distribution of power from the ruled to the ruler. If there is such a thing as “income or wealth” inequality, the obverse side is the “political inequality”.

Professor Lawrence White[1] on the difference of rule of law and rule of men, ``The contrast between the rule of law and the rule of men is sometimes traced still further back to Plato’s dialogue entitled Laws. In that work the Athenian Stranger declares that a city will enjoy safety and other benefits of the gods where the law “is despot over the rulers, and the rulers are slaves of the law”. In other words, government officials are to be the servants and not the masters of society. The rule of law is vitally important because it allows a society to combine freedom, justice, and a thriving economic order.”

When government officials elect to end up as “masters of society”, one of the main acts to attain such goals is to deliberately trample upon with laws of the land to allow laws to work to their favor.

In short, despots legitimize their power grab by coercively instituting their own set of laws. The Philippines is no stranger to this as seen through former President Ferdinand Marcos’ proclamation 1081, ``Marcos ruled by military power through martial law, altered the 1935 Constitution of the Philippines in the subsequent year, made himself both Head of State as President and Head of Government as Prime Minister, manipulated elections and the political arena in the Philippines, and had his political party--Kilusang Bagong Lipunan (KBL) (English: New Society Movement) control the unicameral legislative branch of government called the "Batasang Pambansa". All these allowed Marcos to remain in power and to plunder.[2]”

And since the manipulation of laws tends to rearrange the political economic order according to the whims of those in power by restraining civil liberties and economic freedom, ergo, the benefits or privileges will be partial to those within the ambit of the administration.

Said differently instead of having resources distributed through the marketplace, resources will be allocated politically in accordance to the order of importance as seen by the authorities. Nevertheless when the concentration of power is left to a few to decide, then price signals will be distorted and that lobbying, favouritism, corruption and cronyism will be her common feature.

The Phony War Against The “Cockroaches”

So what has these to do with the current state of the markets?

Alot.

The emergence of proposed regulatory reforms by the Obama administration for Wall Street comes timely with the US SEC-Goldman Sachs brouhaha.

Aside from the noteworthy coincidence[3], the US markets appears to be validating our view by ignoring the impact of the US SEC-Goldman tiff (see figure 1).

Figure 1: Political Act Slowly Unraveling

In contrast to the camp that sees the Goldman controversy as an issue of fraud, by looking at the incentives that drives the actions of political authorities, we have argued otherwise[4].

Besides, it is not within our ambit to comment on juridical merits of any legal case and neither are those who claim that it is about ‘fraud’. Commenting on the legal aspects based on news accounts signifies nothing but “trial by publicity”.

If Goldman had been truly a “cockroach”, then there must be other cockroaches too from which the sudden apostasy of the Obama administration must mean a total “war on cockroaches”.

And true enough, we find that Goldman’s practice hasn’t been isolated but an industry practice especially among the TOO BIG TO FAIL institutions.

According to the New York Times[5], ``Many banks on Wall Street and in Europe were even bigger players in the types of complex investment deals that Goldman is now defending. Merrill Lynch was at the top of the heap, assembling $16.8 billion worth between 2005 and 2008, according to a new report by Credit Suisse.

``UBS put together $15.8 billion worth of similar products, according to the Credit Suisse estimates, while JPMorgan Chase and Citigroup each created more than $9 billion worth. Goldman Sachs was a comparatively small issuer, at $2.2 billion.”

Yet if one looks at the market, except for Goldman Sachs (GS), the SPDR Financial Select Sector (XLF) [where JP Morgan, Citigroup, Merrill and GS is 24.3% of index weighting] and the S&P Bank Index (BIX) has simply shrugged off any “contagion” against a so-called “war on cockroaches”.

Noticeably, the broad based US markets as shown by the S&P 500 (SPX), which includes the Dow Industrials, the Nasdaq and the mid cap Russell 2000 all went to a bullish rampage by breaking to the upside as of Friday’s close.

Oddly too that the so-called aggrieved party in the controversial case was also reported as practicing the same allegedly skulduggery employed by Goldman, this from John Carney[6],

``It was a piece of regulatory arbitrage: In essence, IKB was investing in complex mortgage bonds without having to set aside regulatory capital or report the increase in risky assets to its regulators or auditors.”

``In short order, Rhineland became one of the biggest buyers of the complex investment products puked out by the likes of Lippman at Deutsche Bank, JP Morgan Chase—and Goldman. One banker told Euroweek that IKB—through Rhineland and similar tactics—had become one of the five or six largest investors in Europe. Thus, Goldman found them a willing buyer for the junk piled into Abacus” (underscore mine)

Take note of the word: regulatory arbitrage.(as we will be using this later)

More Dirty Dancing Politics

As the days go by, more and more Goldman-Washington ties are being uncovered.

In contrast to common knowledge that the Democratic Party has been less affiliated with Wall Street, this is turning out to be untrue, according to the Politico, ``The Democratic Party is closer to corporate America — and to Wall Street in particular — than many Democrats would care to admit.” A chart from the New York Times can be seen here.

Moreover, we discovered that there are five former employees of Goldman currently employed in the Obama administration. This perhaps reveals the extent of connection between the two supposed rivals.

In addition, the timing of Friday’s government lawsuit likewise coincided with SEC’s report about its “failure to investigate alleged fraudster R. Allen Stanford”[7]. This may seem like an effort to possibly dampen media’s impact from regulatory failure by exposing a much bigger news. Apparently this succeeded.

And speaking of regulatory competence, one cannot help but guffaw at news reports where 33 SEC employees, including high ranking officials, spent much time during the crisis in porno browsing!

According to the NY Daily News[8], ``The shocking findings include Securities and Exchange Commission senior staffers using government computers to browse for booty and an accountant who tried to access the raunchy sites 16,000 times in one month.”

Perhaps, Madoff, Standford and Goldman people were trying to arbitrage falling markets with “porno” finance-whatever that means. This resonates clearly of the quality of the bureaucratic mindset.

Moreover, there have been pressures for Goldman to amicably settle with the SEC even if “they’re right on the merits of the case”[9].

And surprisingly, President Obama despite earlier reports to verbally assail Wall Street turned up with a conciliatory voice at a recent speech ``Ultimately, there is no dividing line between Main Street and Wall Street,” Obama said in his speech at Cooper Union, about two miles from the financial district. “We will rise or we will fall together as one nation.”[10]

We read a popular American blogger offer a bet against anyone who thinks Goldman will win the suit. Apparently this perspective is looking at the wrong issue.

Goldman can lose a case and still win the war. In the game of chess, this is called sacrifice or even queen sacrifice. Yet in a staged or scripted dispute, like in wrestling, one party’s loss is just a part of drama to fulfil other goals. A real life example of a staged battle is the US-Spanish “Battle of Manila”[11].

History As Guide To Future Actions

Let us put the issue in historical context.

Rightly or wrongly banks and financial institutions have been in the public “hot seat” from nearly time immemorial[12]. But in contrast to having reduced power from financial reforms, the banking system had even acquired more political clout in spite of these. The Federal Reserve was even stealthily hatched amidst scepticism over the banking industry.

Here is G. Edward Griffin’s speech[13], Author of The Creature from Jekyll Island, on the inception of the Federal Reserve (all bold highlights mine),

``Why not? why the secrecy? what's the big deal about a group of bankers getting together in private and talking about banking or even banking legislation. And the answer is provided by Vanderlip [Frank Vanderlip president of the National City Bank of New York] himself in the same article. He said: "If it were to be exposed publicly that our particular group had gotten together and written a banking bill, that bill would have no chance whatever of passage by Congress." Why not? Because the purpose of the bill was to break the grip of the money trust and it was written by the money trust. And had that fact been known at the get-go, we would never have had a Federal Reserve System because as Vanderlip said it would have had no chance of passage at all by Congress. So it was essential to keep that whole thing a secret as it has remained a secret even to this day. Not exactly a secret that you couldn't discover because anybody can go to the library and dig this out, but it is certainly not taught in textbooks. We don't know any of this in the official literature from the Federal Reserve System because that was like asking the fox to build the henhouse and install the security system.

``That was the reason for the secrecy at the meeting. Now we know something very important about the Federal Reserve that we didn't know before, but there's much more to it than that. Consider the composition of this group. Here we had the Morgans, the Rockefellers, Kuhn, Loeb & Company, the Rothschilds and the Warburgs. Anything strange about that mixture? These were competitors. These were the major competitors in the field of investment and banking in those days; these were the giants. Prior to this period they were beating their heads against each other, blood all over the battlefield fighting for dominance in the financial markets of the world. Not only in New York but London, Paris and everywhere. And here they are sitting around a table coming to an agreement of some kind. What's going on here? We need to ask a few questions.

``This is extremely significant because it happened precisely at that point in American history where business was undergoing a major and fundamental change in ideology. Prior to this point, American business had been operating under the principles of private enterprise--free enterprise competition is what made American great, what caused it to surpass all of the other nations of the world. Once we had achieved that pinnacle of performance, however, this was the point in history where the shift was going away from competition toward monopoly. This has been described in many textbooks as the dawning of the era of the cartel and this was what was happening. For the fifteen year period prior to the meeting on Jekyll Island, the very investment groups about which we are speaking were coming together more and more and engaging in joint ventures rather than competing with each other. The meeting on Jekyll Island was merely the culmination of that trend where they came together completely and decided not to compete--they formed a cartel.”

In other words, the trend towards consolidation of the industry via “financial reforms” has empowered more cartelization than less. And today’s proposed financial reform bill will enhance and not reduce such relationship in contrast to opinion of the reform advocates.

John Paulson And The Survivorship Bias

I’d like to show the relevance of hedge fund manager John Paulson’s reputation during the latest boom-bust cycle (see figure 2).

Figure 2: Google Trend/Wall Street Journal: John Paulson’s Popularity

As we have earlier argued, the SEC-Goldman dispute is a fait accompli argument (Wall Street seems to agree[14]).

That’s because Mr. Paulson, among the 12,400 hedge funds as reported by Hedgefund.net during the 3^rd quarter of 2007, only shot to fame in early 2008 (left window) after profits in his fund skyrocketed (in mid 2007) which left the field biting his dust (right window).

In most of 2007, John Paulson, like Manny Pacquiao in the early 90s, was relatively an unknown figure (Mr. Paulson has hardly been searched by anyone)! This means that counterparties when appraised of Mr. Paulson’s participation in early 2007 would have simply ignored him as he was just one among the many “mediocre” aspiring hedge fund managers.

This also reveals that many people tend to read and value information based on today’s account and not during the time when the controversial transactions was developed. This cognitive error is known as the survivorship bias, or the ``the logical error of concentrating on the people or things that "survived" some process and ignoring those that didn't[15].”

---

[1] White, Lawrence Avoiding and Resolving Financial Crises: The Rule of Law or The Rule of Central Bankers?

[2] Wikipedia.org, Proclamation No. 1081

[3] Norris, Floyd, Fortunate Timing Seals a Deal

[4] See Why The US SEC-Goldman Sachs Hoopla Is Likely A Charade

[5] New York Times, Questions for Banks That Put Together Deals

[6] Carney John, Goldman’s Dirty Customers, The Daily Beast

[7] Wall Street Journal, The SEC's Impeccable Timing The Goldman suit helped to hide the IG report on the Stanford debacle.

[8] NY Daily News; While economy crumbled, top financial watchdogs at SEC surfed for porn on Internet: memo

[9] Bloomberg, Goldman Sachs Should Cut Losses in SEC Standoff, Lawyers Say

[10] Bloomberg, Obama Challenges Financial Industry to Join Regulatory Overhaul

[11] Wikipedia.org, The Battle of Manila (1898)

[12]see Quote of the Day on Wall Street: After Nearly A Century, Hardly Any Change

[13] Bigeye.com; A Talk by G. Edward Griffin Author of The Creature from Jekyll Island

[14] See SEC-Goldman Sachs Row: The Rising Populist Tide Against Big Government

[15] Wikipedia.org, survivorship bias

Survivorship Bias: A Great Musician Plays Great Music But No One Hears

What happens if one of the best musicians popped up at a corridor of a stereotyped arcade unannounced, garbed in a nondescript attire (to assume the role of a mendicant) and played some his best music, would the person or his music be recognized?

The Washington Post conducted an unusual experiment in January 12th 2007 along with American Grammy Award winner violinist Joshua Bell to determine people's priorities and perceptions.

According to the Washington Post,

``It was 7:51 a.m. on Friday, January 12, the middle of the morning rush hour. In the next 43 minutes, as the violinist performed six classical pieces, 1,097 people passed by. Almost all of them were on the way to work, which meant, for almost all of them, a government job. L'Enfant Plaza is at the nucleus of federal Washington, and these were mostly mid-level bureaucrats with those indeterminate, oddly fungible titles: policy analyst, project manager, budget officer, specialist, facilitator, consultant.

The complete article here.(HT: David Kotok)

click on the video to see experiment...


Joshua Bell whose violin had a price tag worth $3.5 million and whose concert ticket prices are worth more than $100...collected a measly $32.17 cents after 43 minutes of play. Some even gave pennies!

Why is this of interest to us?

Because the experiment reveals of people's survivorship bias where, to quote Nassim Taleb in his Fooled by Randomness, "we are trained to take advantage of the information that is lying in front of our eyes, ignoring the information we do not see."

In this case, for the 1,097 people that came by (except for one), the crowd didn't recognize the person or underappreciated or undervalued his music (got only $32.17). And of the $32.17, $20 or 62% even came from the person who recognized the multi-awarded artist.

Without some form of stimulus or conditioning (e.g. advertising), his talent or his music had simply been overlooked or ignored. To consider, people have paid over $100 to watch his concert! This gets us thinking: are people paying more for the ambiance or crowd or for social purposes than to merely watch the artist and his music?

Of course the best objection would be that he could be playing into the wrong audience or market. But that won't be convincing.

I think the lesson from the experiment is that there are simply many undiscovered talents, or skills or works of art/music out there which have been underrated simply due to our reliance on heuristics or cognitive biases for valuation.

In short, people use intuition more than rationality.

Swine Flu: The Black Swan That Wasn’t

``There is only one thing which causes man to look for and to organize a tool which is an instrument of compulsion and prohibition. That thing is fear. Men look to government to protect them because they fear. And virtually without exception, everything that human beings fear becomes a project for government." Robert LeFevre The Nature of Man and His Government

The Swine Flu could have been a Black Swan. And perhaps yet it could.

The Black Swan theory as proposed by my favorite iconoclast Nassim Nicholas Taleb comprises three traits:

One, it “lies outside the realm of regular expectations”,

Two, it “carries an extreme impact” and

Finally it makes people “concoct explanations for its occurrence after the fact, making it explainable and predictable”.

Since the swine flu struck, it had practically caught everyone by surprise. Next, many have been unnerved or nations have been in a state of panic; the World Health Organization (WHO), the health agency of the multilateral organization the United Nations, have raised the pandemic alarm level to 5 out of the maximum 6, which implies pandemic levels or the risks of the global spread of disease as “imminent”. (Reuters). Lastly, there have been many theories circulating in traditional media or in the cyberspace as to why and how such ailment came to be.

So this episode contains elements fitting of a Black Swan. But what seems arguable is the degree of impact.

Since the Swine Flu surfaced in the news, markets have initially been devastated, albeit not equally. Realizing the sensitivity of today’s fragile environment, I had also been tempted to undertake “crash” or defensive positions.

However, it dawned upon me that panics are always triggered by our brain’s Amygdala, which had been hardwired into our fight-or-flight responses by our primitive progenitors, who were faced with survivalship against the adverse forces of nature. Panics are actually exacerbated by the lack of information.

Hence, considering the uneven nature of the market’s responses, the underlying market trend, the most recent experiences of the world to deal with epidemics (SARS, Avian Flu) and the rapidly advancing state of our technology, I decided that it would be best to defer fear and possibly deal with this from the reverse.

Figure 1: US Global Investors: SARS Blip

A great example would be the Severe Acute Respiratory Syndrome (SARS) episode, as shown in Figure 1.

From the benefit of hindsight, the SARS was a short term dislocation or a blip or another account of Posttraumatic Stress Disorder (PTSD) for the tourism industries of key East Asian economies. From the market perspective, it served as a window of opportunity to profit from fear.

Since global markets have rallied furiously following the initial shock from the Swine Flu this implies that the pandemic risks have been digested and discounted in contrast to the headlines and the actuations of governments.

Sensationalism-Survivorship Bias: Markets versus Media and Politics

So why the flagrant disparity between the market and news headlines or from political authorities?

Because it is primarily about perspective.

In Mexico, the epicenter of the disease, the present death toll from the Swine flu has been reduced from 176 to 101 (Guardian) and now to 75 (BBC)! But even at 176, this number represents as an infinitesimal fraction relative to Mexico’s population of 110 million (CIA).

Moreover, the expanded global reach is said to cover 18 countries which had reported accounts of infections, as The Independent reported, ``The World Health Organisation said that 18 countries have now reported 766 infections. The confirmed cases include 443 in Mexico, 184 in the US, 85 in Canada, 15 in Spain, 15 in Britain, six in Germany, and smaller numbers in 12 other countries. Italy reported its first known case yesterday, a man in the Tuscany region who returned from Mexico on 24 April. He has since recovered. Almost all infections outside Mexico have been mild. In Britain, where two new cases were confirmed – one being the husband of a woman who was confirmed the day before – some 632 possibles are under investigation”.

The accounted fatalities, as of this writing, have been 17 globally, according to the same article.

To compare, the US Centers for Disease Control and Prevention (CDC) reports of 36,000 influenza associated deaths and 200,000 hospitalizations annually. This translates to 98 deaths per day and 548 people hospitalized per day from seasonal influenza in the US alone.

In addition, 115 people die from car accidents a day in the US (car-accidents.com), 38,500 People die each week around the world from the Aids virus and 1,288 is the number of British people who die from strokes in an average week (The Independent).

In other words, the actual collateral damage has hardly surpassed the average annual losses from its seasonal strain counterpart or from other common causes of deaths even based on US figures alone. Yet because the disease has reached 18 countries with 766 infections and 17 deaths, the WHO has triggered global alarm bells and international hysteria by placing the pandemic alarm level to 5!

So opposite to the survivorship bias, which usually fixates on winners, global authorities today have been entranced with sensationalism and has virtually used fears to respond on an overkill basis.

Notwithstanding, the ensuing consternation has led to divergent definitions of the disease; the Swine Flu has been reported as little to do with the Swine itself (Poor Pig- serves not only as human’s dish but as fall “guy” animal!) where according to the Reuters ``The WHO has said it would call the new virus strain Influenza A (H1N1), not "swine flu," since there is no evidence that pigs have the virus or can transmit it to humans. Pork producers had said consumers were shunning their product.”

Bizarrely too, even some US Farmers have raised concerns that their herd of pigs might be contaminated by infected humans!!!

This paradox as reported by another Reuter’s article, ``There is no evidence of this new strain being in our pig populations in the United States. And our concern very much is we don't want a sick human to come into our barns and transmit this new virus to our pigs," said National Pork Producers chief veterinarian Jennifer Greiner. If humans give it to pigs, we don't have things like Tamiflu for pigs. We don't have antivirals. We have no treatment other than to give them aspirin," said Greiner.” (bold highlight mine).

Yet many have alluded to the Spanish Flu as its origins, but the effects have been so far way way way off.

The Spanish Flu as described by wikipedia.org, ``The pandemic lasted from March 1918 to June 1920, spreading even to the Arctic and remote Pacific islands. It is estimated that anywhere from 25 to 80 million people were killed worldwide, or the approximate equivalent of one third of the population of Europe, more than double the number killed in World War I. This extraordinary toll resulted from the extremely high illness rate of up to 50% and the extreme severity of the symptoms, suspected to be caused by cytokine storms. The pandemic is estimated to have affected up to one billion people: more than half the world's population at the time.”

Perhaps lacking the expected casualty impact in the scale of the Spanish Flu pandemic, authorities have presently been downplaying its association, this from the Associated Press, ``Scientists looking closely at the H1N1 virus itself have found some encouraging news, said Nancy Cox, flu chief at the federal Centers for Disease Control and Prevention. Its genetic makeup doesn't show specific traits that showed up in the 1918 pandemic virus, which killed about 40 million to 50 million people worldwide.

``"However, we know that there is a great deal that we do not understand about the virulence of the 1918 virus or other influenza viruses" that caused serious illnesses, Cox said. "So we are continuing to learn." (all bold emphasis mine)

The irony is, if the said expert does not understand much about the virulence of the 1918 virus, how can she conclude that the genetic make up of today’s strain doesn’t resemble the specific killer traits of 1918 virus? Isn’t this a case of rationalization?

So like in the markets, we seem to be witnessing evidences of reflexivity behavior being applied to the Swine Flu incident-where the present outcome (diminished degree of impact and rising markets) seems to be influencing the public’s thinking as reflected by news accounts and backed by shifting views or sentiments of officials as cited by mainstream media.

Yet the frenzied policy responses have resulted to some unintended consequences. For instance, Egypt’s arbitrary decision to slaughter its entire pig population has spawned a religious schism between majority Muslims and Christians.

Another, Mexico’s decision to shut down stores and companies or its economy has prompted some agitation among the citizenry. According to the Reuters, ``The Labor Ministry said it would fine or forcibly close companies that stay open Monday and Tuesday as a major factory association and many small businesses say they plan to.

``"As far as I know we're coming to work next week. Unless someone comes from the government to tell us to close," said Victor Barracas, a bookstore employee in central Mexico City.”

It appears that the Mexican government prefers its population to suffer or perish out of starvation than from an overblown epidemic!

Talk about governments knowing the interest of their people.

Conspiracy Theories

Nevertheless, the compulsiveness over the Swine Flu won’t be complete without “conspiracy” theories.

Since the current strain of Swine Flu combines genetic material not only from pigs but from birds and humans, where “it has bird flu from North America, swine flu from Europe, and swine flu from Asia. Humans do not have natural immunity to this strain”, (qualityhealth.com) some have suggested that this has been a “human engineered pathogen” meant as a biological weapon for biowarfare.

Many possible scenarios have been floated; it could have been an experiment gone awry or accidentally leaked into the population, or a deliberate covert test by some government entities for political purposes (deflect attention from the economic crisis?), or from a rogue insider who could have stolen from the government’s biolabs in order to advance an unspecified cause, similar to the Anthrax tainted letters mailed to the US Congress from which an employee, Bruce Edwards Irvins, a microbiologist, vaccinologist, and senior biodefense researcher of the US Army Medical Research Institute of Infectious Diseases (USAMRIID) in Fort Detrick, Maryland was held responsible (Global Research).

Or it could also have possibly been perpetrated by vested interests aimed at creating at an atmosphere of pandemic for economic or financial interests, or worst, perhaps in cahoots with the government.

And this isn’t new, according to qualityhealth.com, ``in 2006 investigators discovered that a major pharmaceutical company knowingly dumped HIV-tainted drugs for hemophiliacs onto European, Asian and Latin American markets.”

Anyway, such plot may run across the similar lines as with the movie Mission Impossible II.

Stock Market and Pandemics-Then and Today

True enough a full blown pandemic at the scale of the Spanish Flu will result to economic mayhem.

Economic activities in heavily impacted areas will suffer most while deglobalization in trade, tourism, migration or investments will probably worsen, given today’s recessionary environment.

But we learned that such devastating pandemic don’t necessarily translate to stock market collapses.

Since the public has been obsessed with the Spanish Flu, Bespoke Invest gives a good account of how the US stock market reacted to its outbreak in 1918 see figure 2.

Figure 2: Bespoke Invest: Spanish Flu and Dow Jones Industrials

We quote Bespoke Invest, ``There were three pandemic waves from 1918-1919, with the worst coming from October to December of 1918. While fear of the flu was widespread, the market really didn't react too badly. Following the first pandemic wave, the market sold off a little bit, but then rallied during the summer months before topping out prior to the second wave. The market trended downward during the worst wave of the flu outbreak, but it only went down 10.9% from peak to trough, and then it rallied significantly during and following the third wave. World War I was also coming to an end in late 1918, so the end of the pandemic and the war probably contributed to the subsequent rally in stocks.”

Let me emphasize that despite the huge losses of human lives and massive economic disruption brought about by both World War I and the Spanish Flu, the Dow Jones lost only 11% from the Spanish Flu plague.

However, it won’t do justice to say that the Spanish Flu was the biggest driver of the markets then, as with the culmination of World War I, because there could be other possible unseen variables which may have contributed to the market action, although we also don’t deny that both factors could have provided for significant inputs.

Unfortunately, history, for the mainstream, is always seen from a single observation that had taken place.

But the point is; initial fear from a shock usually dominates the markets, which is then followed by gradual recognition of the problem and its eventual resolution-the recovery.

Today we seem to share a similar impact but at very compressed or short circuited cycle see figure 3.

Figure 3: Stockcharts.com: Swine Flu: Aborted Black Swan

Major global stock market benchmarks as seen by the Dow Jones World (DJW), Emerging Markets (EEM), Europe’s Stoxx 50 (STOX 50) and Asia (DJP1) seems to have simultaneously suffered a “blip” (circle) from the pseudo Swine Flu scare which eventually was more than recovered by most global bourses at the close of the week’s session.

Another way to look at it is that collective governments push to inflation has far larger influence than fear generated from the pandemic menace. Besides, by stoking fear governments implied action is to spur inflation by spending more for protection.

In addition, today’s environment is very much different than that of 1918. The world has been more globalized or integrated. Moreover, technological diffusion has been increasingly deepening this integration whereas monetary standards that drive the risk taking environment have been distinct.

As to how this has altered the pandemic risk environment we suggest some based on news accounts;

-the lessons from SARs and the Avian Flu have fostered stronger collaborations among global governments in dealing with potential pandemic risk by agreeing on “a sensible set of protocols for pandemic preparedness, sharing of genetic samples and other ways of coordinating a global response.” (Economist)

-technology impelled advancement in incubation and manufacturing techniques. Again from the Economist, ``It is possible, though, that new technology will come to the rescue. Gregory Poland of the Mayo Clinic, an American hospital chain, argues that thanks to SARS, bird flu and fears about bioterrorism, work has been undertaken on a range of new incubation and manufacturing techniques.

``One example is DNA-based vaccines, which are made in cell cultures, not incubated slowly in eggs. Vocal, an American biotechnology firm, has shown in early tests that its DNA vaccine for potentially pandemic influenzas, such as strains of H5N1, is safe and effective, and it claims the technology can be scaled up easily.”

-technology enabled information sharing via the cyberspace which has cultivated mass collaboration, networking and openness in the medical and science industry that may lead to faster vaccine discovery and production.

From the Reuters, ``Scientists in Mexico, the United States and New Zealand have since posted full sequences of its DNA taken from 34 virus samples in an online public library. And the list is growing.

``What this means is scientists everywhere can now use these descriptions to create new tools to fight the virus, such as rapid diagnostic test kits and vaccines.

``While the fastest conventional tests take up to two days, scientists are designing highly specific ones that can pick up this swine H1N1 flu virus in four to six hours…

``The genetic sequences have just been made available ... many laboratories are rushing to find the best test, it will take one to two weeks (for us to design one), but we need a lot of validation, we need hundreds of specimen to do that," said microbiologist Yuen Kwok-yung at the University of Hong Kong.”

Conclusion

So while the risks of pandemics will always be present in a rapidly evolving global environment, whether due to natural or lab-induced viral mutations, the world’s capability to address such risks based on global collaboration and technological adoption appears to be more enhanced than the yesteryears. Hence, conditions from the Spanish Flu, the SARS, Avian Flu or the pseudo Swine Flu have been different.

But this doesn’t guarantee immunity from other prospective tail risks.

Nevertheless, the recent Swine Flu which had the elements of surprise and rationalizations from the public almost seemed to have morphed into a full blown Black Swan risk except that the degree of impact was apparently muted in terms of collateral damage or as viewed from the financial market’s response.

The only profound impact from the present episode based on last week’s drama had been government sensationalism and its attendant overreaching political response which had been greatly amplified or inflamed by media.

Fear, as we know it, is a conventional tool of control used by governments to subvert civil liberties by coercion. Thus, considering today’s socialization trends of important segments of the global economy, it can’t be dismissed that this could be another part of the tactical socialization thrust to impose more government on our lives.

Nonetheless, the market reflecting on its inherent discounting mechanism has shattered this prism of state instituted fear and by virtue of reflexivity behavior has equally diminished its justification. The likelihood is that the threats of the pseudo pandemic will evaporate overtime.

Over the interim, global stock markets and the commodity markets will most likely continue to manifest on the concerted inflationary measures adapted by global governments.