Teaching children about money: the Poverty Week experiment

I caught up on Stanford Business magazine today. Let me share a quick story told in the Class Notes written by my classmate John D. Lee. He is a financial advisor, and may have a professional perspective on money that most of us lack. Yet, all of you readers can replicate the experiment with your families, if you wish.

In appreciation for all that we have (and just as an interesting experiment), we attempted to approximate what it would be like to live at the poverty level for one week. We confined ourselves to using one bedroom, one bathroom, and the kitchen as our entire family’s living quarters (though our dog, Nero, chose to ignore those rules). Except for when our jobs required it, we stopped using iPods/iPhones, the internet, and cable TV/TiVo. Our total food budget for the family was $108 for the week, and we made a donation to a local homeless shelter with the money we saved. While none of us particularly enjoyed the experience (and eating so much beans and rice), I thought it was good for our 9-year-old son, Archie, and we all came away more appreciative of our good fortune. Archie’s insight was that the thing he liked the least about the experience was the loss of freedom and choice. Truth!

Nassim Nicholas Taleb, Antifragile: a review

AntifragileYou knew that Nassim Nicholas Taleb’s Antifragile was in my reading list: having read it, I now owe you a review. Taleb’s The Black Swan was a book I found not only clever and innovative, but engaging and somehow necessary (for reference, here is my 2007 Black Swan review); Antifragile, rather less so.

What is antifragile? Taleb has coined the neologism to describe a class of things that “benefit from shocks”: “thrive and grow when exposed to volatility, randomness, disorder, and stressors and love adventure, risk, and uncertainty.” “Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.” It is a property of living beings that Taleb describes in mathematical form (convexity) and proceeds to apply to ideas, cultures, political systems and much more. He is least interested in the application of the idea to the “vulgar” world of finance, perhaps feeling that the events of the past few years have abundantly proved his point.

Figure 12

Notwithstanding the author’s ambition, scope and breadth of intellectual interests, let me say right away that this would be a bigger book if it didn’t hit the reader in the face repeatedly with bitterness, sarcasm and contempt. The deeply held opinions of the author may not have changed since his previous books; his tone, I think, has – and not in favor of readability. Just witness the ad personam taunting and teasing directed at certain people (Thomas Friedman, Paul Krugman, Joseph Stiglitz, Robert Merton) and schools (“The Soviet-Harvard delusion”); the author’s scorn for entire professions, such as academia and management; his rants against large corporations, with the exception of Apple (!), and disdain of corporate leaders, except for Steve Jobs. Passages like this may be occasionally entertaining to the reader, but grow to be too much:

The historian Niall Ferguson and I once debated the chairperson of Pepsi-Cola as part of an event at the New York Public Library […] Neither Niall nor I cared about who she was (I did not even bother to know her name). […] My experience of company executives, as evidenced by their appetite for spending thousands of hours in dull meetings or reading bad memos, is that they cannot possibly be remarkably bright. […] Someone intelligent—or free—would likely implode under such a regimen.

The most convincing arguments in the book are about medicine and diet. Which is somewhat surprising from a non-specialist writer, until you remember that most medical and nutrition professionals have a bias for intervention (medicate, perform surgery, keep you on a diet, sell you supplements), when subtraction (not intervening and removing things instead) would often just work as well. They therefore live an implicit conflict of interest, the paradoxical result of which is “if you want to accelerate someone’s death, give him a personal doctor”. Taleb is right to call the reader’s attention to iatrogenics, the (usually hidden or delayed) damage from treatment in excess of the benefits. His ideas on diet also make sense: our bodies benefit not just from variety of nutrients, but from some “randomness in food delivery and composition” and some stress in the form of periodic deprivations (such as in the Orthodox lent) and occasional fasting. Even here, though, the author’s Levantine superiority complex (and don’t you forget that Steve Jobs’s ancestors came from Syria!) gets to be rather quirky:

I, for my part, resist eating fruits not found in the ancient Eastern Mediterranean (I use “I” here in order to show that I am not narrowly generalizing to the rest of humanity). I avoid any fruit that does not have an ancient Greek or Hebrew name, such as mangoes, papayas, even oranges. Oranges seem to be the postmedieval equivalent of candy; they did not exist in the ancient Mediterranean. […] As to liquid, my rule is drink no liquid that is not at least a thousand years old—so its fitness has been tested. I drink just wine, water, and coffee.

His brief critique of Singularity efforts follows logically from his arguments, but is delivered with the recurring scornful attitude. Well, at least he remembers the fellow’s name:

I felt some deep disgust—as would any ancient—at the efforts of the “singularity” thinkers (such as Ray Kurzweil) who believe in humans’ potential to live forever. Note that if I had to find the anti-me, the person with diametrically opposite ideas and lifestyle on the planet, it would be that Ray Kurzweil fellow. […] While I propose removing offensive elements from people’s diets (and lives), he works by adding, popping close to two hundred pills daily. Beyond that, these attempts at immortality leave me with deep moral revulsion.

The least convincing arguments in the book are those in praise of entire economic systems based on “small is beautiful” (going hand in hand with the author’s love for the Swiss political system). Taleb rightly praises small entrepreneurs for their risk-taking: even if small businesses are individually fragile (as in the example of restaurants) or merely robust, even harboring a bit of antifragility (taxi drivers), their ecosystem (the restaurant scene) becomes antifragile. And he is right to point out that size can make you fragile: it is probably true that large projects are intrinsically over time and over budget due to intrinsic negative convexity, and that “the problem of cost overruns and delays is much more acute in the presence of information technologies”. Yet, one cannot seriously propose the London Crystal Palace (an overgrown conservatory built in 1850-51) as a model of architectural effectiveness, let alone human achievement, today.

It seems to me that in deliberately ignoring that it is mostly large organizations that create large economic surpluses, Taleb gets way too close to the current “degrowth” narrative, a crackpot economic proposition if there ever was one. While he openly despises large corporations and the people who work in them, he seems happy to write up his books on a computer built in a very large factory in China (as long as it is a subcontractor for Apple), to have his writings published by very large publishing houses, and to fly in planes built by large corporations and run by other large corporations (even while pointing out the fragility of air traffic control systems), for example to meet interesting people in Davos, at a large annual World Economic Forum gathering that would not exist if there were no very large corporations to sponsor it. Even the aforementioned New York Public Library is probably a much too large and bureaucratic organization for his taste, given that his model for an antifragile life and thinking is the “flâneur with a large private library”, no doubt acquired via independent (often antiquarian) booksellers.

With the exception of, say, drug dealers, small companies and artisans tend to sell us healthy products, ones that seem naturally and spontaneously needed; larger ones— including pharmaceutical giants— are likely to be in the business of producing wholesale iatrogenics, taking our money, and then, to add insult to injury, hijacking the state thanks to their army of lobbyists. Further, anything that requires marketing appears to carry such side effects. […] There is no product that I particularly like that I have discovered through advertising and marketing: cheeses, wine, meats, eggs, tomatoes, basil leaves, apples, restaurants, barbers, art, books, hotels, shoes, shirts, eyeglasses, pants (my father and I have used three generations of Armenian tailors in Beirut), olives, olive oil, etc.

Eyeglasses? Last time I checked mine, Luxottica had made those – and Luxottica is a very large multinational that has long abandoned its “small is beautiful” stage. Maybe Mr. Taleb orders his glasses from Warby Parker – fine. But do Warby Parker’s owners really not want to grow it into a much larger company? And does Mr. Taleb like a glass of vintage Chateau d’Yquem less than a Greek retsina, knowing that Chateau d’Yquem is owned by LVMH, a large corporation, and not a small artisan?

In summary, Antifragile is a thoughtful book with much to recommend it for, and you should read it if you like the author’s broad, non-academic erudition, share his reverence for ancient history and Mother Nature, and don’t mind his personal quirks too much; but the book’s flaws in tone of voice – and, sometimes, in argumentation – make it less strong than it otherwise could have been.

Amendments to Terms and Conditions

Among the revised Terms and Conditions I just received from a retail bank I do business with:

On the basis of special market conditions, the Bank may be compelled to introduce negative interest rates. A new provision has been added to reflect this option.

Any interest shall be credited to or debited from the account on an annual basis.

The joys of editing

You’ve got to love the editors at The Economist. Merry Christmas!

No one can know for certain what future investment returns will be. If the writers at The Economist were sure of the answer, they would be lounging about on their luxury yachts instead of sweating over split infinitives.

This is what the Greek default looks like

Europe will have to make its choice this year. Either a much tighter, more constrictive fiscal union with a central bank that can aggressively print euros in this crisis, or a break-up, either controlled or not. I don’t think they can kick the can until 2013, as the market will not allow it. Either the ECB takes off its gloves and gets down to real monetization when Italy and Spain need it, or the wheels come off.

If you want to understand what’s going on in global financial markets, go to John Mauldin’s site and subscribe to his free weekly newsletter Thoughts from the Frontline. Every week he pores over analyst reports, travels, talks to a lot of people who know what’s going on behind the scenes, and sits down to package thoughts, numbers and charts to be conveniently delivered to your inbox to provide you with food for thought.  Also from this week’s newsletter: this is what the Greek default looks like.

Greece has two choices. They can choose Disaster A, which is to stay in the euro, cutting spending and raising taxes so they can qualify for yet another bailout; negotiating more defaults; getting further behind on their balance of payments; and suffering along with a lack of medicine, energy, and other goods they need. They will be mired in a depression for a generation. Demonstrations will get ever larger and uglier, as the government has to make even more cuts to deal with decreasing revenues, as 2.5% of their GDP in euros leaves the country each month. There is a run on their banks. Any Greek who can is getting his money out.

Greek voters will then blame whichever political group was responsible for choosing Disaster A and vote them out, as the opposition calls for Greece to exit the euro. Which is of course Disaster B.

Leaving the euro is a nightmare of biblical proportions, equivalent to about 7 of the 10 plagues that visited Egypt. First there is a banking holiday, then all accounts are converted to drachmas and all pensions and government pay is now in drachmas. What about private contracts made in euros with non-Greek businesses? And it is one thing to convert all the electronic money and cash in the banks; but how do you get Greeks to turn in their euros for drachmas, when they can cross the border and buy goods at lower prices, as inflation and/or outright devaluation will follow any change of currency. It has to. That is the whole point.

So how do you get Zorba and Deimos to willingly turn in their remaining cash euros? You can close the borders, but that creates a black market for euros – and the Greeks have been smuggling through their hills for centuries. And how do you close the fishing villages, where their cousin from Italy meets them in the Mediterranean for a little currency exchange? What about non-Greek businesses that built apartments or condos and sold them? They now get paid in depreciating drachmas, while having to cover their euro costs back home? Not to mention, how do you get “hard” currency to buy medicine, energy, food, military supplies, etc.? The list goes on and on. It is a lawyer’s dream.

There is a third choice, Disaster C, which is worse than both of the above. Greece can stay in the euro and default on all debt, which cuts them off completely from the bond market for some time to come. This forces them to make drastic cuts in all government services and payments (salaries, pensions etc.), and suffer a capital D Depression, as they must balance their trade payments overnight, or do without. Then they choose Disaster B anyway.

The roots of the subprime mortgage crisis, and everything that followed. From a David Foster Wallace article

One reads David Foster Wallace‘s long-form journalism collected in Consider the Lobster slowly and with care, knowing there won’t be any more of his pieces for Harper’s, The New York Observer, Premiere and so on. (Incidentally, Gourmet, the magazine that commissioned the title story, has recently ceased to exist, too.) One of these pieces, appearing in this collection in its full uncut glory, got a brief revival in the 2008 elections: it is “Up, Simba”, where DFW got to cover on behalf of Rolling Stone none other than John McCain on the campaign trail in the 2000 Republican primary, which McCain lost to George W. Bush after a non-inconsiderable amount of “negative advertising”.

“Host”, the piece that closes the collection, profiles for the Atlantic Monthly a conservative radio talk show host named John Ziegler working at KFI in Los Angeles, and it is insightful and probing and sad. I just wanted to notice one little thing, and point it out to you. When the host is off the air, the writer’s ear does not tune out to the mindless chatter of the advertising segments. The writer keeps listening. And (this is 2004) he observes that there is quite a bit more of a certain type of radio advertising than there used to be.

As of spring ’04, though, the most frequent and concussive spots on KFI are for mortgage and home-refi companies. In just a few slumped, glazed hours of listening, a member of this station’s audience can hear both canned and live-read ads for Green Light Financial, HMS Capital, Home Field Financial, Benchmark Lending. Over and over. Pacific Home Financial, Lenox National Lending, U.S. Mortgage Capital, Crestline Funding, Home Savings Mortgage, Advantix Lending, Reverse mortgages, negative amortization, adjustable rates, APR, FICO… where did all these firms come from? What were these guys doing five years ago? Why is KFI’s audience seen as so especially ripe and ready for refi? Betterloans.com, lendingtree.com, Union Bank of California, bethebroker.net, on and on and on.

I don’t want to attribute any prescience to DFW’s words. While he might be read as implying that nothing good would come of it, this may very well be just our interpretation as readers in 2010, with the privilege of what we know today. As a writer, he merely observed and reported. May we observe the world around us with the same open-mindedness and insight.

On accountants, economists, investment bankers, civilization, good and evil

You might be interested, dear readers, in the interview in the current issue of Stanford Lawyer with the eclectic Charles T. Munger, Warren Buffett’s longtime partner in Berkshire Hathaway. A few snippets for your enjoyment follow.

On the SEC:

The SEC is pretty good at going after some little scumbag whom everybody regards as a scumbag. But once a person becomes respectable and has a high position in life, there’s a great reticence to act. And Madoff was such a person.

On derivatives:

Some of the most admired people in finance—including Alan Greenspan— argued that derivatives trading, substituting for the old bucket shop, was a great contribution to modern economic civilization. There’s another word for this: bonkers. It is not a credit to academic economics that Greenspan’s view was so common.

On the accounting profession:

They are way too liberal in providing the kind of accounting the financial promoters want. They’ve sold out, and they do not even realize that they’ve sold out.

On economists:

They say it’s not economics if you think about the consequences of good and evil, and good and bad business accounting. I think what we’re learning is that when you don’t understand these consequences, you don’t have an adequately skilled profession.

On Lehman Brothers:

You can’t save everybody. That would have created unlimited revulsion in the body politic. I probably would have let Lehman go, too.

On Goldman Sachs:

The culture of Goldman Sachs as a partnership was morally superior and better for the surrounding civilization than the culture that came after it went public.

On investment bankers:

I have lived in my own life with responsible investment banking. When I was young, First Boston Company was an honorable and constructive firm and very much served the surrounding civilization. Investment banking at the height of this last folly was a disgrace to the surrounding civilization.

Understanding the Financial Crisis: extremist predictions for 2009

On Saturday, I had the good fortune to attend a Stanford University alumni event in London (the only European date in a four-year, 20-city world tour by President John Hennessy and distinguished faculty, called Leading Matters). It is not only a way for Stanford to reconnect with alumni, but also a great opportunity for alumni and their guests to hear about multidisciplinary research from faculty members on topics ranging from personalized DNA-based medicine to ecosystems sustainability and energy policy.

The most successful session by far, though, was one where academia and practice came together: Business School Dean Bob Joss (whom I am a great fan of – see a short article here) started off a discussion with alumni Jerker Johansson, CEO of UBS Investment Bank, and Bill Browder, founder and CEO of Hermitage Capital Management.

browder-bill-hermitage-capitalNow, I’m going to focus on what Bill Browder said. It is very much of a Black Swan scenario – yes,  blacker than it’s been so far. Not that I’m giving you such a big scoop: first, because Browder has already gone on the record as fundamentally bearish (see here);  second, because in a couple of weeks’ time you will be able to listen to the whole session on iTunes (the meritorious organizers of the event are making recordings and notes public – see for example the Los Angeles sessions from last January here); third, because he’s probably going to give much the same speech at the  London campus of the University of Chicago next week. It was Browder’s talk that generated the most heated debate at the cocktail reception and dinner that followed, and I did take some notes, so I thought I’d share them with you.

Browder made four – admittedly extremist, but in his view quite solid – predictions for how the crisis will play out in the rest of 2009.

  1. Commercial banks will start “gating” their deposits (i.e., introducing restrictions on how much a depositor is allowed to redeem), probably in the European Union.
    Rationale: the entire banking system still has a precariusly low level of capitalization, and government guarantees are no longer credible – a country like Ireland, with €7bn in offical reserves, cannot possibly make good on €400bn of guaranteed deposits. If 10% of depositors decide to pull their money out, Ireland needs to come up with €40bn in cash, and by the time the ECB has scheduled a meeting to see if they can help out the Irish, the whole Irish banking system is insolvent. That’s why the last resorts for banks – or for governments, really – will be to tell you that you cannot take out more than, say, a thousand euros per week. Can’t happen? It’s already happened – in Russia, Argentina, Latvia, Ukraine. Sooner or later, it is happening somewhere in the EU.
  2. The price of long-term US government bonds will crash.
    Rationale: 10-yr and 30-yr Treasury yields are unrealistically low. The US is facing the biggest budget deficit in its history: even if you argue that the US is not just like any other borrower (which Browder doesn’t believe, by the way), bond prices cannot defy gravity indefinitely. Who will buy enough bonds to finance a $2 trillion deficit? Nobody. Even if buyers can be found for bonds covering half of it, for the other half the Fed’s going to have to print money. And you don’t want to be caught holding bonds with a single-digit nominal return when the Fed prints enough money to generate double-digit inflation. (By the way, an interesting side effect may be that other countries can’t issue bonds at all, because issuing by the US Treasury is crowding out everybody else).
  3. There will be a number of sovereign defaults, including in the EU.
    Rationale: follows from the above. Current risk premiums already imply a probability of defaulting within the next 5 years between 10 and 20% for the usual suspects: Ireland, Greece, Poland, Italy. The probability that at least one of them defaults, even if we don’t know which one, is pretty high. Again, it’s happened before (Russia, Argentina, etc.)
  4. The price of gold will go up.
    Rationale: it’s the only thing that governments cannot print.

The best question from a rather traumatized audience was: “What has to happen for you to be wrong?”

Browder replied that, for his argument to be wrong, asset prices have to stop falling. If we’ve bottomed out today, then the predictions above are wrong. However, note that, no matter how much they commit in relief programs and stimulus packages, governments have never been able to stop asset prices from falling.

Recommendations for the retail investor? Put 90% in Treasuries with extremely short maturities (2 weeks to a month) or, if you have access to it, buy commercial paper by the likes of Microsoft, Johnson & Johnson, and Philip Morris. Put the other 10% in gold. And sit tight.

The only bright spot in Browder’s argument was: the Euro is not going to fall apart. Stress on the Euro is coming from the likes of Ireland and Portugal, not from the healthier countries. The people with the biggest problem have the biggest incentive to stay in the Euro, because doing otherwise would be disastrous for them (as far as Italy goes, I’ve believed for months that without it we’d all be in the streets, banging pots and pans, Argentinian-style). Conceivably, France and Germany could decide they’d be better off getting out of the Euro and leaving the rest of the Euro countries to fend for themselves: yet their political commitment to the Euro is too big. It took 40-50 years to make the Euro, it won’t get unmade in the short run.

And on that happy note, my dear readers, let me remind you that the next Leading Matters is scheduled in San Francisco on May 9 and, given the proximity to the University, promises to be packed with interesting speakers, although it won’t be featuring Bill Browder, I believe. Still, if you have any friends who’ve been to Stanford, get yourself invited and you’ll have a great time fulfilling your intellectual curiosity. And wishing you were back in school, maybe!