Oh! So Now You are Sorry?

Last week Messrs Prince and Rubin, formerly of Citigroup, testified before a government commission looking into the financial meltdown.  Having lived through the “experience” I thought I might share some of my earlier Observations.

·        Separating the Truth from Fiction

“Of all the offspring of Time, Error is the most ancient, and is so old and familiar an acquaintance, that Truth, when discovered, comes upon most of us like an intruder, and meets the intruder’s welcome.”

            Charles Mackay – Scottish Philosopher

If you don’t understand something ask for an explanation. If the explanation doesn’t make sense, then ask for clarification.  If it still doesn’t make sense the problem is not you or your capacity to understand. It’s that “it” doesn’t make sense. 

Implying that people who “don’t understand” are dense is a common persuasive tactic of people who themselves don’t actually understand (or worse).

The problems we often encounter are not caused by our lack of mental capacity, but by our willingness to go along with such an implication.

            -03/24/2008

·        Demigod (Demon)

Corporate culture has a negative aspect I would like to address.  I call it the deification (often later demonization) of senior executives.  These folks are not demigods (or demons).  They are not smarter (or vice versa) than before they got promoted (appointed, whatever) and their intelligence and acumen does not vary with the fortunes of the firm.  They are humans just like the rest of us.  Nonetheless this process goes on constantly, often the result of actions by their subordinates.

We are neither unintelligent nor uneducated and don't help ourselves or the firm by buying into the process I have described.

We should overcome the temptation to do so.

          - 07/07/2008

·        Standards do serve a purpose

When the justification is that we have to because “well everybody else is doing it and we have to stay competitive” then it’s time to take a deep breath and remember what happened to …..

          -09/08/2008

·        What happened (11/05/2007)

Here is my take:

People (yes that means everybody) tend to overestimate the accuracy and precision of their knowledge and that often leads to overconfidence and a lack of perception of the amount of risk they are undertaking in making financial decisions. This in turn tends to burn them from time to time and it kick starts the law of unintended consequences hurting others.

10/01/2008 Supplement: Senior executives in financial firms, quasi governmental entities (Fannie, Freddie), and regulatory authorities listened to and accepted the explanation (by senior but subordinate experts) of the “risks incurred” for various proposed offerings and undertakings.  The senior executives and those making a proposal were far too confident that the analysis of the risk/reward balance on the proposal was based on accurate and complete underlying data. That is a classic and oft repeated mistake.  This led to tragic overconfidence and the assumption of a level of risk that was unknown and unprecedented sending the law of unintended consequences off on a gallop.

But make no mistake we all had a hand in this. Whining that it was someone else’s fault isn’t going to help.

          -09/29/2008

·        Prognostication is a four letter word (and so is overconfidence)

I was all set with a different Observation for today but then a financial guru testified before Congress on Thursday.  I read a transcript of part of his testimony and I just could not resist.

What he said was:

It was the failure to properly price such risky assets that precipitated the crisis. In recent decades, a vast risk management and pricing system has evolved, combining the best insights of mathematicians and finance experts supported by major advances in computer and communications technology. A Nobel Prize was awarded for the discovery of the pricing model that underpins much of the advance in derivatives markets. This modern risk management paradigm held sway for decades. The whole intellectual edifice, however, collapsed in the summer of last year because the data inputted into the risk management models generally covered only the past two decades, a period of euphoria. Had instead the models been fitted more appropriately to historic periods of stress, capital requirements would have been much higher and the financial world would be in far better shape today, in my judgment.

What he meant (in plain English) was:

They thought they had it figured out but they didn’t and it turned out to bite everyone on the....*

Overconfident Prognosticators, all of them, including the “guru” (and you know what I think of those guys).

You may wish to reread my 03/31/2008 (“worse than a lollygagger”) and 05/19/2008 (“…use your head Fred…”) Observations. If you don’t have them I will send them to you. I already sent them to the “guru.”

*reminds me of when I was young and used to set off firecrackers with my buddies.  Once we set off several hundred in a row without a failure.  Then one of didn’t go off after being lit.  Georgie Wade stuck his head over the darn thing; it flared up and burnt his eyebrows off.

            -10/27/2008

When you're at a "Buffett" pick up some food for thought

Portions of CNBC Transcript: Warren Buffett's 'Stock Split' Interview - Part Three: Kraft-Cadbury

Published: Wednesday, 20 Jan 2010 

In response to the reporter's comment that there is a great deal of uncertainty in today's economy and perhaps we should wait to invest when things are not so uncertain., Mr. Buffett had this to say:

 It doesn't make any sense to try and time things that way.  Nobody knows what's going to happen tomorrow, ever. The only thing is they get very apprehensive about it at certain times, particularly when other people are apprehensive.  When people get scared, they get scared as a group.  The confidence comes back sort of one at a time...

In response to the reporter's question on whether the  uncertainty about the near term future of a company should postpone  the purchase of the stock of that company Mr. Buffet stated:

The idea that you try to time purchases based on what you think business is going to do in the next year or two, I think that's the greatest mistake that investors make because it's always uncertain.  People say it's a time of uncertainty.  It was uncertain on September 10th, 2001, people just didn't know it.  It's uncertain every single day.  So take uncertainty as part of being involved in investment at all.  But uncertainty can be your friend.  I mean, when people are scared, they pay less for things.  We try to price.  We don't try to time at all.

Later in the interview the reporter stated that many consider that the market is currently overpriced and has diverged from the economy. Mr. Buffett responded:

 ..., I think markets frequently will diverge from the economy.  That's why I think it's a big mistake for people to start when they think about buying a stock, I think it's a big mistake to start, to think about what's going to happen in the next 12 months or the next six months either to the company or to the -- or to the economy generally.  I do not -- if I'm buying XYZ company I am not concerned about what they're going to earn in the next year. The next year is going to be over and then people are going to be looking at the year after that.  If I'm right about where they're going to be in five or ten years we'll make a lot of money but I can't time stocks based on what they're going to do this quarter and next quarter.  I don't know anybody else that can, but maybe they can.

In my view thats the difference between someone who can actually have a positive Alpha and people who try but can't for any length of time.