Book Review: Fooled by Randomness

I hadn't intended this blog to become a collection of book reviews, but I've come to like the idea of keeping a log of my thoughts on the books I've read. If for no other reason, keeping a book-review blog helps me to feel OK about actually donating a book to our favorite non-profit bookstore (Books for America) after I've finished reading it. Anyone who's seen our bookcase can attest that Nicole and I have a book problem.

As for the book Fooled by Randomness by Nassim Nicholas Taleb, there's far too much packed in to do any kind of justice to the book in a reasonable summary. Indeed, my main criticism of the book is that it is poorly written. It's very discursive and often he brings up topics that you would really already have to know something about in order to understand what he's saying. Sometimes I did and sometimes I didn't. In fact, in a postscript, Taleb mentions how boring he finds writing if he's confined to an outline or a deadline or a page limit. He just wants to let it fly and the book reads a lot like the author was writing for himself and is only letting you along for the ride. And this is a shame because this book really has some important and profound things to say.

Basically the book is about how we human beings are constantly trying to tell ourselves a story about what has happened and why it happened. And we almost never want to tell ourselves that something has happened for no reason other than a random, meaningless fluctuation. Even when we know better at some level, we cling to emotional explanations for random events. Taleb's villians are CEOs, bankers, journalists and historians who all try to make money by explaining things that are actually random. Think about it: if you watch the nightly news, every day you hear that the Dow was up or down some amount (which is usually a pretty small percentage change) and then they tell you why. Millions of transactions occurred that day and, if you add them all together, the result was that the market moved a tiny, tiny bit. Isn't the most logical explanation that, in fact, nothing happened today. People traded stocks for whatever reasons (someone is retiring and selling, someone else if saving for retirement buying and neither side of that transaction much cares about whatever went on today) and the market just moved randomly a bit. Day after day. People used to think that the weather was being dictated by the gods too. And they used to pay shamans to make the weather better. Today we think we've evolved, but is your investment adviser really earning his or her keep or they just betting on sun in the summer and snow in the winter and taking credit for being brilliant?

Taleb makes pains to point out however that we are all susceptible to emotional thinking about random events. It's in our nature. And here, the book moves beyond being about investments or markets or the financial crisis or MBAs. It really becomes a book about philosophy. (Indeed there's a section about philosopher John Popper that I didn't really get, except that he's Taleb's favorite philosopher). Because we're not in control of our lives, Taleb favors a stoic disposition. Treat each fortune and misfortune with the same equanimity and you will have risen above the randomness of markets, weather, cancer diagnosis, car accidents and love. I'm not convinced about the philosophy, but I do appreciate the book's call for us to stop inventing stories where none exist. And in this sense, the book is very similar to Malcolm Gladwell's Outliers, reviewed below. We constantly hear stories about why and how this one person succeeded but rarely about how and why all the others failed. Because if we heard about the hows and whys of the failures we might come away with the conclusion that the successful person is just lucky. Taleb certainly would think so.

I can't quite recommend the book, if only because Taleb has (by his own admission) re-written it in a book called The Black Swan. I'll probably read that too in the hopes that someone took a stronger editorial hand in that one. If not, he's supposed to be coming out with a third book which will be the same stuff told in yet another way (again, to his credit, he admits this). So stay tuned for those reviews. In the meantime I might start thinking about things to post that aren't book reviews.

Book Review: Malcolm Gladwell's Outliers

I read Malcom Gladwell's Outliers this morning (ok, I skimmed some parts but I think that counts, see my post on How to Talk About Books You Haven't Read). The book is quite enjoyable and very well written. The fact that I was able to read most of a 200+ page book in a morning is a testament to that. It's also eminently skimmable because Gladwell likes to tell stories but you can read the setup and the conclusion and skim the interior parts.

The book has two theses, only one of which is captured by the title. The "Outliers" thesis is that super-successful people, aka society's outliers, get where they are through luck. Luck does not replace talent, intelligence or hard work, etc. Those things are necessary but not sufficient to make you a Bill Gates or a Beatles, or an NHL hockey player. What matters is that you are born in the right place at the right time in order to be able to have opportunities to perfect some skill that others do not get. In some cases, these opportunities are very specific: Bill Gates, Steve Jobs and others who were born at the right time to take advantage of the computer revolution and who had truly extraordinary opportunities as kids to learn to program. Gladwell similarly profiles a group of Jewish New York lawyers born in the 1930s with parents in the garment industry. (Which may not sound like a recipe for success but Gladwell is convincing on this point.) Gladwell's thesis is that it takes 10,000 hours of practice to be truly great at something. That's about 10 years. When the personal computer revolution took off only a small handful of people had 10 years of programming experience AND were young enough to bet their futures on a crazy idea (a computer for everyone) rather than get safe IBM jobs. Even the child prodigy Mozart is an example not of innate ability but of the power of practice. By 17 he already had 10 years of composing experience and his early works are (a) not that good, and (b) probably "cleaned up" by his father who took down his notation.

Gladwell's second thesis is interesting but not as convincing and a bit hard to pin down. It's not about "outliers" at all, but rather it's about how our cultural background shapes our ability to succeed. This is dangerous ground, not because there aren't good examples of one culture being better at something than another, but because it's dangerous to generalize from specifics. So Gladwell convincingly shows that at least a handful of airplane crashes were caused by (Korean or Brazilian) co-pilots being too deferential to pilots. Korea and Brazil, apparently, are cultures that are highly deferential to authority but in an airplane cockpit this can be deadly. Now, that's a fine observation and Korean Air has put in a place a program to re-train flight crews that is probably a good thing. But how far does that take us? And what in the heck does this have to do with whether or not someone is an outlier?

Gladwell tries to bridge the gap by arguing (seriously) that Asians are better at math because they come from a rice cultivating culture which rewards patience and persistence (and because they can literally say the words for numbers in one syllable making a string of numbers easier to memorize). By contrast, Westerners give up too easily on math because they don't believe that hard work pays off when it comes to math problems. Again, the idea that maybe Western kids should be taught that math success is related to work and not some innate math ability is a good one that should be spread far and wide. And I suppose if Asian kids get their 10,000 hours of math in much faster than Western kids we might see more math outliers from their culture. But so what? It's just not clear what the point is of this cultural difference thesis. So being a Jewish New York lawyer in the 1930s was helpful if you wanted to found a successful firm. Why? Largely because these particular lawyers were discriminated against and couldn't get jobs at the elite firms. They had to start their own firms and take on work that the elite firms though was beneath them. But that work turned out to be things like hostile takeover litigation which became huge in the 70s and 80s.

Ultimately Gladwell's book is a good read, if for no other reason than it makes you feel better about not being a super-genius (he profiles and honest-to-goodness super genius whose life has basically sucked). And he's spot on when he says that there are way more 1600 SAT 4.0 GPA kids than Harvard can ever take and so it ought to just have a lottery instead of this fiction that it has sorted through them and picked the best, Harvard-worthy, kids. But his point is a bit depressing even though valid. You might be smart and able but without being in the right place at the right time you won't be an outlier, just an ordinary successful person. And if do achieve an unusual success it might have been luck as much as anything. Beyond that, I suppose his point is that we're prisoners of our culture and there are some things we might do well (like tell the pilot he'd damned well better not try to fly through that thunderstorm) and some things we do not do as well as other cultures (math). OK. Thanks, Malcolm. What was I supposed to do with information? Not much I suppose, but if you figure it out and you're able to get lucky and capitalize on it before anyone else, maybe you too can be an outlier.

Book Review: When Genius Failed

The second book I read on finance (OK, listened to on Audible) was When Genius Failed by Roger Lowenstein. It was a great follow-up to Liar's Poker because it follows John Meriwether, a key figure at Solomon Brothers in the 1980s and, thus, a key figure in Liar's Poker. Meriwether was one of the top traders at Solomon and he had one particular stroke of genius: to find other geniuses to tell him how to trade. Meriwether saw early on that a set of super-geniuses who were applying rocket-science to trading might be able to make a heck of a lot of money if they got out of the ivory tower and on to the trading floor. In one of my favorite passages in the book, Meriwether calls up a Harvard professor to try to poach one of his grad. students and the professor offers himself instead.

Meriwether and his group were incredibly successful, he but ended up leaving over a bond trading scandal. Pressing on, Meriwether took his group from Solomon and started a hedge fund called Long Term Capital Management (LTCM). He hired a former Vice Chairman of the Federal Reserve. He hired two of the most highly respected financial economists around (John Merton and Fischer Black, both of whom would win the Nobel Prize while working for LTCM). These guys were so smart that they thought they couldn't lose. They had incredibly complex and intricate computer models that told them that the odds of losing all their money were so low, you wouldn't expect it to ever happen in the history of the universe. Guess what?

Long story short, LTCM lost it all and had to be bailed out. The government didn't offer any funds, but the New York Fed. called all the big Wall Street bankers into a room and basically ordered them to work it out. (The one firm that wouldn't play ball? Bear Stearns.)

The book is well written and provides interesting pictures of the LTCM principals, though some of the detail about trading strategies is a bit dry and long. But what's amazing about this book is that, much like Liar's Poker which was written a decade before, everything that is falling apart now was falling apart then and no one seems to have learned. After LTCM (and after Lowenstein's brilliant deconstruction of what went wrong) it's flabbergasting to think that in 2006 the same banks that had to bail out LTCM were convinced, utterly, that they couldn't loose money on subprime mortgages because housing prices never fall!

Reading this book makes me think of the people who stayed in New Orleans because they'd been through hurricanes before and figured they could make it through Katrina. That attitude seemed to pervade our entire financial system. The tragedy of LTCM is that it perversely made people in power feel optimistic that any problems like that could be dealt with and solved. But the Category 5 subprime crisis hit and all the financial levies broke, and now we're in the midst of the greatest crisis since the Great Depression. Just like New Orleans, the warning signs were all there and Lowenstein meticulously flagged and catalogued them in When Genius Failed.

Book Review: Liar's Poker

So what with working at the Federal Reserve and with the economy falling apart, I've been on a financial book reading kick lately. I thought I'd start reviewing the books I'm reading. I should note that nothing I do at the Fed really has to do with economic policy so these opinions are my own.

First up, is a book I found at our favorite used book store that they were about to toss: Liar's Poker by Michael Lewis. It chronicles his years in the mid-1980s working as a banker at Solomon Brothers. It's a fun, witty and probably accurate portrayal of people who are hyper-competitive, very rich, and, it seems, out of control. Not out of control personally--these aren't people going to Studio 54 and doing lines of coke. Instead, they seem out of control in the wizardry of their financial dealings, and the way they live with and profit from conflicts of interest. Lewis seems to be saying, "Look at the way these people operate and tell me how it can last much longer?" Stunningly, of course, it lasted another 20 years. (Wall Street's ways lasted that long, Solomon did not).

The book also contains a fascinating description of Lewis Ranieri and his invention (not too strong a word) of the mortgage-backed securities market. No one could conceive of any use for these things until Washington changed the rules for the Savings & Loan industry (leading eventually to insane overreaching by the S&Ls; a crash; and a huge bailout in the early 1990s -- sound familiar?). Although the products got more complex and the markets got bigger and bigger, all the things that ended up going wrong are right there in this book, written 20 years ago. The wonder is not that it all came crashing down, the wonder is that it lasted as long as it did.

What, me worry?

A second post-election piece I didn't post at the time I wrote it (Nov. 5):

I've explained why I voted for Obama and I don't regret it today. But I am feeling a bit defensive because I've seen some emails from McCain voters that make important points and I hope I can provide some reassurance to my conservative friends.

First, I've been thinking about the political shortcomings of the Baby Boom generation for some time (well before Obama was on the scene). And perhaps more than anything I felt we needed a President who wasn't defined by the Vietnam War. I saw a documentary the other night about the 1968 Democratic Convention in Chicago and I can see how each side thought the other was out to destroy the fabric of America. But it's not like that anymore and I'm tired of the silliness of it. Negative ads are fine if they help define the issues, and yes, I believe character still matters. But Elizabeth Dole's ads claiming her Sunday school teacher opponent was a closet atheist probably helped tip my vote. It was manipulative, irresponsible and personally and spiritually hateful. You know, for years Republicans have tried to convince minority voters that if they only vote for one party all the time they'll be (and have been) taken for granted. Well, the same holds true for Christian conservatives.

Second, I'm honestly not sure if I would have voted for Obama if I hadn't actually met the guy and, as President Bush famously said of Vladmir Putin, "gained a sense of his soul." Obama was a professor at my law school and I took a seminar from him. I got no sense that he's a radical, that's he's not pro-America, or that he's a socialist. If I'm right about Obama, the far left blogosphere is going to be deeply disappointed in his presidency. If I'm wrong about him (and look how well this looking-into-his-soul thing worked out for GW Bush w/r/t Putin) then I'll be very disappointed. In fact, a couple of my old law school professors recently had a debate on "whether conservatives should vote for Obama." Prof. Cass Sunstein, who is very liberal, made the case that conservatives should vote for Obama because, well, because he doesn't think Obama is really as liberal as his voting record and his anti-NAFTA campaigning in the primary would suggest. My best sense is that Sunstein is right. Imagine Clinton without the the sex and the lies and things don't seem too bad.

Third, look, I have to say that the top of the Republican ticket, John McCain is not a conservative except on a few social issues. McCain wasn't a conservative in 2000 and that's why he lost the primary. He pretended to be one this year but I didn't buy it. McCain voted against the Bush tax cuts. He came around on those because he knew he had to. But his economic instincts are not conservative and on any other issue I didn't trust him to govern as a conservative (his response to the foreclosure crisis and financial meltdown - a housing rescue plan of some $300 billion and blaming "greed on Wall Street"- sounded a lot like Chuck Schumer to me). If we're going to have socialism in this country I'd rather come by it honestly.

My last line of defense is this: Ronald Reagan started out as a Democrat. And he always said that he didn't leave the Democratic Party, but that the party left him. The Republicans are in the wilderness because of Tom Delay, Ted Stevens, No Child Left Behind, "You're doing a heck of job Brownie" cronyism, etc.

More Obama

I wrote two posts after the election but didn't put them up because they seemed not to say what I wanted them to say. Having re-read them, I think they hold up better than I was giving them credit for. Here's the first:

I've seen a couple of emails from people who voted for John McCain and it makes me wonder where the Republican Party goes from here. The party needs to start by understanding why John McCain got the votes he did and what they can (and cannot) build on.

What the GOP cannot count on in 2012:

1. Obama the inexperienced. A lot of folks had deep misgivings about Barack Obama as a candidate. They were concerned about a lack of experience and concerned about a lack of depth that was hidden by his soaring rhetoric. He's going to president and in four years, for good or ill, he'll have experience.

2. Obama the radical. Even more potently, many Americans were concerned about what Obama's real views were. Some of this was based on falsehoods like his being a Muslim (or having been raised as one) but these attacks gained plausible support for many conservatives when they learned about William Ayers, Rashid Khalidi and Jeremiah Wright. If Obama is radical, time will tell. I do not believe he is, nor do I believe that he harbors any anti-American views. I don't believe he's a socialist looking to have government take over massive sectors of the economy. But again, time will tell.

If Obama is not up to the job, or if he turns out to be too radical, the Republicans can be assured of victory in 2 years and again in 4. This is the genius of the American system: no one in our government has the kind of power to do much lasting damage without the support of the people. (Almost all of the most consequential decisions of the Bush administration were made with solid popular and Congressional support; and if the surge hadn't worked the troops would probably be on their way home now anyway).

What the GOP can count on
1. Joe the Plumber. No, not the actual Joe the Plumber, but the underlying idea that Joe was meant to symbolize. (Having the actual Joe out campaigning was, in my view, a real mistake for McCain.) The refrain from conservatives I hear over and over is "what happened to personal responsibility?" Bailouts for Wall Street are unpopular, so the political establishment (including McCain) propose bailouts for homeowners to "even the score." Yet what conservatives want are no bailouts for anybody. Here, John McCain failed to take a chance. His very early position was to be skeptical of handing taxpayer money over to people who made bad decisions and gambled with their homes. But, afraid of losing hard-hit areas like Michigan, Ohio, Pennsylvania, Florida, and Nevada, he turned around and proposed his own $300 billion bailout plan. If he'd stuck with a personal responsibility theme instead the worst that would have happened is that he would have lost all these states. But in the end, he lost them all anyway and wouldn't conservatives feel better about it if he'd lost them heroically fighting against a bailout? President Nixon spoke of a "silent majority" and the housing crisis is one where I believe a silent majority exists. It consists of people who, despite having seen their home values drop, are not willing to hand over their money to irresponsible neighbors in order to try to prop up home values. For these conservatives, even if you could prove that they'd be better off paying for a bailout, I think they'd rather take the hit than establish a regime where the irresponsible are cushioned.

This is a respectable position. The government has been trying hard to avert another Great Depression which was really, truly, bad for just about everyone. And that may require some interventions that conservatives hate. But many conservatives seem willing to accept some undeserved losses in order to prevent others from getting undeserved gains. This is not cruelty; it's a realization that if people are rewarded when a gamble pays off but protected when it doesn't, they'll keep on betting more and more so that each bailout will be bigger than the last. Better to take the pain now of letting them all fail than the death-by-a-thousands-cuts of ever increasing bailouts.

Obamacons Transform!

Tomorrow I intend to vote for Barack Obama. I consider myself a libertarian-conservative Republican and yet I plan to vote for someone with the most liberal recent voting record in the United States Senate. Why?

1. Post-partisan Doesn’t Mean Bi-partisan

McCain has made a lot of the fact that he has been behind bipartisan legislation on a number of issues and that, by contrast, Sen. Obama has consistently voted with the left wing of his part. This is true, but it misses the point. Sen. Obama is a liberal and I wish he wasn’t (or was less so). But Sen. Obama is not the one claiming that those who vote for him represent the “pro-America parts of America” or are somehow the only “real America.” At his best, starting with his 2004 speech at the Democratic national convention and including his speech on race relations, Sen. Obama has shown an ability to understand the other side and to acknowledge their points without demonizing them. McCain is stuck in a Baby Boomer, Vietnam-era mindset where politics itself became an extension of war by other means. (Bill) Clinton, Gingrich, Bush, (Hillary) Clinton, all fall prey to this same sort of mindset. And for those who lived through the turmoil of the 60s and 70s when it quite plausibly seemed that America was coming apart, it’s easy enough to understand (though still sad and deplorable). But for Generation X and especially Generation Y (or whatever you call them) this kind of politics just doesn’t fire them up the way it did the Baby Boomers. Instead it turns them off in droves. Sen. Obama is trying harder than any politician in a generation to transcend the “politics of personal destruction” which has been simultaneously practiced and decried by both sides.

So no, I don’t expect Obama to be a centrist president. He’s got a liberal voting record and I expect he’ll be a liberal president. Nor do I expect him to be all sweetness and light. But I’m tired of being told who’s a “real American” and who isn’t. I’m tired of a politics where the ostensibly conservative candidate can’t just run on the issue in what I believe is still largely a center-right country, but has to exaggerate his opponent’s views into socialism as though he’s campaigning in 1928 instead of 2008. (Incidentally, many people including me thought that George W. Bush was going to be this kind of President. Remember “I’m a uniter not a divider?” So why do we think Obama might be different? Well, Bush ran a very divisive campaign in 2000 which I was too willing to write off as something one must do to get elected. And I must admit that my personal experience as a student of Obama’s at the University of Chicago also gives me comfort that he really is who he says he is.)

2. Sarah Palin

First, I think she was treated unfairly by the mainstream media. But, at the end of the day, one has to demonstrate that one is ready to be President. You don’t get the benefit of the doubt on this one. Obama has largely done that through two years of very tough campaigning. Palin’s seven weeks on the public stage were unlikely ever to have been enough to prove she was ready (which is a strike against McCain having picked her, not a strike against her personally) but she didn’t do enough with the time she had to put people at ease. But far more important to me is that Palin seems to embody the sort of politics of demonization that I hope Sen. Obama can help the country start to overcome. She lost me with “pallin’ around with terrorists” and “real America” and with the media criticizing her as a violation of her First Amendment rights. (Gov. Palin, you should try reading the First Amendment sometime. It’s quite interesting. It starts with “Congress shall make no law…”)

3. The Decider

I’ve come to believe that the Presidency is not about being the smartest person in the room but about making decisions and setting a tone and philosophy for governance. Obama has done that, even if it is to the left of where I’d like it to be. McCain has not. The Palin pick was ill-considered as were the shifts in campaign strategies. And McCain’s response to the economy has been muddled beyond belief; especially if one thinks all the way back a few short years ago when he opposed the Bush tax cuts. I know Obama is going to be a liberal president. I don’t know what I really expect McCain to do. My support for McCain was strongest during the Russian invasion of Georgia because I thought McCains swift and forceful condemnation was right on and Obama’s waffling sounded indecisive and weak. But we’re in a domestic crisis now and we need a leader who knows where he wants to take the country. One prerequisite for a market recovery is for the market to feel that there are clear rules. The ever-shifting bailout policies have sown confusion and made a bad situation worse. A McCain presidency really does seem like more the same on economic policy confusion.

4. A Fresh Start

Finally, Obama promises a fresh start for the United States’ reputation. I don’t expect this to last long or be very deep, but it will help for a bit. Ultimately the United States isn’t going to change on a lot of issues that cause other countries to dislike us (the death penalty, unilateralism, and just the fact that we’re big and have our hands in everything under the sun). But one lesson of the Bush administration is that we still need allies and our traditional allies are likely to find it easier to justify to their voters cooperation with President Obama. In fact, given Obama’s popularity overseas, it may be difficult, at least at first, for our allies not to increase their cooperation with the United States and we could certain use help in Afghanistan.

5. Competence

Three words can explain why President Bush is mired at a 25% approval rating: Iraq, Katrina, Foreclosure (or Bailout, take your pick). These have been challenging times, no doubt, but the president seems utterly unprepared and out of his depth on them. Obama lacks executive experience and he may turn out not to be competent. All we have to go on is his campaign. But the same is true for McCain who has been a legislator all these years. His executive experience must likewise be judged by his campaign. Who’s run the more competent campaign? I believe it’s been Obama. As the Economist said in its endorsement, Obama is a risk, but based on all the evidence we have, he’s a risk worth taking.