F.A. Hayek ♥ Mick Jagger

June 30th, 2009

I love when seemingly disparate things synchronize in unexpected ways.

According to The Legal Underground,  Nobel laureate Friedrich von Hayek (1899-1992) “was exceedingly fond of t-shirts, especially those portraying images of Mick Jagger…”

Surprising enough; doesn’t fit our image of Hayek.

But it gets better.  Sir Mick is a fan of Hayek.

Before quitting to start the Rolling Stones, Jagger attended the London School of Economics, where Hayek had taught.

Supposedly, Jagger’s adviser at the LSE “said that Mick Jagger did a careful net present value analysis of the value in attending LSE as compared to the foregone revenue from playing rock and roll. When the dollars came out higher for music, Mick came by and apologized to the adviser, but said he couldn’t afford to continue in school; LSE was just costing him too much money.”

Did I mention that Jagger also owns an Enigma machine?  The rare 4-rotor type.

Now if I could just work Salma in there somehow, it would be perfect.

(Sir Mick: If you’re reading this, a comment confirming/denying the above story would be appreciated.)

How Fortunes are Made and Lost

January 27th, 2009

From The Big Bonanza: An Authentic Account of the Discovery, History, and Working of the Comstock Lode by Dan DeQuille (Hartford, American Publishing Company, 1876):


Bulls and bears – Doings of the brokers – On a margin – “Pussycat Tilde” and “Bobtaile” – Going up! – Dealers and dabblers

During the prevalence of a big stock excitement, times are lively along the Comstock range. Virginia City then hums like a Brobdingnagian beehive. All who failed to make fortunes on the occasion of previous excitements in stocks are going to do better this time. They have seen how these things work and this time are going to sell when they can do so at a fair profit. They don’t want the last cent; they will give someone else a chance to make something.

This is the way they talk at the start. As soon as there is a marked advance in stocks, however, they will be heard to say: “As soon as I can double my money I am going to sell.” In three days from the time of their making this assertion, stocks have taken such a jump that they could sell and double or more than double their money. Everybody is saying, however, that they are not selling for half what they are worth; that they will sell for twice or three times present prices be­fore the end of another month.

The men who were intending to sell whenever they could double their money cannot think of doing anything of the kind as things are now looking. Instead of selling they become excited, put up their stocks (which they had probably bought and paid for “out and out”) as a “margin,” then put in all the money they can raise besides and buy as many shares of their favorite stocks as they can in any way manage to secure. Stocks still go up, and each day these dabblers will be found counting their profits. They have invested largely in the low-priced stocks of “outside mines” – mines in which nothing of value has yet been found, but mines in which, all are saying, grand developments are liable to be made at any time – mines, in short, which in dull times are generally designated as “wildcat.” The masses – the servant girls, chambermaids, cooks, hostlers, washerwomen, preachers, teachers, hackmen, and draymen – are wildly and blindly buying these low-priced stocks, and from day to day they are going up “with a rush,” and everybody is getting rich. Our men who only “went in” to make a fair profit now tell you that they made yesterday ten thousand dollars; today they have made fifteen thousand dollars, and in a week or two they will say that they are worth a quarter of a million, half a million, or a million of dollars.

But they are not going to sell yet; no indeed – the rise has only com­menced. Pretty soon stocks fall off a little. Never mind, tomorrow they will do better. Tomorrow they are still a “little off,” as is said when stocks are going down. The next day they are rather “soft,” which is the same thing as a “little off.” However, that is all right. Our dealers – amateur speculators – have some points given them by a friend who is on the inside. A development is about to be made in a favorite mine. The “bears” are trying to break the stock; but they can’t do it; no, sir! – impossible. Too much merit in the mines at this time. All will be up and “booming” in a day or two. Next time you shall see them go higher than they have yet been seen.

Our men who started in to make a fair profit might yet sell and double their money – much more than double it – but they are not going to do anything of the kind. They are going to wait till “things take a turn.” The “bulls” will soon make a grand rally, and when things go up again, our men will sell. They admit that they should have sold when their stocks were all up before, but never mind! they will go to the same figures again in less than a fortnight, when they will be sure to sell.

There does come a “spurt,” and for a day or two there is a cheering improvement in prices along the whole line. Faces brighten and everybody talks of all stocks going higher than ever.

All at once everything is again “soft,” the next day “softer,” and the next decidedly “off.” It is then said that someone in the “bear” interest has been telegraphing to the “Bay” (San Francisco) a pack of lies about the mines, and the “bears” “below” (at San Francisco) have made use of these lies to get up a “scare.” Never mind! the scare will be over in a day or two.

But stocks still go down. Then it is said that some big dealer is “unloading” and there is talk of a “crash.” Still our men who started in but to make a “fair profit” do not feel like taking thousands, when they might a short time before have taken tens of thousands of dol­lars. They still hold on, saying that even though one or two big deal­ers are unloading, the big men among the bulls will “stand in” and take all the stocks that are offered. Also, they will have some points from a friend “on the inside” and developments are about to be made in one or two of the mines that will make all who have sold “very sick,” particularly those bloodless demons who have “sold short.” The “shorts” will have a merry time of it when they come to “fill.”

Thus matters stand when suddenly there comes what looks very much like the beginning of a “crash.” The “bears” are all diligently crying: “Stand from under.” Many persons become frightened and throw their stocks upon the market. Down go prices and soon “soft” is no name for it. The masses – the tinker and the tailor, the preacher and the teacher, the hostler and the waiter – rush in to try to “save themselves” and there is seen a grand and unmistakable crash. Brokers are calling on all sides for “margins” to be “made good,” and men are rushing about trying to raise money to “put up” in order to prevent their stocks being sold at less than cost.

They perhaps raise the money required and for a few days breathe again, when there is a further decline in stocks, and the brokers are again sending notes to their customers telling them that if they do not put up more money they will be sold out. Sooner or later there comes a time when the customer can raise no more money, and his stocks are thrown into the market by the broker – in whose hands they re­main – and are sold. Thus ends the grand speculation.

Our men who at the start were resolved to be content with a fair profit are generally found among the number of those who are sold out, when they are heard to say that if they ever have another such chance to make money they will not hold on for the last cent. They have said the same thing year after year ever since the opening of the Comstock mines. But whenever there is a grand upward movement in stocks, they never fail to become excited and try to buy about ten times as much stock as they can pay for. In this way they lose all except what they may have happened to purchase at a fair price in a mine of real merit.

XML for financial derivatives

November 23rd, 2008

The December Liberty has an excellent article on the origin and causes of the current global financial crisis; probably the best on the subject I’ve read – From Reform to Crisis by Jim Walsh.

There is plenty of blame to go around – like most man-made disasters, the causes are many and interlocking, and certainly no one intended the result.

One of the generally agreed-upon ingredients was the lack of transparency in extremely complex, yet widely traded, derivatives – mortgage-backed securities, SIVs, CDOs, CMOs, CDSes, etc.  The opacity of these instruments made it extremely difficult to evaluate their underlying risk and value, which in turn made them hard to price and trade in volatile markets.

Which is a shame, because in principle the trading of derivatives, even (or especially) complex ones, offers significant economic benefits to society – these will be lost if the current panic results in this market being regulated out of existence.

But the transparency problem does need to be solved.

My friend Fred Hapgood mentioned that this ought to be the kind of problem that computers are good at solving.  He’s right.

According to Walsh’s article:

SIVs and CMOs were pools of standard MBSs sliced up (often into 64 equal parts) and reassembled according to their riskiness, geographic concentration or other standards. In some cases, Wall Street whiz kids would break a 30 year mortgage into individual securities based on each of 360 monthly payments; then they would bundle thousands of the one-month payments into larger securities offerings. Finally, CDOs were pools of CDSs sliced up and reassembled to reflect default risks more precisely.

It’s easy to understand why these instruments are opaque – their risk and likely return depend on that of multitudes of other derivatives, which in turn depend on hundreds or thousands of individual mortgages and loans, sliced and diced every which way.

In principle these factors can be fully evaluated (after all, they ultimately depend on the creditworthiness of individual borrowers, something the financial world has always coped with). In practice evaluation is impossible because it can only be accomplished by pouring thru thousands of pages of documentation describing the assets and conditions represented by a derivative, and then doing the same for each of the other derivatives of which the derivative is comprised, etc., traversing the entire tree of rights back to the individual borrowers.

As Fred said, this is exactly the sort of thing computers are good at.

So, my proposal is that an appropriate regulatory body should define an XML schema to exactly describe the chain of rights, conditions and assets represented by any traded derivative.  Issuers would be required to legally define the derivative in terms of the XML schema, which would be publicly posted in machine-readable form.

The schema would allow derivatives composed of other derivatives to be simply described as a set of links to (or copying of) the XML descriptions of the constituent instruments, with appropriate operators for expressing conditions, time-dependency, etc.

I imagine the regulator would require these XML descriptions to be posted in such a way that a potential trader could find them online in a uniform way – for example, an exchange might maintain a single database with links to the XML descriptions of all traded instruments.

The rest is details.

A standardized XML schema and the single rule that issuers must describe their offerings using the schema should allow automated analysis of arbitrarily complex instruments, all the way down to each individual loan or other asset.  Each trader could do their own analysis, with their own assumptions and rules – the XML data would supply only the definition of the instrument to be analyzed.

It seems to me that this would solve the transparency problem in a robust and extensible way.  Full information would be provided in a usable form before trading.

Since a portfolio is just an aggregation of assets, entire portfolios could be analyzed in the same way – by buyers, lenders, shareholders, regulators, and analysts.  Markets would then be able to sort out, by the usual means, which kinds of derivatives make sense, who is solvent, who is taking risks, and how much.

I’d love to hear criticism of this idea.