Narrative Fallacies Are Kind of Like Porn

January 31, 2009

In his book The Black Swan, Nassim Taleb heavily references the narrative fallacy which represents the human tendency to construct stories around facts, regardless of how the story changes the interpretation of the facts, and regardless of whether the final story is true.  In some cases the story actually distorts the facts.  For more information, I strongly suggest reading the book, its worth it.

I suppose I can thank (or curse) Nassim for explaining the narrative fallacy to me because now it appears in my everyday life.  I don’t generally look for it, but my awareness of it makes it stand out like porn: you know it when you see it.

Now I don’t claim to be perfect when it comes to my economic and financial blogging, and I am sure I have made mistakes.  I am also sure that I have misinterpreted facts, and maybe even misquoted them on occasion.  But after all, I’m one guy with a day job, no editor and a wife who’d prefer I spend less time doing this anyway.   And I don’t get paid to do this, ergo read what I write with a grain of salt.  However, when I read stories from paid writers on mainstream financial news services I expect a basic level of understanding economics and finance and at least a strong editing process.  Lord knows I could use a good editor!

In any event all this brings me to an excerpt from a Bloomberg article I just read, an article written by Eric Martin, poor Eric.  The problems I have with the article are in the passages below.  For the record while I am only pasting a section, I am not contextualizing this just to pick on Eric, I don’t know him at all, and nothing prior to this passage or after this passage serves to correct these errors or narrative fallacies.

The S&P 500 slipped 2.3 percent to 825.88 to complete a fourth straight weekly drop, its longest losing streak since July. The Dow Jones Industrial Average fell 148.15 points, or 1.8 percent, to 8,000.86. The Russell 2000 Index of small U.S. companies declined 2.1 percent.

Benchmark indexes opened higher after the Commerce Department said gross domestic product contracted at a 3.8 percent annual pace in the fourth quarter, less than the 5.5 percent estimated by economists in a survey. Still, the report showed that a buildup of unsold goods helped pare the decrease in gross domestic product.

‘Poor Report’

“It was still a pretty poor report,” said Jeffrey Kleintop, chief market strategist at LPL Financial in Boston, which oversees $233 billion. “If prices hadn’t been falling so dramatically, we would have seen an even worse number.”

Yeah, and if you had proofread your own comments I wouldn’t be blogging about it.  So sure, yes, here Eric is quoting a narrative fallacy from Jeffrey Kleintop, so this empty statement is not his own.  Regardless, reading that passage invoked the old expression: “if my aunt had balls she’d be my uncle”.  The facts are that 1. prices fell and that 2. the economy slowed less than expected. Right?  Those are the facts, nothing more, nothing less.  Reorder them if you like, make sentences out of them if need be, but please avoid linking them, and definitely avoid adding an arbitrary narrative or causation.

The narrative fallacy here is simply filler for a guy who really has nothing to say, or maybe two guys who have nothing to say.  I’m sorry, I don’t know Jeffrey at all either, which probably makes me the ignorant one here since his current employer, LPL Financial, describes him as “‘Wall Street’s Best and Brightest’ and his market commentary is regularly sought out by national print media and business television and radio.” However I just can’t believe that this was a quote worth passing along. And if that gem was not enough to set me off, it was back to back with this piece of pure frontier gibberish.

Unadjusted for inflation, GDP shrank at a 4.1 percent pace, the most since the first three months of 1958. The drop in so- called nominal growth explains why corporate profits slumped as the year ended.

Please, please, just take a moment before I highlight this one.  Read it again, and if that don’t work, read it another time.  Have you spotted what’s wrong with this one?  Ok there are two, but one is silly.

The real problem I have with this statement is the implication that the “drop in so-called nominal growth” is cited as causation for why corporate earnings (profits) slumped. !@#$^&*!!!

Dude, I am pretty sure that this is Econ 101.  The fall in GDP did not cause profits to slump.  Slumping profits were ultimately a component of the final GDP calculation.  Apparently Eric now thinks GDP is a leading indicator of economic activity.  Man, if this is the trash that gets you to become an acclaimed financial author then please sign me up.  Really, if we have to sift through shit like this to get the news then we are all going to die young.

Ok, and I promised a small bone to pick too.  Why the use of “so-called”?  It makes it sound like we should doubt the use of the word nominal. It’s kind of like a so-called friend who wrecks your car but never offers to pay for the damage.  To be fair to young Eric (I have no idea how old he is, but if he is asking us to question the use of the word nominal next to GDP, then I am just going to assume he is still in his 20’s) “so-called” does have two distinct definitions:

1 : commonly named : popularly so termed <the so–called pocket veto>
2 : falsely or improperly so named <deceived by a so–called friend>

The first definition supports his use since nominal GDP is a popular term, however I think most people would agree that the colloquial use is the latter, creating an element of doubt or distrust. I don’t know, maybe I’m old fashioned, OK I am old fashioned, but it doesn’t seem prudent for a financial reporter to refer to nominal growth in a manner that will generally construe that we are now questioning the basic diction of economics.

Sure we can question the mortgage market, the investment banks, the regulators, the Bush administration, greedy homebuyers, hedge funds, Bernie Madoff and even economists, but should we really question that pesky term “nominal GDP”?

But I digress.

Merriam Webster, Accessed January 30, 2009

LPL Financial Services Appoints Jeffrey Kleintop, CFA, Senior Vice President, Chief Market…
Business Wire, March 27 2007, Accessed January 30, 2009

U.S. Stocks Drop, Capping Market’s Worst January, on Economy
Eric Martin, Bloomberg, January 30, 2009


Today’s Regress is Tomorrow’s Progres

January 29, 2009

Markets move in all directions if you live long enough.  Through the bull runs savvy investors who previously bought on fear finally sell into greed.  And those cyclical tail-end greedy goers usually end up on the sidelines for the next cycle or two, or so I’ve learned.

In the interim, Wall Street concocts new products and/or new structures to entice a new generation of investors, traders and speculators, and to entice older generations, who have long since licked their wounds, to try something new.

Through these cyclical shifts, rules are rewritten, laws are rewritten, and regulations are rewritten.  This cycle will prove no different than those in the past.  In this one however, there has been so much financial innovation over the last 30 years, that there is likely to be, and probably regrettably, an equal and opposite amount of push back into the structure of the our current system.  The details are unknown, but the outcome will be the same.  A once opaque illiquid market will turn retail, enticing the next generation, and luring former casualties (probably from the ’87 crash this time) back into the market.  Simultaneously, the real adventure seekers, and next big-bonus people will be concocting new opaque ways to disguise wide margins on Wall Street.

This is the game that drives our financial system.  It can never change because it wouldn’t work any other way.  Without the lure of profits, innovation is stifled.  While the dot-com catastrophe left craters as scars, it also helped catalyze the single greatest achievement in the field of communications in the history of mankind.  We now have an infrastructure to synthesize, publish and share information in profound contrast to the years prior to 1995.

What will be the benefit of the fallout of this financial meltdown?  Its still uncertain, but reading this article from Bloomberg on the future of a central clearinghouse for OTC derivatives might actually end up achieving what the products were originally intended to do, reducing systemic risks in the system by allowing risk to be priced fairly at the market.

Derivatives are simply a bet on the performance of some underlying instrument.  A credit derivative is a contract betting on the movement of  a credit instrument or a bond.  An equity derivative is similar in that it is a contract on an underlying equity instrument often times a stock or a commodity.

The pricing mechanism for derivatives however is driven less by pure fundamental valuation of cash flows, but rather by a combination of values not the least of which is volatility.  Volatility in turn is a measure of risk.  Thus part of the pricing mechanism of a derivative is linked to the risk of the underlying asset. This allows investors the ability to buy or sell risk from their portfolio.  For some people reading this quick summary the immediate response is, duh.

However given what we’ve been going through, and using “financial weapons of mass destruction” as the trite summary of one of the more popular views of derivatives today, it is important that we realize that like the bubble, it may not be the derivatives themselves (dot coms) that are the problem but quite possible how they have been valued in the market (dot coms were widely valued on click-throughs or numbers of impressions “eyeballs” and rarely on revenues or cash flows).

The majority of the derivatives that today’s retail investors are exposed to are actually exchange traded contracts, with the exception of structured products that package OTC derivatives into retail friendly instruments.  The derivatives that have caused a great deal of our current pain, however, have been OTC or Over the Counter contracts.  The difference between the two is that exchange traded options are just that, they are traded on open exchanges with full price transparency.  In an exchange traded sale the last sale price, a bid and an ask are printed to the tape for all to see.  OTC contracts however are traded much more like stocks were in the days of street corner trading at  Broad and Wall Street, with individual buyers striking deals with individual sellers, generally without much knowledge of recent pricing to any non-market making participants. The problem with that type of market is that the pricing mechanism is terribly inefficient because information asymmetries are rampant.

New regulations are threatening to change the OTC market, and make it resemble the exchange traded market with the implementation of a central clearing agency.  While this change will certainly be bad for the profit margins of market makers in the near term, it may ultimately become a boon creating a larger market appetite and ultimately driving  up volumes for market makers as the market grows.  It also would more than certainly help create the marketplace that mssrs. Greenspan, Cox and other great de-regulators were hoping for, one in which systemic market risks are muted because risk has been sold to those with the appetite.

I postulate that one of the real tragedies of 1990-2008 was not that the counter party system was too large or unregulated, and not that derivatives were “weapons of mass destruction”, but rather that the OTC marketplace was fundamentally flawed by its own opacity.  We may learn, and I hope sooner than later, that a ubiquitous counter party system might in fact be a good thing, as long as buyers and sellers are charging the right price for risk.

There were a good number of intelligent investors who were massively short the markets, and not shy about their views on the financial sector from 2006-2008.  For some reason though their fervor never caught on.  I suppose a great scandal may arise when someone starts looking into the possibility that collusion in the OTC market may have misstated and mispriced many of the risks in the housing market by keeping the price of credit insurance artificially low until it was too late.

In the meantime, for the rest of us, yesterday’s Nasa technology becomes tomorrows household appliance.  As such I imagine that derivatives may play an even larger role in our futures than most people have considered recently, particularly with volatility at sustained high levels. Equally, something new, sexy and profoundly dangerous is bound to incubate in the minds of  bankers aspiring to return to the bonus checks of yesteryear.

U.S. Draft Law Would Ban Most Trading in Credit-Default Swaps
Matthew Leising, Bloomberg, January 28, 2009

Paradigm Shift in Black & White

January 28, 2009

This was recently passed on to me for the purpose of sharing with all of you.  Names have been omitted or changed to protect anonymity, but the impact of the story is not effected.  I found it a simple but telling example of the impact the election of Barack Obama will have on future generations of Americans and the level of profound impact his presidency will have on race relations in this country.

On the Presidential inauguration day, 2009, the following was observed while riding in the elevator at New York City private school at dismissal time.

A little, blond, first grade girl looked up into her nanny’s eyes and said, “Sam, you are so lucky.  You are the same color as President Obama.”  With that, Sam smiled and took the little girl’s hand to lead her off the elevator.


Counter Intuitive: Inflation, Deflation or Stagnation

January 27, 2009

The other day I was exercising my mind, trying not to hurt myself, around the arguments for and against inflation.  There seems to be enough consensus that an inflation trade is less a matter of if and more a matter of when.   I am writing here to offer at least one reason why inflation may not materialize.

Government spending need not lead to inflation as long as the supply of currency does not exceed demand.  In a deflationary period the demand for cash spikes.  As asset values are in decline the safest place to park wealth is in cash and cash equivalents.  This drives nominal yields down, but real yields remain higher than nominal yields as long as the economy is deflating.   As the cost of goods and services is in decline each dollar becomes worth more in real terms.  There is no single country in the world today besides the United States that can provide the volume of liquidity desired.

At some point in the future, however, when the risk taking returns with the prospect of a new growth cycle, conventional wisdom is that the excess liquidity will lead to inflation, and in our case today it could lead to massive inflation or even hyper-inflation.  However, this scenario presupposes that as the cycle reverses we are not working to tighten our currency again.  It also presupposes that we would be looking to remain a debtor nation.

While the balance of debts at the end of this crisis will certainly serve to weaken the dollar, our new administration at least plausibly has the gumption to do what it takes make sure the US pays its debts.  In that scenario we would see a strong plan towards a balanced budget aided in large part to additional tax revenue, likely from the upper class and from the war on energy independence.  As Obama has stated we will see a large deficit for some time, by my guess is he will work to make sure it is gowning smaller and not larger.

As a debtor nation, our debt holders will want the faith that an expanding economy will be able to provide the economic strength required to service and retire our debts.  While raising taxes generally has the opposite effect, the current administration will be walking a tightrope of fiscal and monetary policy.  In addition, with advisors like Paul Volker in the shadows, I don’t think the current easing will be abused as it was by Greenspan.  As soon as we see a recovery underway I would venture to guess that monetary policy will grow quite hawkish rather quickly, further stifling a rapid expansion and ensuring a prolonged muddle through.

Regarding current market levels, valuations, and earning multiples there has been a lot of talk about bear market PE multiples falling into the single digits.  While I have generally felt this was the natural order for where we are headed, the counter intuitive argument from mean reversion in earning multiples lies in comparing inflation and interest rates with past troughs.  As long as interest rates remain low and inflation remains low, earning multiples may see their bottom where they have been, in the low double digits.  What many people who argue that 1970’s earning multiples bottomed in single digits forget is that interest rates and inflation in those days were much higher then than they are today.  From a simple discounted cash flow perspective, using interest rate assumptions as low as they are today provides some serious support for current market levels.  I’d guess the major indexes remain range bound unless or until real earnings come under new pressure.

Dick Fuld Ditches the House for $100

January 26, 2009

We knew the housing market was bad, especially in Florida, but you’d still think Dick Fuld would be able to get more than a hundred bucks for a house that cost him and his wife $13.75 million less than five years ago.

On Friday,, a web site that bills itself as “a guide to the most notable and influential New Yorkers,” pointed out that back in November, while the collapse of Lehman Brothers was still reverberating throughout the world of finance, ex-CEO Fuld made time to transfer his Jupiter Island mansion into his wife’s name.

Today, the New York Times speculates about the nefariousness at play (though oddly gets the price of the house wrong):

It is possible that he is now transferring properties because of his fears of investor lawsuits or a possible bankruptcy, lawyers in Florida said.

“This is the oldest trick in the books” said Eric S. Ruff, a lawyer with Ruff & Cohen in Gainesville, Fla. “It’s common when you hear the feet of your creditors approaching to divest yourself.”

And then Bloomberg explains that, chances are, his wife didn’t even pay the $100:

“This is not a true sale,” said Laurie Delong, a customer service representative in the Martin County assessor’s office. “He more than likely quit-claimed this property over to her. That’s an instrument used when there’s no money involved.” Such transactions are typically done between family members for estate planning purposes or in the case of a divorce, she said.

The good news, for anyone in the market to buy a Florida get-away, is that there’s a house just down the road from the Fulds’ for sale. You can check out the full specs of the 5-bedroom spread here (in addition to the pool cabana, media room and elevator, it comes with “garages for three cars and a golf cart”). The asking price is $19.9 million, but now that we know what other places in the neighborhood are going for, maybe there’s room to negotiate.

Dick Fuld’s $100 house
Barbara Kiviat,, January 26, 2009

ObamaBlog, Blogama, BlogObama the Presidential Blog

January 26, 2009

So I know I am not the first to report on the presidential blog, but boy is it amazing to see.  Talk about a 180 degree change in transparency.  I can still remember the media reporting that Bush was going to close off the White House, keeping privacy at the top of his first term agenda.  The difference between Bush’s secrecy and Obama’s transparency is a contrast of black and white.

You can find a link to the presidential blog below.  In it you will find a number of items from the President’s first week in office.  Among them is a copy of the video and text of his inaugural address.  I have Wordled the speech for fun below.

President Barack Obama's Inaugural Address

President Barack Obama's 2008 Inaugural Address


By request I have also Wordled George W.’s 2000 inaugural speech below for comparative purposes.  Thanks for the suggestion!  Why didn’t I think of that?

President George W. Bush's 2000 Inaugural Address

President George W. Bush's 2000 Inaugural Address

The White House Blog

President Barack Obama’s Inaugural AddressPresident Barack Obama’s Inaugural Address
The White House Blog, January 21st, 2009

“President Barack Obama’s Inaugural Address”
Greenewable, Wordle, January 25, 2009

Bush Inaugural Address

Ode to 200

January 25, 2009


I honor of my 200th post I am offering a link fest to unaudited 200th posts from around the web!  Surprisingly I did not see another person doing something similar.  Given how unoriginal most of us bloggers are I assumed someone must have created and ode-to 200 page.  However a large number have posted their 200th mileston entry. The google results at the time of this writing listed some 291,000 results for “200th post”.  Some bloggers have made 200 a special report, and others have just made a special mention of it.  I, like many others who have hit the 200 milestone never thought they’d get here.  I certainly didn’t realize how many other windbags there were out there.

As I read someone else say in my search for fellow 200ers since less than a handful of people actually read this blog, I suppose it has become a strong testament to my own need to ramble, often meaninglessly about things I can only pretend to understand.  At the very least I have learned that blogging is cheaper and more fun than therapy!

Surprisingly, a good number of the 200th posters that I found as the top results in Google were around the same time as me, between December 2008 and January 2009.  I wonder if there is any significance to that?

Below is a random collection of 200th posts from around the web as results I obtained from google searching for “200th post.”

Progressive WoW

Delaney’s World


Wearing Mascara

There’s Always Room for One More

My Montessori Journey

David’s Photo Blog

Public Spark

Sweet Melissa



Texas Daily Photo

Selenian Boondocks


Life Is A Feast

Broke & Beautiful

Stallion Alert

Accidental Scientist

Greenbay Pressgazette

Media Junkies

Oh and of course there is a WordPress tag for 200th-post