Less than 24h after publishing our rant on Economic models, we get John Kay’s brilliant piece in our inbox – “A wise man knows one thing – the limits of his knowledge”. It is the ultimate summary of the many dangers of modelling in general, not just in economics – among which dangers we count over-complicating things, but most importantly over-estimating a model’s value as predictive/forecasting tool. In fact, as the article argues and as we’ve seen countless times, we tend to over-estimate models even in their ability to analyze the past, especially if one is asking the wrong questions. We also cite a few quotes by Taleb and an article on Edge.org by Emanuel Derman.
“Nothing substitutes for thinking”, as Munger and Buffett have said, and someone has also said that “not everything that counts can be counted, and not everything that can be counted counts.”
Bill Miller himself once said: “This is a brutal business, success equals survival. If you have survived, you will have succeeded”. We have said it a little differently since 1988: to finish first, you must first finish. Mr. Miller, famous for his 15-year streak of beating the S&P 500, has announced that he will step down as co-manager of the Legg Mason Value Trust in April 2012. Is Mr. Miller’s rise and subsequent fall a matter of genius becoming overconfidence or simple probability theory playing out – as per Taleb? Not knowing the inside workings of Legg Mason, no one can really claim to know the answer. To help us think about it, we collect several links inside.
The IMF has recently issued a report on China’s financial system’s stability that has grabbed plenty of headlines, and yet today it seemed that there were pessimistic articles about banking all over the world. European and US banks are also the subject of stories that highlight risk, interconnectedness, poor balance sheets etc.. While the financials’ situation isn’t necessarily news, it is the trend that’s interesting. Inside we collect quite a few articles about the world’s financial system, all of them very from yesterday or today. Collectively they plant a bleak picture, one that seems very different from what we (still) observe in Brazil’s banking system. It’s very hard to separate signal from noise, especially so in the middle of a crisis, but it’s great food for thought.
In a thought-provoking op-ed, Ross Douthat tells a very summarized history of Jon Corzine (of MF Global infamy). He notes that America has been fertile ground for a kind of “reckless meritocracy” where brilliant, ambitious people who work very hard actually get to very high places – which is great – and then proceed to do themselves, their companies and society in general great harm by failing spectacularly. Mr. Douthat says this happens or has been happening “mostly by (this elite) being too smart for its own good”. We were ready to disagree with him until we got to the last two paragraphs – the text is actually great.
Always great to be able to catch up on reading, or almost, and here are a few articles that caught our attention – along with two book lists bound to make us fall behind in our reading again.
According to the news, this is the line MF Global insiders used when questioned why they went along with Jon Corzine’s trades: “He was from Goldman Sachs”. Thus Mr. Corzine guided MF Global to a very public, very messy bankruptcy – and hundreds of millions of dollars of client money are missing. We wrote just days ago, regarding the “key people” aspect of a company: “Ultimately, it’s all about the key people (…) – it’s vital to understand their real motivations, aspirations, personalities and incentive/moral systems. Not what they say it is, what it really is.” Finding out about a given company’s true culture is just as difficult and time consuming, and as we can see in this example, just as important.
Three recent stories with one theme in common: the rise of the middle class and the availability of credit. Looking at banks or diversified financials top-down is not our specialty and, as we’ve said in our Q3 2011 report, “is only of interest to us in order to gauge an important part of the risks”. Keeping this in mind, one of the articles is bullish and points to recent reports showing that credit here has actually accelerated in September, despite talks of banks – and financial authorities – reining in loan growth. The other two articles are also bullish but still reflect, in a way, the difficulties of sustaining such growth.
Two very recent stories on CDSs (credit default swaps) highlight the issue of Risk. Risk has a lot of aspects to it and some get overlooked, such as counterpart risk, process risk, instrument risk (liquidity, clarity of regulations, how tested it was in real-life distressed situation etc.)… Not reading the fine print, for instance, has led more investors astray than they would like to confess. Much has been said about CDO-Squared and complex instruments in general, but the CDS was actually not supposed to be complex. Even so, investors in Greek debt CDSs are finding that “default” may not be what they thought it was… And another side of the debate is counterpart risk: what if the instrument is good, the writing is clear and so on – but the counterparts (whoever they are in this immensely interconnected financial world) just can’t honor their side of the deal?
A few notes about Day One (Monday, Oct. 17th) in the 2011 Value Investing Congress. You can follow their own live updates on Facebook or Twitter. We start with David Einhorn – he wasn’t the first speaker of the day, but things started to get interesting when he came onto the stage. Having attended both, the Ira Sohn Investment Conference is a better event: shorter in length, better attended and with better speakers, more focused and, we dare say, with more committed speakers.
Farallon Capital’s Tom Steyer is so secretive that even a more “politically-minded” profile seems like a good excuse to collect links about him and Farallon. Mr. Steyer was one of Bob Rubin’s traders at Goldman Sachs in his famed risk-arbitrage desk from the mid-1970′s to the late-1980′s (along with other famed managers such as Eddie Lampert, Daniel Och and Richard Perry). We have a few links and videos about Mr. Steyer inside.
