E-piphany

I was just watching an interesting History Channel documentary. It aired some time ago, but thanks to the magic of DVR I just watched “First Apocalypse,” a tale about the latest thoughts on why the dinosaurs perished (as an aside, my DVR list looks like what a 10-year-old boy would put together, partly because I have a 5-year-old boy so I’m always thinking “Hey, dinosaurs!” and partly because I tend anyway to have the interests of a 10-year-old boy) along with the now-tired admonishment about what that means for humans as a species. (Since the man-made global warming thing seems to be in retreat, I am hopeful that we’ll stop getting hit over the head with this every time we turn on the tube for ‘escapism’, but I’m not that hopeful).

The documentary was nevertheless very well done, and examined several alternative theories for the mass extinction at the end of the Cretaceous period. One snippet struck me as particularly poignant and timely. The observation was made that the big dinosaurs quite possibly were victims of their own “success.” As they grew ever larger, the sauropods (the big plant-eaters) became very efficient at consuming lots of vegetable matter from high up in the tree canopy. They obviously had to consume lots of vegetable matter, because they were huge. The theropods (think T-Rex) were clearly adapted for bringing down those big sauropods from time to time.

The problem is that those hugely successful evolutionary winners became increasingly vulnerable to small changes in the environment. For a big sauropod, it takes a whole lot more of dead vegetable matter (hay) then living vegetable matter (grass) to keep it alive, so they have to keep moving to the fresh stuff; when the climate made bigger swings requiring longer migrations, it is entirely possible they came to the point they couldn’t keep up. A long gestation period, which tends to be associated with big beasts, also meant that the species’ numbers couldn’t susatin themselves if there was a mild stress to the population. They got simply too big, and failed.

The theropods, especially once the big plant-eaters were gone, had a similar problem: they were too slow to catch the remaining smaller prey. They could bring down anything more than two stories high, but nothing under five feet tall, and starved.

The poignancy comes from the juxtaposition of Nature’s way of handling things (you got too big to handle stress? Then you are the weakest link: goodbye!) with the government’s way of handling things (you are too big to handle stress? Then lay down and we’ll give you a little foot massage).

I have written previously about “Too Big To Fail,” and the fact that bigness is not a sufficient reason for the government to break up a company. We can talk all we want about the danger that the collapse of a megabank would have on the System, and bemoan the problems that would create, but there’s just no solid antitrust law that permits the government to seize private property and rearrange it to its liking just because it would be convenient for it to do so. If the business got large in legal ways, you’re kind of up a creek in terms of forcing it to break up (although I have previously argued that the government could give a positive incentive to such a company if its shareholders voluntarily decided to break up the company).

But saying the government is powerless to break up the Citibanks, Chases, and Goldmans of the world is not the same as saying it should be helping them. This is where our policy really stinks: we give the sauropods thermal underwear to help them handle the temperature swings.

Why is that bad? If we had been able to keep the Triceratops from extinction it would seem to be an unrestrained positive, wouldn’t it? (At least, my 5-year-old would think so. And a bunch of environmentalists, probably).

Well – see, here’s the thing. If T-Rex and Stegosaurus and Maiasaura were still around, mammals would probably still be the size of small rats. And speaking personally, that would suck because I like being alive, and I like being larger than a small rat. And frankly, being up here on the food chain beats the hell out of being down there.

The point is merely the simple one that we tend to be good at seeing immediate consequences and excruciatingly bad at estimating eventual outcomes that follow. We know this, and it comes as no surprise to state it. Shouldn’t we mentally compensate for that? I know that seeing Citigroup disintegrate would be extremely scary and have some really bad short-term repercussions, but if all of the super-dealers were to break up into smaller, more agile entities, would that be so bad?

I think, since we have so many people suggesting that the government should break up those who have become too-big-to-fail, there is some reasonable chance that this is broadly understood in principle. Where I differ from the break-em-up crowd is that I think we don’t need (and cannot) just break them up. Nature will break them up just fine. We just need to stop giving longjohns to Apatosaurus.

What am I doing, writing a commentary again?

You would think that my better judgment would prevail after years…years…of writing market commentary and whining about the amount of work it is. Now, as a co-owner of my own firm, there is no one who can force me to write.

And yet, I write.

Perhaps it is that I just enjoy reading my own writing. Surely, hubris and exhibitionism must play some role in the decision of any blog author to offer his product (at least, for those who offer their blog free and by so doing wave dismissively at any suggestion that they might be adding actual value to anyone). But in my own case I would like to think there is more: as a trader, it is a helpful discipline to put one’s thoughts down in an orderly rhetorical structure, to see if those thoughts withstand even the basic rigors of elementary logic. I could, though, do that privately with none the wiser.

It is, I think, a bigger test to throw that rhetorical argument out there, to the world, where the argument will be examined – sometimes to be confirmed, sometimes ridiculed (and usually both). Over the years I have written less and less to ‘hear’ myself talk and more to make myself listen.

This is my first time, however, to completely expose myself to the chaotic democracy of the Web. This may not be a great decision, but we will see. My former commentaries have always been directed at other market professionals so that the feedback I received – positive or negative, insightful or obtuse – was at least generally polite and on-point, and I enjoyed a productive discourse with hundreds of my colleagues and clients over the years. To be frank, I read other blogs and some of the posted comments are…well…let’s just say they can be impolite and off-point.

This is also my first time I have written outside of a firm’s infrastructure, meaning that I lack (besides an editor) the oversight of overbearing and hyper-sensitive compliance departments and well-meaning senior management with carefully-cultivated Spidey senses about the risks to “firm reputation.” I don’t really think I will miss those guys. They are, after all, the reason that Maestro, My Ass! was not published when it was written, but only this year. But the only reputation at risk now is mine, and the only limitation to my topic is my common sense.

Uh oh!

An editorial in the Journal on 7/30/09 asked whether New York Fed President Dudley is overreaching when he speculates about whether the Federal Reserve should try to target asset bubbles. The Op-Ed author, Donald Luskin, argued that they should not because let’s face it: their track record on seeing the bubbles after the fact isn’t great. These guys were worried about inflation in May of 2008.

I agree with Luskin that the Fed ought not to specifically target asset bubbles, but that doesn’t mean the Fed is powerless to prevent them. The Fed, in fact, has done a great deal to encourage them: not by lowering rates, per se, but by generally making the economic environment very safe and predictable: publicly announcing their thinking and their moves, working hard to save dumb players and to keep the economy from recession, and it’s those things that cause bubbles. Even if there is a bubble-bacterium present, that is, the Fed can restrain its growth by refraining from providing a warm, moist environment in which the bubble can prosper. If Dudley wants to prevent bubbles, all he needs to do is occasionally encourage the Fed to tighten 50bps rather than 25bps, and do it between meetings, without an announcement. Or just tighten 62.5bps and confuse investors. When investors are uncertain, they will act to preserve a margin of safety, and it is that which will keep bubbles from growing too rapidly.