Reflections on: The Big Short by Michael Lewis

I had told myself to stop reading financial books - brings back too many bad memories - but I made an exception with this book. Why? Partly from friends' recommendations - but mostly because I respect  Michael Lewis as a writer.

Strangely enough, I don't typically like Lewis' books while I am reading them. I find them hard to get through. The plots (if you can call them plots) are slow and filled with too much minutia to be called a fun read. But, none-the-less,  I find myself compelled to read on and finish the books. And in the end, I'm very happy I did.

In The Big Short, Lewis tells a story, well actually several stories, of individuals who shorted the mortgage market just prior to the market debacle a few years ago. They were betting that the mortgage market would collapse - and it did. He talks about their personalities, the reasons behind their convictions, their difficulties in executing their strategies and a host of almost amusing anecdotes. In the end they were right and their shorts paid off. On this level, I found the book just painful. Perhaps others readers may be amused or alarmed by those stories, but not me. Given my history, it was just painful.

So why am I ultimately glad I read this book? Because this book is not about its plot.  Lewis puts his real story under the surface.

In good poetry or art - images are presented to the reader/viewer. What these images mean depends at least in part on the viewer. The goal of the artist, or in this case the author, is to present images that are rich with content such that when the viewer sees it, meaning emerges. I believe that the defining characteristic of art is that the viewer/reader must interact with it to create meaning. An artist is someone who creates a medium (poetry, painting, books....) that is rich in content that encourages its viewer to create meaning.  Michael Lewis is an artist.

In The Big Short, Lewis' plot and anecdotes are just foils to tell a more gripping story - what I call "The Universal Story".  I can't tell you exactly what that story is - partly because of its nature and partly because it will be different to each of us. But it is there!!  And though I am doomed to failure, I will very briefly expound on what I call "The Universal Story".

The Universal Story (stupidly told)
Our personal realities are a narrative construction. We cannot define the meanings of even simple words such as "good" or "bad", "smart" or "stupid", "tall" or "short" without having an accompanying narrative or story which explains what the concept means. And within each of those stories are more words which take their meaning from even more stories. So eventually, our reality becomes a collection of narratives, or stories, which weave in and out in our conscious and subconscious mind to give the world meaning.

Some of these stories are ones we created ourselves. But most of the stories are created and shared with others. (The Social Construction of Reality). In his books (and by this I mean The Big Short and Money Ball as examples), Lewis presents a specific segment of the reality governed by a specific set of narratives. Money Ball is about professional baseball and how talent was evaluated. The Big Short, is about the financial markets.

The Universal Story is what happens when a person decides that these narratives, the things that define our personal and socially constructed realities, are lies. This is what I feel Lewis is exploring in this books. Lewis explores segments of our reality (baseball and the financial markets) which are governed by false narratives.  His heroes (who are also perhaps victims) are people who perceive and struggle with this falseness.

Or perhaps that is just in my imagination.

Asides:

• Lewis (correctly) puts Spring/Summer 2007 as the critical time of the financial crisis. His book effectively ends by late 2007.
• Lewis points out several times the "classed society" aspect of this collapse and that in general the ruling class of Wall Street made money both in the bubble and in its burst.
• At its height, the collapse was seen as having extreme consequences to society as a whole - as in a collapse of society/civilization.  ( I know I felt this way when I experienced it)
• The failure of AIG, Bear Stearns , Wachovia, Lehman etc. was in some way justice for a complete misunderstanding of their own business model and the misalignment of risks. And Goldman wasn't far behind.
• Ken Lewis (former CEO of BofA) is an idiot. See my blog on Too Big to Fail.
• Subprime mortgages (loosely defined) was the cause of the collapse. I don't argue this point, but to me, the real damage was what happened after liquidity disappeared from the market in the summer/fall of 2007. The subprime crisis ate through the capital of Wall Street and the banking industry, but as long as they could still fund themselves they wouldn't collapse. 
• When markets tank, even good assets go bad. For example, the hedge funds who were making big returns started losing clients because the clients need the money to cover losses taken elsewhere. (Or as I have often heard: "When the paddy-wagon comes, it takes the good girls along with the bad" or "When all hell breaks loose, all correlations go to 1")
• Information lags were hugely important in the dynamics of what happened. As a lover of network modeling I find this interesting.
• The 'heroes' of this book are all outsiders. They were either non-financial people who looked askance at the "truths" financial people told, or they were financial people who took on the roles of outsiders.  In one case, this was only after a great personal loss which changed the person's entire view of reality.

Reflections on : A Treatise on Human Nature by David Hume - Part1 Section1

According to Hume in A Treatise on Human Nature (1740), there are two types of mental activity: "impressions" and "ideas". From Hume's comments, I would describe impressions as including all mental activity that is not an idea. This would include emotions, of course, but also physical and mental perceptions that occur while interacting with the world. For example, if you touch a hot stove, you experience hotness (the impression) independently of the idea of "hot".

Impressions and ideas can be "simple" or "complex". Simple impressions and ideas cannot be broken into component parts of other impressions and ideas. Complex ones can be subdivided into simpler parts.

There is a very close association between simple impressions and ideas - so much so that they may often appear inseparable in the mind.  When I touch the hot stove, I feel the hotness and think "hot" almost simultaneously. 

All simple ideas are preceded and derived from simple impressions. "All our simple ideas in their first appearance are derived from simple impressions, are correspondent to them and which they exactly represent." The impression comes first, then the idea. "We cannot form to ourselves a just idea of the taste of a pine apple, without having actually tasted it."

Complex ideas, composed of simple ideas (and their related impressions), correspond closely to complex impressions. "...all simple ideas and impressions resemble each other; and as the complex are formed from them, we may affirm in general, that these two species of perception are exactly correspondent."

In general, complex ideas can be linked to preceding complex impressions, just as in the simple idea case. However, there are exceptions.  Hume gives an example. Imagine you are shown a pallet of blue shades ranging from dark blue to light blue. One shade in the middle is missing. You can form an idea of what that shade looks like, even though you haven't actually seen it because you can derive the idea from the impressions of the blues on either side of the missing spot. So while there can be complex ideas not preceded by a directly corresponding impression, the idea is derived from a collection of impressions that closely resemble the idea. "Ideas produce the images of themselves in new ideas; but as the first ideas are supposed to be derived from impressions, it still remains true, that all our simple ideas proceed either mediately or immediately, from their correspondent impressions."

From my own analogy, I suggest we can form the idea of a number, say for example "152" because we have a prior impressions/ideas of 1, 2, 3 etc. I also suggest that this same process could be extended to the idea of infinity. I note that this logic seems to support Hume. While we can have the idea of infinity, it still leaves us uneasy mainly because we have never had the experience/impression of actual infinity.

Given this discussion of impressions leading to ideas, and not the reverse, Hume states that there are no innate ideas. They are all derived from our impressions. "...ideas are preceded by other more lively perceptions, from which they are derived, and which they represent."

As I was reading this chapter I kept think of the left brain / right brain theory - particularly that it would be interesting if you substituted those words into Hume's argument. I also thought about the books, Drawing from the Right Side of the Brain by Edwards and The Feeling of What Happens -  Body and Emotion in the Making of Consciousness by Damasio. Finally, I felt that Hume was weighing in on the always popular party question: was mathematics invented or discovered? His comment that there are no innate ideas seems to put him in the "invented" camp. I would disagree with him on that point.

The "Cheers" Book Club

We should all have a "Cheers" bar - a place where everyone knows our name - where we are accepted.

We all need - desperately need - to be accepted. This need drives so much of our life -who we hang out with, what we believe, what we do for a living. The need to be accepted drives our very sense of self. If we don't feel accepted, perhaps its because we are not worthy. Maybe there is something wrong with us.

Most of us counter this fear, this sense of worthlessness, by learning to (or at least pretending to) accept the beliefs of those around us. Sometimes learning to accept is healthy (such as Buddhist practice) - sometimes not so healthy. I will adopt my parents' goals so that they will accept me. I will accept a religious doctrine so that my church will welcome me. A professor will accept standard scientific thinking so that she herself will be accepted into the scientific community.

But what happens when you can't accept?

There have been a few points in my life where I felt so out of step with those around me that I began to truly despair. At one point, the split between what I felt was true differed so strongly from the commonly accepted that I began to question my sanity. The worst part of this was that I knew that voicing my skepticism and concerns would only drive me further from those around me.

I was in asset management at the time, and my concerns were about standard investment theory (which related to the nature of risk and returns, which is turn was based on an questionable view of the nature of reality....). Hand in hand with this non-acceptance of standard theory was my questioning of what was marketed as investment expertise. Questioning the theory of experts is roughly the same as questioning the religious doctrine of priests. It was a difficult time for me because I was constantly being measured by a standard I did not accept as valid. Yet my livelihood and my reputation depended on this measurement. [I will add by way of disclaimer that none of this related to actual investment strategy or performance. It related more to the perception of risk and return - pretty subtle point but perception is often more important than reality.]

What I needed was a friend - an outside voice - to tell me that I was OK. That I was not alone. I needed to know that there was a community out there in which I would be accepted.

I found what I needed. It was the book Fooled by Randomness by Nassim Taleb. About a chapter into this book I had a shocking revelation: "This guy is in my head! All of these rants and arguments that I have been keeping bottled up in my head are spewed out all over these pages. How could this be? This guy is crazy - just like me!"

There was so much of this book that truly was a rant - and I loved it. This guy Taleb knew his finance theory - I had read an earlier book by him called Dynamic Hedging. And here he was, someone with real professional credentials - ranting just like me.

I had no doubt that this book would be a failure. It was a ranting, poorly written book that challenged accepted concepts of risk and return in finance and in life. Who would read that?

Much to my surprise, Fooled by Randomness was a success and Taleb wrote an expanded second edition (with less ranting) and then the book The Black Swan. Taleb's success meant something special to me. Not only did I find a kindred spirit in Taleb himself, but there were a lot of other people out there who found his opinions worthwhile. These were my people! I was not alone!

So I found the acceptance I so desperately needed in a book. While I was reading this book a feeling of relief washed over me.  I was under so much stress, and while this book did not change the stress of my daily life, I could face the days a little more easily knowing that I was not alone.

All my life I have found comfort in books. I remember how meaningful the books of Hermann Hesse were to me when I was in high school (Demian, Siddhartha and The Glass Bead Game). And Ayn Rand's passionate cry of self-worth in Atlas Shrugged still echoes in me today.  If nothing else, these books (and others not mentioned) told me that I was not alone. I don't always agree with their views - but as people I respect and accept them - and I hope they would me.

I Stand Corrected

My last blog was me ranting about non-fiction "idea" books burying their key point too deeply - forcing me to read too much of the book before I could tell if it would be worthwhile.  One book I complained about was The Checklist Manifesto by Gawande. I realize now I was wrong.

If you bought a book titled The Checklist Manifesto, what would you think it was about? Checklists - right. And would the book have been in favor of checklists? - Yes! Of course! So there it is. The key idea of this book is that checklists are great. And this key idea wasn't buried deep in the book - it was right there on the book's cover.

The problem is, I assumed there would be more and kept looking, thinking that the golden nugget would be on the very next page. But no - the golden nugget was sitting on the book cover and I had just passed right by it. It turns out that the rest of the book was about medical and aviation stories where lives were saved through the development and use of checklists.

Part of me wants to start a new rant on people writing books based on one idea that could be said in 3 words: "Checklists are great". But just maybe there is something more to this idea and it deserves more than 3 words - even if it is simple.

I was tutoring a student in statistics last semester. He was an engineer and plenty smart, but he was struggling in his class. The exams involved word problems and were quite confusing for the uninitiated. After our sessions, he ended up doing well in the class and I think I really helped him. I think my best advice to him on the subject was this - I told him to go through this process on every exam problem: 1) Determine what kind of problem it is. You do this by looking at the data itself and looking for certain key words in the question. 2) Go to the spot in the software that addresses that type of problem - he should already have mapped out the software to know where to go for each type of question.  3) See what information the software asks for and see if it fits the data provided. 4) Assuming that is a yes, go to a prepared list of things the professor will look for to get full credit.

I know from talking to several students in the class that they study and learn the material, but during the exam, they get confused by the word problems and end up wasting most of the exam time wondering what to do or going down wrong paths. They end up not being able to finish the exam in time. My method takes about 3 minutes - if the person is prepared ahead of time - and should allow a student to finish the exam in about half the time provided.

The secret to my method was a checklist. Not that I thought of it as a checklist at the time, but that is what it was. I thought of it more as a decision tree, which is just an enhanced checklist.

All of this makes me wonder - where else could I use checklists? And why don't I use them more often? What kind of problems can be addressed with checklists? Do some people internalize checklists quickly and does this give them a huge boost in productivity and learning? (My guess is yes on that one) This sounds like the subject of a new blog.

Pet Peave on Books

I read a lot of non-fiction books - typically several at the same time. Some of these books never get finished and some never understood. But I like having a constant stream of new ideas and perspectives.

One thing I have noticed - and it bothers me - is that most mass-market non-fiction books have only one core idea and the entire rest of the book is fluff around that idea. The better version of these books have their core idea placed near the front, and then repeat it in different ways for the rest of the book. With these books, as long as the idea is neat, you get the payoff early and you can either appreciate the repetition for the rest of the book, or you can stop reading and still feel like the book was worthwhile.

Unfortunately, I seem to have stumbled across several "idea" based books that start the book with fluff and bury the idea somewhere nearer the middle or the end. With these books, I'm left to wonder when and if the idea will ever show up and is there any reason to keep reading. These books often end up sitting buried under something in my car or beside my bed with a dog-eared page about a third of the way through.

One such book is Why Beauty is Truth - A History of Symmetry by Ian Stewart. I am now about 60 pages into this and I'm really starting to wonder when this guy will say something interesting. Clearly the book is about symmetry and beauty and math - it says that on the cover. But all I have read so far are seemingly pointless stories about ancient mathematicians. Hopefully these stories will tie into something eventually, but I may not make it that far.

Another book is The Checklist Manifesto - How to Get Things Done Right by Atul Gawande. I bought this book partly due to the great recommendations on the book cover - probably not a good idea.  I have read the first 35 pages and so far the book is a waste of time. All the book has said in 35 pages is the super-obvious "the world is a complex place".

So when do I give up on these books? For novels I have a rule of thumb that says:  if I get half way through and I don't care about the characters or what happens next, I say it is OK to stop reading. What about these nonfiction books? Does the same half-way rule apply?

This topic was probably not worth a blog - but these books are ticking me off.

Wrong Steps

When I was an early teenager, I remember I had a brief flirtation with the idea of becoming a geologist. I quickly gave up on this idea when I decided that nothing could be more boring than thinking about a bunch of static rocks. Plus, I knew a geologist and he seemed pretty boring to me.
I am now starting to think that giving up on geology may have been a mistake.

I think my idea that rocks are static was wrong. Its all a matter of perspective. Sure rocks may look like they don't change or move, but that is because I am measuring them in terms of my own short human perspective. If the earth is more than 4 billion years old, then that is plenty of time for a rocks to do a lot of cool stuff. Plus - as recent events in Japan show, occasionally rocks move a lot, even in our time frame.
I sometimes think that if rocks were sentient beings, their sense of time would be so long that we would never recognize them as sentient, and conversely, the rocks would never recognize us as sentient. They would say, "How could anything with such a short lifespan develop consciousnesses?"

But the real reason I'm starting to think I wrote geology off too soon is that I now keep finding that a lot of geologists think interesting things that don't strictly deal with rocks. I'm sure I mentioned before about geologists modeling earthquakes with networks and power laws (Pareto distributions) [cool stuff!]. I have also mentioned the book Why Stock Markets Crash by Sornette - a professor of geophysics [financial cool stuff]

Today I went through a forgotten corner of my bookshelf and I stumbled upon a book I bought many years ago. It is called Chaos Theory Tamed by Garrett Williams. The great thing about this book is that while it goes into a lot of the math of chaos theory, it tries to teach the theory along the way, not just present it. The writer really seems interested in sharing the what he thinks is a cool subject with his readers. And low and behold, they guy was a retired geologist/hydrologist.

When I got into finance, I figured I had stumbled into an intellectual nirvana. I now see financial theory as hidebound and static, especially compared to what I am reading by geologists. I wonder if it is because financial theory is really geared around making money today - or tomorrow - and the fact that given its short time perspective it is bombarded by too much information. Geologist on the other hand take a long view.

A Weird Cosmology - Part 7.2 - The Question

[I wrote some of this post below a couple of years ago as part of a larger piece name "The Ultimate Question"]

In Douglas Adams’ book, The Hitchhiker’s Guide to the Galaxy, a story is told of an extra-terrestrial species that devoted itself over many millennia to finding “the ultimate answer”. After several failed attempts, the species came upon a method. To find the answer, it would manufacture a super colossal computer - a computer so complex that it would incorporate biological and geological components. Even with its enormous size and complexity, this super colossal computer would take several millennia to come up with the answer. The super colossal computer took the form of a planet, and the name of this planet was “Earth”.

The computer known as planet Earth delivered the ultimate answer roughly 1000 years ago. (Since that time, at least until very recently, earth just coasted along.) The alien species awaited the ultimate answer with great anticipation and reverence. On the fateful day of the answer’s unveiling  - a day of fanfare and ritual  - the super colossal computer known as Earth finally spoke. And the ultimate answer was : “forty-seven”.   After recovering from shock, the priests and scientists of the species asked - “Forty-seven? What does that mean?” “What does ‘forty-seven’ answer?” The computer responded , “Oh, so now you want the ultimate question. I wasn’t built to find the ultimate question. To find out that you will need to build a much larger computer”. [I paraphrased this from the book]

The species never did find out what the ultimate question was. A few years later it got caught up in some intergalactic trouble and died out.  It really is a shame.

Douglas Adams moves on with his story, leaving us with nagging questions:  What could the ultimate question be? How could a species devote so much time and energy trying to find an answer without knowing the question?  And if it took a planet sized computer many millennia to come up with an answer like “47”, just how big of a computer would be required to come up with the ultimate question?

I love this story - and as the years pass I love it for different reasons. To me now, the story makes a  point in "My Weird Cosmology". And that is: the Question is far more important then the answer. The Question is the creative force of the universe - just as in The Hitchhikers Guide where the earth was created to answer a question - I believe that our reality may "arise" in response to the Question.

I am obviously not talking about a literal question. So stay with me here. Imagine you are engrossed in an activity - enthralled. Perhaps you are reading a great book on a new topic you are interested in, or listening to a lecture. All of a sudden, an idea, a wonderment, arises in your mind.  Connections start to form, ideas flit back and forth. Its not in the front of your mind yet, but its there behind the scenes. The actual question hasn't formed yet, nor the answers - but its there - or almost there. And in this moment order is being formed from chaos.  It is a sacred moment of creation. OK I know a physical object wasn't created, but something was created.

I once read a story by the fantasy writer Michal Moorcock  where a hero made his way to the castle at the edge of reality. He looked out over the formless swirling chaos at the edge of reality - and in that moment - his presence - his life force - gave form to the chaos and reality was extended.  I think about the Question in a similar way. Reality arises from the Question. But the beauty of the Question is that it is not the answer. It merges order and chaos to create life. Chaos survives, order survives - it is life. 

Why do I use the Question as my creative force?  Hard to say in words. When an idea forms to me, as part question and part answer, it comes with power, energy, an almost physical force. I sense it as a force. Along with it, it is a source of wonderment - a joy. And in my way of thinking - there are no absolute answers - to anything. So in this Weird Cosmology - the Question reigns supreme.

For those of you who feel my weird cosmology so far is not weird at all - maybe now you will change your mind.