It's time to meet the Muppets

Barry Ritholtz's latest column:

How to avoid being a Wall Street Muppet

Since the era of Adam Smith, the following has been held to be true:

Individually optimal decisions often lead to collectively inferior solutions.

Do Brokers watch out for their clients (i.e. their investment returns)? Or are they watching out for themselves (i.e. broker commissions)?

What do you guys think about Brokers?

Let's just ignore the "ideal" when considering the "real" factors in this situation and instead choose to follow a more cynical truth: no rational, self-serving capitalist would ever watch out for shareholders. Why would someone sacrifice their own livelihood for someone else's? Practically no one would. Unless they had to.

And to some degree, Brokers must serve shareholders. Just enough to not lose them entirely. But not out of the goodness of their hearts.

Unfortunately, not every Broker has to respond to a higher authority that says "do no harm" (not exactly - most Brokers do; but how some skirt their fiduciary duties is beyond this post), and that's where the client must fend for himself.

Wall Street Brokers are not particularly evil; if these astute vendors convince clients to buy into their miracle financial product spiels and dizzying factual presentations, they're no different than the very savvy salespeople that perniciously sell the $100-dollars-a-pop miracle Dead Sea salt scrubs every day at the local mall. 

Both the Wall Street Broker and the Mall Merchant know how to sell their product beforehand. Both are selfishly watching out for their own self-interest, and both know how to play with their client's emotions.

Granted, there's nothing wrong with Dead Sea salt scrubs or complex financial products - choosing them out of ignorance; that's what's wrong.

A quick solution: becoming financially literate and learning the basics of how investing works. Investopedia, Yahoo, Wikipedia and MIT's Open Courseware are all excellent educational resources. 

An additional pragmatic piece of advice: asking financial advisors if they're working under the fiduciary standard, questioning them about how they're being paid and demanding they explain the credentials they hold can be a first step.  

The doer alone learneth.

No, I'm sorry, we only let you know the price once you've promised to buy the product.

City Cycles: Utopian rises, Dystopian falls and the City's continued existence

Original Art from The Economist 

From the latest edition of the Economist:

Free Exchange | Down towns

The article begins with the following sentence: "When cities start to decline, economic diversity is the thing that can save them."

I agree with this premise, but there's more to a city than economic diversity. There's additional factors that contribute to economic diversity; cultural and aesthetic values that make a city's permanence long lasting.

I wrote a letter to The Economist to let them know my point of view:

Dear SIR, 

A city's revival and/or survival might not only be dependent on economic diversity, as your article suggests; it is also necessary for the humanistic component to be strongly present in order to make a metropolis an autonomous and productive settlement. Neglecting the aesthetic and cultural values inherent in cities and failing to promote them as such can give way to the gradual decline of any city. Detroit's fixation on its industrial prowess and its failure in achieving "economic fuel" from other sources quickly led to its demise. The California Gold Rush promoted the "California Dream", but that dream successfully graduated from gold to farming, filmmaking, technology and other pursuits. It was that same "Dream" that attracted thousands of immigrants to make California their home through the decades. 

While your article does an excellent job detailing the technical death of cities and its potential revival through hard facts, regarding economic diversity as the sole reason cities flourish is short-sighted: economic diversity is the product of properly motivated profit-seekers, but money is fungible and highly fickle - the way people live and experience a city, however, is much more permanent and long-lasting when the proper social and cultural factors are put in place. 

If this is wishy-washy or hard to fathom, just go and visit Paris for a day. Anyone with a soul will understand that there's much more to the city than its economic prowess.

Lewis Mumford's magnum opus "The City in History" backs this up.

Lewis Mumford 

The following are excerpt's from the book's last chapter, "Retrospect and Prospect":

"The chief function of the city is to convert power into form, energy into culture, dead matter into the living symbols of art, biological reproduction into social creativity. The positive functions of the city cannot be performed without creating new institutional arrangements, capable of coping with the vast energies modern man now commands: arrangements just as bold as those originally transformed the overgrown village and its stronghold into the nucleated, highly organized city." 

"We must now conceive the city, accordingly, not primarily as a place of business or government, but as an essential organ for expressing and actualizing the new human personality - that of 'One World Man.' The Greek and barbarian, of citizen and foreigner, can no longer be maintained: for communication, the entire planet is becoming a village; and as a result, the smallest neighborhood or precint must be planned as a working model of the larger world. Now it is not the will of a single deified ruler, but the individual and corporate will of its citizens, aiming at self-knowledge, self-government, and self-actualization, that must be embodied in the city. Not industry but education will be the center of their activities; and every process and function will be evaluated and approved just to the extent that it furthers human development, whilst the city itself provides a vivid theater for the spontaneous encounters and challenges and embraces of daily life." 

"As we have seen, the city has undergone many changes during the last five thousand years; and further changes are doubtless in store. But the innovations that beckon urgently are not in the extension and perfection of physical equipment: still less in multiplying automatic electronic devices for dispersing into formless sub-urban dust the remaining organs of culture. Just the contrary: significant improvements will come only through applying art and thought to the city's central human concerns, with a fresh dedication to the cosmic and ecological processes that enfold all being. We must restore to the city the maternal, life-nurturing functions, the autonomous activities, the symbiotic associations that have long been neglected or suppressed. For the city should be an organ of love; and the best economy of cities is the care and culture of men." 

"The final mission of the city is to further man's conscious participation in the cosmic and historic process. Through its own complex and enduring structure, the city vastly augments man's ability to interpret these processes and take an active, formative part in them, so that every phase of the drama it stages shall have, to the highest degree possible, the illumination of consciousness, the stamp of purpose, the color of love. That magnification of all the dimensions of life, through emotional communion, rational communication, technological mastery, and above all, dramatic representation, has been the supreme office of the city in history. And it remains the chief reason for the city's continued existence."

The city is a constantly thriving collection of buildings and the people that inhabit them (to live, work or play), whose survival is threatened daily through population depletion/expansion, economic strife and other factors. 

Despite these threats, cities have always flourished.

To disconnect a city's economic vitality from its very human owners is to disregard the mechanics responsible for the machine's output.

Not recommended.

On "Communicating Economics"

Paul Krugman writes:

What every economist, and for that matter every writer on any subject, needs to realize is that unless you are a powerful person and people are looking for clues about what you’ll do next, nobody has to read what you write — and lecturing them about what they’re missing doesn’t help. You have to provide the hook, the pitch, whatever you want to call it, that pulls them in. It’s part of the job.

Powerful advice for any writer.

I'll drink to that.

Economics - Artistically Scientific or Scientifically Artistic?

Economic Art

Barry Ritholtz listed the 10 reasons why economics is and art and not a science in his Washington Post Business section column this past Friday (August 9, 2013).

1. Economics is a discipline, not a science.  

2. Markets are frequently ahead of, and often out of sync with, the economy. 

3. Models are of limited utility. As statistician George Box has noted, “All models are wrong, but some are useful.”  

4. Contextualizing data often leads to error. What I mean is that everything economists consider gets forced into their intellectual framework. 

5. Narrative drives most of economics. 

6. Economists are loathe to admit that “they don’t know.” This trait is common in many professions, but I suspect the modeling issue may be partly to blame.  

7. A tendency to confuse correlation with causation.  

8. The peril of predictions.  

9. Extrapolating current circumstances to infinity: Economists suffer from the recency effect, just like everyone else does.  

10. Sturgeon’s Law: Not every economist is a prize winner. There is a wide dispersion of talent in economics, and following Sturgeon’s Law — “90 percent of everything is crap” — many among the rank and file simply are not great analysts.

Ritholtz ends the article by mentioning:

The field of behavioral economics is still relatively young. It has only recently figured out that Homo Economicus — humans as rational and narrowly self-interested actors — is not how people behave in the real world. Economists are just starting to get at these questions of why people make such bad financial decisions, and how we can prevent these behaviors in the future. 

Perhaps one day the answer to the question “Why did God invent economists?” will be: “To help us stop making so many bad financial decisions.” 

As of late, Economics has been placing more and more importance in what Behavioral Economists (or psychologists) have been finding out - take note of Daniel Kahneman's 2002 Nobel Prize in Economics (although Herbet A. Simon, won his own Econ Nobel in 1978 for his very human-behavior linked research in "decision-making processes within economic organizations").

Ritholtz's point of view echoes what the general academia and intelligentsia (big word - please apply in a post-Cold War context please) communities have been criticizing for decades: that Economics is an inexact science, at best.

An excerpt from J. Michael Bishop's "How to win the Nobel Prize" - on the general attitude toward the Nobel prize in Economics and the view that is generally held about economics as a discipline:

"Nobel himself never accepted economics as a science, and even some of the laureates in economics have expressed doubt about the prize. In protest against the award to the outspoken and controversial Milton Friedman in 1975, a previous economics laureate, Gunnar Myrdal, wrote an open letter to a Swedish newspaper calling for an end to the economics prize. Myrdal's colaureate (and ideological opponent), Friederich Hayek, toasted the king and queen of Sweden with the remark that he would have recommended against establishing the prize in economics had he been asked - in his view, the discipline was not sufficiently rigorous and objective. 

One authority on Alfred Nobel and his prizes has suggested that too many of the "Nobelized achievements", in economics "seem perilously close to scientizing the commonsensical.""

"...As for the [Nobel prize in Economics], only its immediate practitioners seem capable of appreciating the merits of its Nobelists. One perennial joke is that mere membership on the faculty of economics at the University of Chicago is sufficient to procure a Nobel Prize. Another is that although the prize for economics was instituted only in 1969, the field of eligible candidates may already have been exhausted.

One administrator of the prize has told the press that "all the might firs have fallen; now there are only bushes left."

Ouch.

In the end, some may charge the many moving parts, changing facets and contributions of economics as a cargo cult science, a concept famously developed by Richard Feynman, a physicist. One such proponent is Deirdre McCloskey. 

Irrespective of the fact, if Economists semantically stick to the description of their studies as a social science all this ballyhoo about questioning the validity of economics should lessen, and more importantly, more important work and studies should reveal more and more about social behaviors, which, in a way, are stronger than the physical forces that govern us.

Scientists try and find out about the world, just like Economists. 

Both can benefit through interdisciplinary work, since both are unavoidably intertwined, at least when the real world becomes involved.

Like Deirdre McCloskey said in an interview, when asked about how she defines economics (Art or Science?):

"Physics tells us that if a 100 Euro note falls to the floor, it will stay there. Economics tells us that it will be invariably picked up."

Both have something to offer.

Pseudo vs. Pseudo

I was gracefully invited to post occasionally on this new site, so I thought I might write a few words regarding what comes to mind on the subject of pseudo-economics.

The use of the prefix "pseudo" with regards to economics is an interesting, paradoxical one; economics itself has often been accused of being a pseudo-science. What can be salvaged from the naive interpretation, namely a pseudo-pseudo-science?

Answer: that which is most valuable in science.

I like Popper's idea of falsifiability of claims as a benchmark for what counts as science, so let's go with that. In this regard, economics has not gotten very far, aside from a handful of results (e.g. net gains from trade) in the last couple of centuries. "Pseudo" looks about right.

There are many fundamental reasons for this dismal performance, but I like to keep causal density, unavailability of experiments and the reflexivity problem as my top three. Once you consider the obstacles, the failures begin to look a little more reasonable*.

Economics is in good company as well; all the humanities - at least when they attempt to understand humans - share these problems. We are outraged to see the natural sciences progress by leaps and bounds while the humanities are left behind. This seems natural to me, however, since the fundamental issues holding economics back have very little to do with computation - the availability of which made the natural sciences explode in the 20th century.

The fundamental challenges that make economics et al. pseudo-sciences are the same ones that we face while trying to make decisions in our daily lives. Even if pseudo-sciences are inefficient at arriving at useful descriptions of reality, they often yield insights into how one goes about learning about the world in the midst of seemingly irreducible complexity. If for only this, we should keep at it.

This then is how I reconcile myself with the idea of pseudo-economics; as long as the endeavor shares the desire to understand reality in an internally consistent way and to falsify this understanding empirically, then its discrepancies with economics or any other field are irrelevant. What matters is disciplined discussion.

*The natural sciences, of course, also face these challenges to a (in my view) lesser degree.

Creatively pursuing the Renaissance Man mold

Disclaimer: The following post requires an above-average level of mental multi-tasking.

A friend of mine just posted a short essay titled "The Modern Well-Rounded Man".

He states - 

Consider: 

1. Increasing division of labour and specialization as a coping mechanism with the complexity of the economic / social system. 

1.1 Please everyone refer to James Burke’s Connections. You don’t need to watch this to get the point intellectually, but it is a wonderful way to get it viscerally.

2. Romantic/humanist ideal of University education / universal man / well-rounded man. 

2.1 Embedded in current education system – “every person should know at least x, y, z”.
2.2 Embedded in social norms and values – we worship individuals with great accomplishments in very specific fields and attribute them equal levels of skill in others / become disappointed when they turn out not to be

There is a tension between 1 and 2. Understanding this was an important step in growing up (insert cynical witticism) for me.

I would add the following (as a "required aside", more than a "direct complement", when considering the requisites for a successful and focused application of points 1 and 2):

3. The Individual Psyche

    3.1 In that singular forces that influence thought, behavior and personality greatly determine path outcomes

4. Productive Creativity

   4.1 As opposed to reproductive creativity, that acts on established discoveries through predetermined rules and norms 

   4.2 Which produces alternative thinking, that works to lessen the impact of the mental/educative limitations imposed on the individual through a regular, functioning society 

   4.3 Which circumvents the inertness found in traditional methods of critical thinking, by going beyond determining whether something is true or not, and looks to add insight through proactive thought rather than reactive response

Then, the author writes:

So of course, you could be a genius and therefore not have to choose between 1 or 2. You could nurture this belief despite ever-mounting evidence to the contrary – essentially by disqualifying any objective measures of intelligence and/or staying away from the big ponds and bigger fish. Beyond being a waste of time, this attitude just distracts you from the essential question of what you think is a good life for you. 

So, a piece of advice to myself and others who fit the mold: 

Choose specialization or versatility consciously, and proceed accordingly. 

Discard the fantasy of not having to choose – if you do turn out to be exceptional, it will be a nice surprise.

I agree with the advice wholeheartedly: Leonardo da Vinci, the proverbial polymath, seems to have chosen to follow the advice given by the author. 

I would like to think that Da Vinci consciously chose to be versatile and focus on the different subject areas he ultimately dominated. In doing so, he was efficient in creating value through his various pursuits - irrespective of the fact that most capable people will find it increasingly difficult to be able to take on so much so superbly (point 1 essentially eliminates this possibility).

There's only one way to go here: Up.

In digressing slightly from the main point (in choosing specialization or versatility consciously and discarding the fantasy of not having to choose between them), I would caution however, the following:

1. Refrain from squashing the childlike wonder (by substituting it with adult intellectual sobriety) that infects anyone and everyone who has ever gone beyond merely "functioning" and aspired to transcend, by pursuing multiple interests (Einstein with the violin and Feynman translating Mayan hieroglyphics)

2. Avoid insulation and extreme introspection, and invite broad participation and healthy debate: learn from others, not just from what they've written, but also from what they've debated with you in person.

And:

3. Never become so arrogant as to think that there's nothing to learn from the less intellectually minded and less educated

Digressing even more:

The following video describes Richard Feynman's questioning brain in a beautiful way, and in a way, encompasses (through his words, tone, logic and overall demeanor) the beauty inherent in the arts and sciences: