Category Archives: Personal Finances

Optionality and Economic Change

The book America 3.0 (available for purchase from Amazon and Barnes & Noble) describes three long economic periods, based on agriculture, industry, and information, as driving profound social change.

America-3_0-480px

When we fought the Revolution against Britain, America’s economy was based on agriculture and the hydrological cycle. Along with the constants of soil and sun, water (where it fell, how it needed to be diverted, where it ran) determined American economic life. Know a man’s relationship to water, and you knew his realtionship to wealth.

american_rivers_map_md

Around the time of the Civil War against the southern rebels, sun, soil, and water were surprased by coal and rail as the foundation of power and privilege. The great rail network, centered around Chicago, enabled greater economies of scale than had ever been seen before in history. The story of the next century, from the racial strife of the 1860s to the racial strife of the 1960s, was the story of industrialization, scale, and how the benefits of coal would be shared.

american_railroads_md

We’re now changing again. “Information” appears to be valuable, and the economic giants of the day are information racketeers such as Google, Apple, Amazon, and Facebook. The world is becoming much less heavy, and manufacturing on demand (from computer-driven milling to 3D printing) may accelerate the acceleration the eclipse of coal by data.

american_cell_maps_md

We do not know what is next. The industrial age seemed to come to an apogee in the late 1940s, as economies around the world (the US, the UK, France, Germany, the USSR, China, Taiwan, both Koreas, and Japan) established bureaucratic-industrial welfare states managed by experts, with only quixotic variations based on national culture and ideology. But that was a false sunlight, as phony as the widespread popularity of the concentration camps (brought to the US by Franklin Delano Roosevelt) of the 1930s.

We know the world is changing. We know now what comes next.

In this environment, we should focus on giving learners many low cost opportunities and few high-cost high-risk paths. In other words, we should give students “optionality,” where they have many opportunities and few long-term costs. We’re not in an industrial age where we know economies of scale will rule the day, nor even in the long hydraulic age where water was the great idol. Students will have to find their own ways. We should help them.

To do this we should (except for core majors that are needed for national security — say science, technology, engineering, and mathematics) make much of the curriculum optional, and allow students “low-risk” trials in different career paths.

As Tren Griffen and Nassim Taleb posted:

If you ‘have optionality,’ you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)” Being able to make decisions which do not require correctly forecasting the future is a wonderful thing. Not one of the great value investors identified in the series of posts in this blog relies on macro forecasts of the future. Instead, value investors use the optionality of cash to buy after the outcome exists (i.e., a significant drop in intrinsic value). Regarding venture capital, Warren Buffett believes: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments. Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities. Most venture capitalists employ this strategy.

It is certainly evil to trick an 18 year old into non-bankruptable loans of tens of thousands of dollars on a worthless major. A 16 year old would be better off learning a trade than learning Shakespeare, especially if that student could learn Shakespeare later. An 18 year old would surely be better off selling drugs (say from a pharmacy, an alcohol ball, a tobacconist shop, or so on) and learning that part of the economy than borrowing money to study political science.

Help our students prepare for an uncertain future, for America’s next stage of economic development. Give them low-cost opportunity and easy failures. Not non-bankruptable student loans.

Optionality and Education

This post introduces optionality, optionality in the context of foresight and then raises implications for education.

Discussing Optionality

A bit ago, both Tren Griffen and Nassim Taleb discussed “optionality” on their blogs.

“Optionality” refers to an investment decision where the reasonable upside is much larger than the reasonable downside.

Here are some of Tren’s thoughts on optionality:

Optionality is lost when you’re initial investments are so large, you cannot afford to abandon your initial plans:

“A rigid business plan gets one locked into a preset invariant policy, like a highway without exits —hence devoid of optionality.” I am at my self-imposed 999 word limit so what follows including this quotation must largely stand on its own without commentary…

“Optionality… explains why top-down centralized decisions tend to fail” …

“Like Britain in the Industrial Revolution, America’s asset is, simply, risk taking and the use of optionality, this remarkable ability to engage in rational forms of trial and error, with no comparative shame in failing again, starting again, and repeating failure.” Entrepreneurs harvest optionality when they tinker and experiment as they run their businesses and as a positive externality benefit their city/region/nation/the world in the aggregate by generating productivity and genuine growth in the economy even if legions of entrepreneurs may fail. Taleb: “Most of you will fail, disrespected, impoverished, but we are grateful for the risks you are taking and the sacrifices you are making for the sake of the economic growth of the planet and pulling others out of poverty. You are the source of our antifragility. Our nation thanks you.”

Optionality in the Context of Foresight

Unlike rigidly planned investment strategies, optionality emphasizes only maintaining flexibility and recognizing success when it happens:

“If you ‘have optionality,’ you don’t have much need for what is commonly called intelligence, knowledge, insight, skills, and these complicated things that take place in our brain cells. For you don’t have to be right that often. All you need is the wisdom to not do unintelligent things to hurt yourself (some acts of omission) and recognize favorable outcomes when they occur. (The key is that your assessment doesn’t need to be made beforehand, only after the outcome.)” Being able to make decisions which do not require correctly forecasting the future is a wonderful thing. Not one of the great value investors identified in the series of posts in this blog relies on macro forecasts of the future. Instead, value investors use the optionality of cash to buy after the outcome exists (i.e., a significant drop in intrinsic value). Regarding venture capital, Warren Buffett believes: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments. Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities. Most venture capitalists employ this strategy.”

“Optionality” is related to the career advise given by Jim Collins. Instead of simply cataloging your skills, and applying for high-paying jobs in which those skills are required, Collins recommended first looking at (a) what you love, (b) what you can be great at, and (c) what you can make money doing. The goal isn’t to aim for some perfect job sometime later in your life, but to set yourself up in an area where you enjoy practicing and you adaptable for those opportunities that appear.

3-circles-hedgehog-concept

Implications for Education

Optionality is an investment choice that has a small potential downside but large potential upside. You don’t need a strict plan, lots of foresight, or even great environmental awareness to look for investment choices that have optionality. You simply need to keep from making bad decisions, and need to tolerate “getting it wrong” (which means simply starting over).

So what does this mean for education?

Student loans are an anti-optionality catastrophe.

Student loans are impossible to get rid of in bankruptcy. They also require a lot of foresight and planning — and worst of all, require it of 18 year old idiots (that is, virtually all 18 year olds).

Being an idiot isn’t a bad thing — if you have optionality, you try, fail, and learn from experience. But being an idiot with debt is a horrible fate.

At the very least, non-bankruptable student loans should never be offered for non-Science/Technology/Engineering/Mathematics majors. To force someone with no work history to take ten thousand, twenty thousand, or more in non-forgivable debt for a worthless English literature degree is horrid. It is the closest thing to “usury” that exists in our world outside of organized crime.

Not only do non-bankruptable student loans kill optionality by making education have a big potential downside, they make that downside more likely. Student loans for non-STEM majors encourage failure by getting students to loan up to enter a ghetto of low wages and few jobs. This is the opposite of encouraging wise investments.

We need to close the on-ramp to the ghetto by discouraging youth from making choices that don’t have optionality. We need to end non-STEM student loans.

seattle_ghost_ramps_blocked

It’s better for an 18 year old to be a drug dealer or go-go-dancer than to take non-bankruptable loans to study sociology. Those options may have optionality. Sociology doesn’t.

Parents and the Two Income Trap

One of the dimensions of force in the education reform debate is child-care, with both parents and large employers viewing schools primarily as a way to turn children into adults with specifics skills, attitudes, and knowledge. Of the three dimensions of force (money, power, and childcare), childcare is the one with the least complex. While teachers and publishers battle each other for the chance to divert money away from children and to themselves, and while States and Districts squabble over political power, parents and large employers do not disagree about much. Both desire children to become productive members of society.

Importantly, both also suffer from a collective action problem. That is, the cost for making America’s education system world-class is high, and any individual parent or employer can opt-out by simply renting better childcare on their own. For employers this means paying slightly more for one of the competent workers, and for parents this means paying slightly more for one of the competent schools. The consequences for employers and employees of the first part of this is clear: a greater labor cost means a higher standard of living (and least in the short run) for competent workers, and greater automation and outsourcing to compensating for it, leading to a lower standard of living (at least in the short run) for those automated or outsourced out of a job.

The consequences for parents are more profound.

The K-12 education market in the United States is profoundly warped. Parents typically buy access to good schools through pay rent or mortgages in good school districts. Because the teaching profession has been lobotomized through low wages, sending children to many schools would be morally tantimount to child abuse. Bidding wars thus erupt to gain access to these good schools, in the forms of expensive mortgages and high rents. People who actually own this property (apartment managers, real estate developers, and mortgage holders) become rentiers who profit at the expense of parents trying to provide a better life for their children. (Thus, landowners are an important rentier class in the education debate, along with teachers and publishers).

This leads many parents to face what Elizabeth Warren called “the two income trap.” The bidding war for good schools, along with the breakdown of widespread sexual discrimination, encourages both men and women to work, and use the excess income to buy housing near a good school. This means that if the husband loses work for whatever reason, the wife cannot temporarily increase the family’s income by taking additional part-time work. Further, in the event of a medical emergency in the family, the wife cannot act as a “free” caregiver. In both cases, America’s two-earner encouraged by our bad schools increases the financial risks of families, and thus increases domestic violence, divorce, and economic ruin.

While the low quality of America’s teacher workforce is certainly one reason for this, others exist as well. America’s education management force is low quality as well. Further, peers matter — who a child goes to school with matters quite a lot. Parents (meaning parents who are actually engaged with and concerned for their child’s future) can reasonable expect a school to be better if fewer students from low-income households attend it. Thus, a brutal but effectve way to increase the quality of schools for many parents would be to exclude students from communities that historically are not focused on education. Brown v. Board of Education and other cases have made this policy untenable, however, leading to more low-income parents to be priced out of good schools because they now have economic competition from communities of comparative earning ability but with a broken pipeline to class mobility.

But in either case, the problems remain. And the economic stress bad schools place on parents mean that solutions that require paying teachers more — such as turning teaching into a profession — may be impractical.

OccupyWallStreet on the Dave Ramsey Show

The Dave Ramsey episode for October 19th, 2011 is dedicated to callers from #OccupyWallStreet.

It’s interesting. In general, the callers on the show match up with Lexington Green’s assessment of #OccupyChicago

The kids I spoke to — and I use the term because that is what people in their early twenties seem like to me — were nice, and reasonably intelligent. Two were recent college graduates who were not able to get jobs. They seemed to be sincere and sensible young people.

One girl had a printout of the “proposed grievances.” (I got the list off their site and put it below the fold, since it is apparently a work in progress and subject to change.) It is an interesting mix. I agree with some of it, as noted in square brackets. I was surprised that it was not more Left boilerplate. It seems to reflect an accurate understanding of the seriousness of crony capitalism as the heart of the problem we face.

These conversations I found enjoyable, though I was as usual saddened by the combination of earnestness and ignorance of this rising generation.

My hatred of the Boomers, who have brainwashed and wasted these kids is boundless. There is nothing wrong with them. They have just never been taught anything but bullshit. They have been betrayed by their parents and their teachers. It is very depressing. The country has been shamefully dumbed down.

The 10/19/11 episode is available for free streaming for about a week. Listen to it!

How to #OccupyWallStreet

Angry about big banks? Instead of blaming your problems on the President, the Congress, or the rich, actually make a difference:

1. Pay off your debts. Large banks cannot charge you interest on debt you don’t have.
2. Don’t use big banks. Large banks cannot charge you fees on accounts you don’t have. Try local banks or credit unions.
3. Get positive reinforcement for doing this. Try a show like the Dame Ramsey Show, instead of pro Wall Street “normal” shows that advocate stupid stuff like not paying off debt.

In other words, don’t go deep into debt, don’t use Chase, and don’t surround yourself with people who advocate those things.

Reviews of Self-Help, Advise, and Financial Book

Books reviewed:

Of these five books, three have helped to improve my professional life (Collins, Godin, and Ramsey), one is a fine technical book (Mecham), and the last seems bizarre and dangerous (Orman).

First, Seth Godin. I think the reason I loved Godin is that it was an easy, breezy, well written, and actionable (!) distillation of the ideas that I focused on in my dissertation: namely, creative performance is a function of your expertise in your domain, the extent to which you can co-opt gate-keepers in your field, and your eagerness to fail. Godin repeatedly emphasizes the second of the three attributes, and really emphasizes the social aspect of business. A hand-drawn chart sums up a number of his arguments very nicely:

While Godin focuses on co-opting gate-keepers, Collins focuses on building expertise. The way one becomes an expert is practice, of course, so the center of Collins’ writing is how to move yourself into a position where you can keep practicing for an extended period. Using a case study approach, Collins emphasizes doing something that in which (a) you find excitement, (b) you make money, and (c) you can become the best in the world. While much of Collins’ tone is written at the level of CxO types, the personal applicability of the lessons are obvious.

As Collins lays out how to build expertise, and Godin seeks out the social aspect of co-opting gatekeepers, Ramsey keeps an eye clearly on failure. All learning comes from failure, and Ramsey’s advise is all about how to embrace this part of life. Essentially, Ramsey seeks to turn disasters into annoyances and annoyances into non-events. Specific advise, such as rapidly paying off debt, paying in cash, and such all have at their root a minimizing dependency on steady incoming cash-flow from an external source. My only criticism is that Ramsey is a much better radio host than he is an author — casually listening to his podcast is more enjoyable than reading him in book format.

All the advise of Godin, Collins, can perhaps me summed up in one sentence:

If you want it bad, you get it bad. If you want it like hell, you get it like hell.

Mecham, by contrast, offers an extended text-based infomercial for his budget software, YNAB. The software is fine, as is the book. Mechan’s advise is broadly compatible with Ramsey, and being conscious about spending decisions is hardly a bad thing. Still, while Godin, Collins, Ramsey together outline an exciting vision of how the economy actually works, Mechan’s writing is a less-useful and more-muddled version of the same (so more like my writing level!)

Godin, Collins, and Ramsey are great writers. Mechan is a fine one. Orman is dangerous. While reading Money Class, I kept thinking, “Who is this written for?” When I read that Orman had worked for Merrill Lynch and Prudential, it all made sense: Orman teaches a spreadsheet-based version of microeconomics which works fantastically if you average the results over 10,000 random people. This is dangerous because it ignores the variability in outcomes that can be critical during the course of building expertise, co-opting gatekeeprs, and failing. Advise that Orman gives that prepares for failure (a large emergency fund) is immediately undone by assuming long-term and constant streams of income (prepare to pay off your mortgage… by retirement).

I dont’ view life as dry or cold, so Orman’s disembodied advise really puzzles me. Failure should not be a disaster which requires a “new American dream”: it is (and has been since you were a toddler) an intrinsic part of learning.

In conclusion, Godin are Collins are must reads. Ramsey is a must-listen. Mecham is perfectly fine. Orman is writing from a different, and colorless, planet.

Where Obama’s mortgage bailout will go

Instapundit links to this interesting article:

THE FORECLOSURE FIVE – New York Post
The beneficiaries of taxpayer charity will be highly concentrated in just five states – California, Nevada, Arizona, Florida and Michigan. That is not because the subsidized homeowners are poor Californians with $700,000 mortgages are not poor, but because they took on too much debt, often by refinancing in risky ways to “cash out” thousands more than the original loan. Nearly all subprime loans were for refinancing, not buying a home.

It turns out that the five states with by far the highest foreclosure rates have some things in common with each other, but very little in common with most other states.

I studied the latest available figures for state foreclosure rates, changes in home prices over one and five years, existing home sales, the percentage of mortgages that are underwater, and unemployment. Then I compared figures for the five most foreclosure-prone states with New York and also with the 25th-ranking median state.

One out of 76 homes in Nevada went into foreclosure in January, for example, compared with one out of 173 in California, with Arizona and Florida close behind. In New York, by contrast, only 1 out of 2,271 homes went into foreclosure.

Of course, real estate speculators existed in every state. Some of them doubtless did not realize that leveraging up to buy a house that one does not plan to live in for many years is about as wise as leveraging up to buy stock that one does not plan to live in for many years.

Certainly, those home-owners are just as sympathetic and deserving of a bailout as all those who borrowed tens or hundreds of thousands of dollars to buy stock.

Is financial innovation worth it?

Half Sigma’s post has face validity, but I am aware of my lack of knowledge of how the financial system works.  So instead of agreeing with it, I will ask for comments so I can learn more.

Government run industries tend not to be very innovative, but the only useful innovation to come out of the banking industry in the last century is the ATM machine. Otherwise, when banks innovate, that’s when it’s time to hold on tight to your wallet. Bank innovation tends to fall into two categories: (1) sneakier ways to trick people into getting into more credit card debt and pay more outrageous credit card fees; and (2) complicated financial products like mortgaged backed securities and derivatives which have led to the recent financial collapse which not only ruined that banking industry but took down the whole economy with it.

via Half Sigma: What’s wrong with nationalized banks?.

Thoughts?

Have you been paying your mortgage? Then it sucks to be you

Do you have a mortgage you pay every month? Or were you saving up to make a big down payment.

Then you made the wrong decision.

Smart borrowers have simply stopped paying the mortgages, letting them (unlike you) qualify for bailouts from the federal government:

Calculated Risk: FHFA Modification Program Details
Q: What is a streamlined modification?

A: A streamlined modification is a modification that requires less documentation and less processing. In this case, the streamlined modification seeks to create a monthly mortgage payment that is sustainable for troubled borrowers by targeting a benchmark ratio of housing payment to monthly gross household income.

Q: Why is it necessary?

A: With the rise in serious delinquencies and increasing number of loans in foreclosure, this program will help borrowers who have missed three or more payments, but want to keep their homes. Because the eligibility requirements and process are streamlined and consistent, the program will allow servicers to reach more borrowers more quickly.

Q: Why must the borrower be 90 days delinquent? Why not earlier in the delinquency cycle?

A: This is a streamlined solution targeted to reach the most at risk borrower. For borrowers who do not qualify, other solutions are available. This in no way substitutes for the meaningful efforts by all servicers and investors that are currently in place. The 212,000 workouts reported by HOPE NOW in September are testimony to that fact. We will continue to see those efforts produce meaningful results.

All smart mortgage holders should stop making all payments for 90 days. In exchange for a hit to your credit rating, you may save tens of thousands in interest and come away with lower monthly payments!

Next up: a credit card bailout.

Bank Nationalization

This sounds like a good idea (really):

Fed eyes Nordic-style nationalisation of US banks – Telegraph
The Fed has been criticised for its rescue of Bear Stearns, which critics say has degenerated into a taxpayer gift to rich bankers.

A senior official at one of the Scandinavian central banks told The Daily Telegraph that Fed strategists had stepped up contacts to learn how Norway, Sweden and Finland managed their traumatic crisis from 1991 to 1993, which brought the region’s economy to its knees.

It is important that neither the owners nor the upper management of failed banks be bailed out. Capitalism is the processing of risk through profit: allowing failing companies and executives to profit turns the free-market on its head. Currently in the United States, bad companies and executives are able to hold the economy hostage, because if they go down, their companies go down, and so do their lenders and borrowers.

“The law was amended so that we could take 100pc control of any bank where its equity had fallen below zero. Shareholders were left with nothing. It was very controversial,” he said.

Here here for confiscatory nationalization of failing banks and investment houses!