Tuesday, January 20, 2009


Economist is someone who, upon hearing something works in practice, snaps "Ah! But does it work in theory?"

Risk manager is someone who, upon hearing something doesn't work in practice, assures "Ah! But it works in theory!"

Executive is someone who, upon hearing something doesn't work, mumbles "But but but my risk manager assured me it works!"

Trader is someone who, upon hearing something doesn't work, inquires "What's the spread?"

Quant is someone who, upon hearing something doesn't work, proposes "It'd work if we assume 1+1=2.429583478, instead of -1.239843924 -- that's where the standard model is wrong!"

IT manager is someone who, upon hearing something doesn't work, yells at her programmers "Why doesn't it work?"

Programmer is someone who, upon hearing something doesn't work, calls her headhunter.

Headhunter has found herself a new job as a bank teller.

Bank asks gubbermen for bailout, again.

Gubbermen asks economist for ideas.

Monday, January 19, 2009

Careful Playing with Black Swan

Now that everybody and their stock broker have bought Taleb's book, everyone knows about black swan. A good number of people may have played with it, I fear.

If you bought deep-out-of-money long-term puts any time after last September, good luck, you probably won't get back to the waterline even if the market goes down 20% from here. Aside from time-decay, the implied vol (VIX) was so hysterically high last October that you have a good chance to lose money even if the market goes your direction.

As usual throughout our evolutionary history, most people follow and lose. Only a select few have what it takes to do the Black Swan Trade.

I'm not talking about the math behind options. Black and Scholes Themselves may not have what it takes to do the Black Swan Trade. I'll use a little anecdote to make my point.

A friend of mine bought some deep-out-of-money LEAPS puts on SPY back in April, 08, when market started rallying on Bear Stearns' bailout. He said "shit is gonna blow up again in September". Pretty succinct, don't you think? But market kept going up, VIX kept going down, as a result he was bleeding a little every day. But early September brought rumors about Lehman. He was almost back above the water! Here's what happened as he told me later (I'm paraphrasing):

There's a good chance that the government will bailout Lehman in the end. So I'll close this one and roll it forward. Then, after I sold the puts, I thought "VIX just shot up and, if the gov bails Lehman out this weekend, I'd be killed by the double whammy of market going up and VIX going down -- look what happened after Bear...just too much risk opening a position now. I'll sit the weekend out."

The rest, of course, is history. With hindsight, he could've opened another Black Swan trade right after the Lehman weekend anyway and made some money. But the risk of doing that back then was also high. Regardless, the point is that the satisfaction was gone. The glory was tarnished. Once you get that close to a ten-bagger, a two-bagger is hardly enticing.

Here's a guy who understands the math, the pitfalls, all the greeks. He saw it coming while the herd was cheering. He just left his would-be-perfect Black Swan Trade open for one weekend.

The Black Swan Trade requires extraordinary courage, persistence, and patience. The herd says you're wrong. The market proves you're wrong day after day for months or even years. Wife complains. Peers jab at you at the bar. Yet if you slack for one day, you may miss the single day you've been suffering months/years for.

It's a miserable way to make money.

No wonder Taleb quit his fund. No wonder he has such a strong urge to brag and show he's right. Now that he's totally famous and proven right, I'm still not sure he's satisfied or that he can ever be. (I'm not trying to psychoanalyze him per se. This is just a generalized observation.)

Maybe it's time to take another look at the Black Swan Trade you did.

Sunday, January 18, 2009

Crisis? What Crisis?

The near-term crisis is over.

Libor is coming down. Mortgage rates are coming down. Bond market of all maturities and for all stripes of borrowers has thawed. Prime consumer credit is moving. CDS spreads have come down from hysterical/historical levels, although it's likely never to come back to pre-crisis levels -- before it disappears. There're still a few anomalies remaining in the market, most notably the spread between nominal and inflation-indexed treasuries. But these anomalies are generally understandable and temporary.

This is not to say all problems are over. Employment and housing will lag at least a few months. The on-going earnings season will be ugly. The tsunami may very well reverberate around the globe back and forth another round, or two. But, barring human stupidity (which can never be barred), these are problems, not crisis.

Oh, another powerful socio-psychological support: the society so much wants Obama to succeed that Citi, BofA, and JP Morgan all decided to move their bad earnings up to Friday, before the inauguration. Wow, that's powerful, meticulous command and control from Obama's still-shadow government, as well as incredible cooperation from our good corporate citizens. Can we assume the remaining bank earnings (Goldman, Wells Fargo) will be good?

On the other hand, the long-term crisis remains healthy and strong, completely unharmed. In fact, I'd say it's been strengthened tremendously by all the scrambling trying to avert the short-term one.

1. Corporate governance.
Lack of shareholder visibility and control, loss of board independence, de-coupling of risk-taker and reward-taker, maturity mismatch between (shareholders and debt-holders) risk and (decision-makers) reward, grossly inadequate risk management systems and techniques, massive built-in systemic chain reaction mechanism...do you see any improvement? Me, neither.

2. Government debt.
Yes, somebody has to pay. That somebody is most likely our later selves and our children and grandchildren, in the form of massively diminished purchasing power and high inflation.

3. Inflation.
Yes, right now it's deflation. And expanded M0 money base alone doesn't cause inflation; more important factors in modern economy include leverage and velocity of money. But greed will drive us to leverage up and churn money as soon as the economy seems to show the first sign of life. And this inflation will be particularly punishing to the poor and polarizing to the society because it will be first and foremost driven by commodities. Will the Fed have enough foresight and political will to jack up interest rates soon enough and fast enough? No chance. In fact, inflation is the path of least resistance to eliminate the massive internal debt. In order to do this, the real interest rate needs to remain negative for a long time. It needs to be an integral part of fiscal policy. I'm not saying it's the right thing to do. It's just the thing people will do.

4. Devaluing dollar.
Yes, right now the dollar is strong for lack of alternatives and unwinding of USD carry trades. But this is bad for US economy and the unsustainable global imbalance. Service economy is a mirage. It's simply impossible to sustain an economy the size of US with lawyers, management consultants, middlemen, and McDonalds and Walmarts. We have to make some stuff, from iPhones to good cars to, yes, steel and toys. To do that we need a significantly devalued dollar to kick start it. Furthermore, there's no easier way to eliminate the massive external debt than devaluing dollar. Yes, it's a scam and everybody knows it but what can they do about it hehehehe...

5. Savings deficit.
No, we refuse to learn to save. It's unamerican. If the government let the crisis blow up, allowed the market to work through its wrongs, and gave people the chance to learn from pain, maybe we would've learned to save. But no, we the people will not allow the government to give us that chance. We are a democracy damnit. The society at large will continue to borrow until the government bails them out, again and again. And the government will continue to bailout the irresponsible until nobody is willing to lend us anymore. And Asia will stop lending, some day.

6. Democracy.
Our democracy failed. It failed when it allowed Bush to invade Iraq and erect Patriotic Act. It failed epically when it re-elected Bush after the disastrous first term. If Bush had just given up in face of pathetic ratings and done nothing about the crisis, instead just followed his inborn, legendary apathy and ignorance, he would've done one virtuous service to the country by giving the capitalist system a chance to work its way through. But hell no, he had to mess up our long-term prospect one last time with the massive, rapid-fire, headless-chicken bailouts. And our elected Congress laid down, spread their collective legs, and let Paulson have his way, any which way he wished. And we had a collective orgasm watching it on TV. Ultimate political porn.

But mostly I'm upset that all the government interventions screwed up the system and made it even more irrational in the long-term. Capitalism requires a minimum degree of rationalism. Arbitrariness increases risk. Arbitrariness from world governments is the ultimate systemic risk. Excessive regulation increases societal cost of doing business. Without all the political headless chickens mucking around, it would've been very painful in the short-term for sure, but the long-term future would've been much clearer and more stable.

Interesting Shakes at Lake Station, Yellowstone

The Lake, which is the location of last earthquake swarm and an underwater bulge atop the caldera, has been doing this for a few days now -- intermittent, abrupt shakes. Notice that the seismometer's sensitivity is set at 500 microvolts, as opposed to 50~125 at most other stations in the park. So the shakes would max out at 100 microvolt sensivity.

These shakes are local to the station, and obviously not seismic. My (amateur) guess is there've been quasi-periodic magma movements or water sprouts at the lake bottom. Notice that Old Faithful sprouts don't register anything at the YFT station set at 125 microvolts. So these bursts are likely at least a hundred times stronger than Old Faithful.

Thursday, January 15, 2009

Most Interesting Seismogram at Yellowstone

My obsession with Yellowstone quakes continues...

Below is a most interesting seismogram for 1/14/09 -- harmonic tremor with a periodically varying frequency:

Saturday, January 10, 2009

Harmonic Tremors Continue at Yellowstome 1/10/09

At 7:40 and 11:10, Old Faithful:

More Harmonic Tremors at Yellowstone

More harmonic tremors at Yellowstone:

1/8/09, at around 7:30, 9:00, and 12:50

1/9/09, at around 8:00 and 13:10:

And, what the fuck is this around midnight?

I didn't realize the Upper Falls station is set at a much lower sensitivity than others, 1428 microvolt vs 50-125 at most other stations. Here's the one on 1/3:

The Lake station has been offline for 1/9/09.

To put it in perspective, the frequency of harmonic tremors range from 3-8/min. Wave your hand up and down once every 10 seconds. Imagine the ground goes like that. You'll see how liquid-like it is, almost soothing.

Monday, January 5, 2009

Harmonic Tremors at Yellowstone on 1/3/09

Since the earthquake swarm at Yellowstone started on 12/27, I've been following it with modest amusement. The idea of a super-eruption (VEI8, or even if just 7) of a supervolcano is mind-boggling, thus fascinating -- certainly would make the man-made financial crisis infinitesimally, pathetically trivial.

BBC did a very good drama on supervolcano -- watch all 12 of the two-part series:

It's drama, but fairly correct scientifically except, of course, the part about timing. Although the timing is intentionally ambiguous, it implies it's sometime in the near future of human civilization. This is pure speculation. To quote an old SNL bit: it's possible...but it's unlikely...but it's possible...but it's unlikely...

However, my passing interest peaked when I checked the U of Utah realtime webicorder in the park (http://www.quake.utah.edu/helicorder/yell_webi.htm).

Look at about 14:00 and 17:00. See something?

Yes, familiar nice sine wave patterns. It's called harmonic tremor. It means the magma was on the move. It has two possible outcomes: either stop and disappear, or the shit blows up.

If you check the other stations in the park for the same time segment, you'll see the same harmonic tremor pattern almost all over the park.

We dodged a potentially huge fucking bullet, this time.

BTW, according to USGS, the water output from Yellowstone River has been steadily increasing since 12/27 while it "should" be decreasing based on historical averages:

It's known that there's a dome at the bottom of Yellowstone Lake, where virtually all of the quakes of this swarm have taken place, that's been rising in recent years. It doesn't take a very imaginative mind to link the two.

What'll happen next? From all I can gather, seismo-vulcanologists say it could happen before I finish this sentence or it could be a million years from now. In other words, they're as clueless as Paulson/Bernanke on CDS, or Bush on the joy of intellectual stimulation, or Obama on unrealistic expectations.

Nothing to worry about, though. If it's a global extinction event, then there's no pain -- who's gonna be around to witness and record all the fantastic screaming and scrambling around and unfulfilled love and unfinished blog posts? The topology of the pain space is circular, infinity = 0. Just as globalization of the financial crisis, through Lehman bankruptcy, made crisis management that much easier and less painful.

Future rat archeologists will no doubt puzzle over their findings a great deal. Poor little fuckers.

PS: As the massive molten mass of magma was sloshing around under Yellowstone, I was enjoying GREAT food and decent wine at a newly discovered Hunan restaurant, the discovery of which was as accidental and meaningless as Yellowstone decided not to blow up at just about the same time, in Flushing with a bunch of friends celebrating my birthday. I thought I had a great birthday party going. But little did I know how great it was.

PPS: If you have to know, it's called 湘水山庄, about 100 yards east of Northern Blvd and Main St, on Northern Blvd. The best, most authentic Hunan food I've found on this continent, before it's covered in three feet of volcano ash anyway. It's so authentic they don't even bother with an English menu. Setting and service are quite decent, and the price is CHEAP.