Saturday 21 March 2020

Ride a Black Swan

One of the many great things about Enron, long before it went under, was that it brought really strong financial practices into the energy industry and made people take financial risk management (FRM) seriously.  We can talk about the rich, deep ironies another time.  I was never a risk manager myself, but was strictly schooled in its principles, technical and pragmatic, the better to negotiate sound contracts (which is my trade).

One of the interesting aspects of FRM is that no commercial institution, even a bank, is held to providing 99.9% certainty in its hedging etc - not even 99% in fact; because it can't be done using shareholders' equity without crippling economic cost.  Everyone knows that 100% physical safety is impossible - the cost of moving from, e.g. Five Nines to Six Nines is prohibitive - and likewise that extreme financial events happen out in the "fat tails" of the distribution, that can't really be catered for within the economics of an enterprise in the same technically-sound ways that can be implemented out to two standard deviations.  But what if folk are deeply risk averse, as they surely have the right to be?  The textbook solution to this puzzle is that they must take (partial) responsibility for their own FRM, by diversifying their exposures.  Not everything will go pear-shaped simultaneously ...

Except of course when a Black Swan glides onto the waters.  At this point, hitherto non-correlated risks all become correlated, in the shit-direction: so Diversification fails (as well as hedges not performing and insurance not paying out).  And then we are down to the last resorts:  burning through capital reserves (which were anyway set at the 95% risk level, so by definition they don't go far enough), and then ... socialisation.

Now as CU said the other day, 2020 looks like making 2008 seem like a picnic.  (E.g., I had a massive hedge on against 2008, and it paid up.)   This time, it's straight through to socialisation, and pray God that good decisions are made.

A lot of Socialists are drawing understandable (sort-of) but very wrong conclusions.  Wonderful, they say - and let's keep it fully socialised thereafter because Capitalism Doesn't Work.  This is the merest crap.  I won't rehearse what a feeble-minded misunderstanding that represents as regards What Capitalism Is; suffice to say that they were saying the same thing at the outbreak of WW1, and WW2 (and in fact every day of every week).  It was equally ridiculous then as it is now.  We socialise against the Black Swans, the Kaiser, the Nazis, the C-virus.  And in normal times, we optimise our affairs intelligently.  Leftist snipers can f*** off, and do something useful in the community. If they know how.

One more weekend thought for now.  The EU can f*** off, too.  Their threats will have no force whatsoever, when negotiations recommence.  What, they gonna threaten us with a 1% hit on GDP?  Shortages in the supermarkets and bread riots?  By then, we'll have solutions for all that stuff - and quite possibly better ones than theirs.  Small comfort right now, but I'd confidently say we'll get a sensible deal quite easily - with whatever's left by then.

Keep safe, all.



E-K said...

Let's hope the Left don't get in or get their way on making this permanent. 'cause we've got the whole Communist shebang now including the police state and doctors who can see you off without a second opinion.

Once people get hungry funny things start happening. And there are previously hard working and decent people who are ineligible for anything like instant support. As with the animal kingdom they will risk everything to get their grub if the pangs are there.

We need to get back to work as soon as is possible.

We certainly don't have a year.

E-K said...

Keep safe, Nick.

Thud said...

It is going to be a shitstorm I know but I have faith that when it ends and sooner rather than later human nature being what it is things will be up and running quicker than the commies and doomsayers think.

Raedwald said...

Already rumblings from the Berlaymont that Rishi's bailout would contravene EU state aid rules if it exceeds €800k per firm ...

Feck 'em. What they gonna do? End the transition period early? Start an action in the ECJ?

Now is the time to use every financial weapon we can wield to establish an advantage. Whilst the EU moves at the speed of treacle, let's demostrate our national agility!

By Tuesday, many Brits I know will be bored already of the lockdown and will start some serious innovation and buccaneering, while their competitors are still organising their baguette deliveries.

david morris said...

Excellent article - again- ND.

I'd just say that to expect the usual suspects to refrain for pushing for moar state intervention in the economy is whistling in the wind. This is their moment
to shine. Expect the Islingtonistas to be all over BBC/Graun/C4 in the forseeable future.

& as for the EU. What Radders said.

Don Cox said...

Excellent post on a subject I know little about.

Is there a good book on the topic ?

Don Cox

Matt said...

What's worse - staying in equities where it's likely to tank further or get into cash where the government is intent on inflating it all away? What are the other alternatives? A gold ETF is unlikely to pay out (see main article) and physical gold had to buy (in quantity) and store.

Anonymous said...

Michel Barnier has the virus and he's quite old..........just sayin'

Nick Drew said...

Matt - this is NOT a recommendation, but

Small quantities; physical; store-for-a-fee, yes of course - that goes with physical; has always paid up whenever I've sold & instructed cash payment

The reason it's NOT a recommendation is that shit happens, and Black Swans defecate a rare and noisome form of shit

Matt said...

@ ND

Yes, I have a BullionVault account already. While a step up from an EFT, what happens if the SHTF? It's not like I'll be off to their vault to claim my gold even if they do have it physically available (IIRC, only separately when you have >= 1 Kg in your account).

andrew said...

Instant coffee
Tinned food

Or whatever the preppers (v. Interesting subculture) are stocking up on for when shtf

E-K said...

Did you ever learn to make an origami swan, Nick ?

Could you make me one and send me it to put next to your junk to remind me that this is oriental black swan shit we're talking about.

Nick Drew said...

no, I stuck to boats: junk, sampan (which is quite fiddly), and catamaran (a doddle)

AndrewZ said...

"By then, we'll have solutions for all that stuff"

It's also possible that we'll have *had* all that stuff. But really severe disruption over a period of months could completely change the context of negotiations between the UK and EU. Instead of needing to protect a high volume of existing trade, we could be negotiating from a position in which we have very little trade with the EU because most of it has stopped. The delays and inspections of goods at ports which were accepted as normal before the era of "friction-less trade" in the Single Market will probably have returned as a result of measures to slow the spread of COVID-19. It may be a very different world.

Nick Drew said...

A very different world indeed, AZ. To hazard a guess: one in which their strong cards (gracious facilitation of economic activity) will weigh relatively less - as you say - than before: while ours (military muscle, intelligence-gathering, creativity, agility, City services) will weight heavier. Who will have the stomach for more self-inflicted damage than is strictly necessary? So who will be happy to take any kind of hit just to teach the UK a doctrinaire lesson? (hich up until recently, they [pretended they] were)

Don - sorry, no: when occasionally I teach I use my own materials

E-K said...

What about the great British pub ?

I've just had to cancel a camping trip. We'd reached the conclusion that wild camping is just vagrancy if it doesn't include a trip to the pub.

I've suggested to Govt that a promise to resurrect the Great British Pub will be a great morale boost to the public - even if not fulfilled.

We need dreams to hold on to right now.

jim said...

What have we learned so far? That our insurance policies are worthless and dominoes are starting to fall over.

How has it played so far? Boris started off with doing very little. Now we do what the French and Germans do. Because it seems sensible and because come August/September we don't want any odious comparisons made. As with CV19 so it will be with anything else, we will tag along.

Brexit is in self isolation for a month or three. But the EU is cool, they will be OK with an extension. They don't want the gammons whining "s'not fair, we needed more time for our whizzo deal". Costs them nothing to drag it out and Boris has a bonzer excuse.

As CV19 falls away economic activity will splutter back to life, it usually does. There might be a few extra houses on the market but not enough to matter much. Holidays may be in short supply and demand high in the nearish term, prices going up. Perhaps an early taker advantage if you fancy the risk. But money might be short. If things get much worse pensions may take a hit.

Post CV19 might be a time for strategic review, retrench here, open up new markets there. Depends a bit on how attractive Boris's Britain looks. If the world's industrial majors start on strategic review we will have to be pretty nimble or we might lose out. EU will not play nice.

What we don't need is any rioting and what goes with it. Very ugly and confidence sapping. Iron fist from day 1 if that happens.

E-K said...

Nick Drew said...

thanks for link, Kev - interesting from Hitchens, a good statement of the laissez-faire case. And he's right that MD's piece in the Eye is an eye-opener, and has surprised many people with its bluntness ("we're all going to die, some much sooner than others")

Nonetheless, I don't think PH is quite right. Another post ...

Anonymous said...

Hitchens, whilst being smart, doesn't really understand how people work and sometimes finds real world context difficult.

He's right about the rate of excess deaths, but these are due to many different causes, and so difficult to place under a single banner. So the public, as a whole, care little, they need a boogeyman. A single point of fear.

If we just Carried On Regardless, then everyone with a sniffle would be rocking up to A+E - getting in at the GP next to impossible these days - and walk-in centres, swamping resources.

The NHS would be swamped, and the excess deaths would head northwards, and the Tories could likely expect a generation in the wilderness after being cast as a government of Harold Shipmans.

Can see the headlines now: "GRANXIT: BoJo loses his mojo because killing granny is a no-no!" screams The Sun.

He also makes an error that, because something was handled, it wasn't a threat.

He may as well have stated that nuclear proliferation isn't a problem, because we've managed to avoid a nuclear war so far, yet we all recognise that would be damn silly.

I can't say for sure we're going down the right path, or that it'll work - social distancing, or the lack of, at checkouts or outside the one-out-one-in local shops, doesn't fill me confidence - but simply doing nothing is ignorant of how people actually function and the consequences of that on the NHS.

And if he's prioritising money over life on such a scale, then at the very least he has a twisted sense of priority, if not bordering on the sociopathic. Money is a tool, partially around resource allocation, but is very much secondary to the value of life itself.

Elby the Beserk said...

Good stuff, Nick. And this is the first real (non-financial) crisis that the EU has had to handle, and it has singularly failed on all counts. Every country has automatically had to go back into nation state node, knowing the EU cannot help them.

We'll be paying this for the resat of our lives. And I suspect for folks of may age, we'll be printing money for the rest of our lives.

That said, things are looking up. Scored a nine pack of Andrex yesterday...

Keep well folks.

Elby the Beserk said...

@Anon 10:57am

I was at school - Leys School, Cambridge, with both Hitchens brothers. Didn't know Peter (different house) tho' I do recall he was expelled for braking into the nuclear bunker in Cambridge. Christopher I knew a bit - we and another lad used to go down tot eh caretaker's flat to watch the nags, and said caretaker would place a few wee bets for us. I do recall CH was also nearly expelled - for selling books from the school library to fund the betting. Other mate WAS expelled - ended up Clerk of the Course at Newmarket. So, well-schooled one might say.

Baroness Trumpington to be was the Headmaster's wife. and an active one. Had a couple of run-ins with her, but we got on well - so much so that she and I watched Celtic become the first Brit European Cup winners, in 1967, in an annex to the headmaster's study which had a TV. Fine fine woman

Anonymous said...

@ she and I watched Celtic become the first Brit European Cup winners, in 1967, in an annex to the headmaster's study

Is that a euphemsim, Elby?
If so, congratulations on the most convoluted euphemism ever.

Raedwald said...

It's a good piece, but it shows why journalists are journalists and statisticians are statisticians. Amidst all the flannel is one hideously misunderstood key statistic - the fatality rate.

Covid 19 may be just 0.5% to 1%, writes Hitchens. Why, that's hardly different to seasonal flu, which is 0.5%.

1. Flu has an R0 of about 1.3, Covid 19 of abour 2.3. In practice that's a massive difference. Many, many more people infected

2. Flu has a practical mortality rate of about 0.1%, Covid 19 in the range 0.8% - 1.2%. It's massively more lethal.

Hitchens perhaps doesn't understand that between 35% and 70% of people have flu jabs - which alters dramatically transmission and death. Flu isn't a pandemic.

It's the job of the journalist to write a story that sells whilst not telling outright lies. It's not a substitute for science.

Elby the Beserk said...

Anonymous said...
@ she and I watched Celtic become the first Brit European Cup winners, in 1967, in an annex to the headmaster's study

Is that a euphemsim, Elby?
If so, congratulations on the most convoluted euphemism ever


I was a callow 16 year old, and she already the magnificent battle axe we all loved in the Lords. We got on well, tho' she put a flea in my ear once or twice. I was nominated House Prefect (Head of House) for my last year. This occasioned an invitation from the then Mrs. Barker to Sunday lunch with them and guests.

Invitation came in a latter, and she address me as was the standard in those days at a public school, by my surname alone.


"Dear Poynton,

it read.

I responded

"Dear Barker,

and was summoned for a flea in my ear lesson in etiquette (deserved!)

She was a Bletchley gel as well.