Tuesday, July 21, 2009

Judge Holden

Judge Holden: Moral law is an invention of mankind for the disenfranchisement of the powerful in favor of the weak. Historical law subverts it at every turn. A moral view can never be proven right or wrong by any ultimate test. A man falling dead in a duel is not thought thereby to be proven in error as to his views. His very involvement in such a trial gives evidence of a new and broader view. The willingness of the principals to forgo further argument as the triviality, which it in fact is, and to petition directly the chambers of the historical absolute, clearly indicates of how little moment are the opinions and of what great moment the divergence thereof. For the argument is indeed trivial, but not so the separate wills thereby made manifest. Man's vanity may well approach the infinite in capacity but his knowledge remains imperfect and howevermuch he comes to value his judgements ultimately he must submit them before a higher court. Here there can be no special pleading. Here are considerations of equity and rectitude and moral right rendered void and without warrant and here are the views of litigants despised. Decisions of life and death, of what shall be and what shall not, beggar all question of right. In elections of these magnitudes are all lesser ones subsumed, moral, spiritual, natural.
Blood Meridian

Little Bill: "I don't deserve this, to die like this..."

Munny: "Deserve's got nothing to do with it."

In the novel there is an investment bank where one of the trading units gets requests from its clients to price their illiquid inventory. (This is an exercise that occurs in real life, because the clients have to mark to market, and for some assets there is no market. So they go out and get bids from a couple of banks, and then mark at the average of these two prices). This trader puts in incredibly low-ball prices. One bank prices a security at $92. He prices it at $50, leading to a mark to market price of $71. The trader knows that with such a low price, the client will be forced into liquidation mode. The trader positions his book for the forced sale that he helped precipitate, generating big profits from his scheme. This is fiction. But if we have learned one thing over the past couple of years, in the world of finance truth can be stranger than fiction.
~Rick Bookstaber

Where to begin? 1st I will say that I have a post coming forthwith about the Tarot card game in Blood Meridian as a microcosm or vignette for the entire novel.

Now though I wanted to further explore the notion of good and evil set forth in these various stories from above. The first two are obviously close in genre but I believe the third to be in the same strain of logic. All try to deal with fairness or merit or mitigations of circumstance, but all in all the three come back to the ultimate logic of games and the men that play them. In the Judge's opinion the world revolves around games with war being the makind's opus. He would revel in Munny's logic that even though Little Bill may be the more exemplary character it does not matter. Once he kills Ned, he enters a new game with Munny. The terrible violence that is the climax of Unforgiven can all be avoided. Munny has the blood money for killing the two wayward cowboys. He can return to his family and move to San Fransisco. However, as Holden lauds above, "A man falling dead in a duel is not thought thereby to be proven in error as to his views."

One could even bring in a fourth story, or, parable as it were, of the Pharisee and the Tax Collector. "The Pharisee stood and prayed to himself like this:‘God, I thank you, that I am not like the rest of men, extortioners, unrighteous, adulterers, or even like this tax collector. I fast twice a week. I give tithes of all that I get.’ But the tax collector, standing far away, wouldn’t even lift up his eyes to heaven, but beat his breast, saying, 'God, be merciful to me, a sinner!' I tell you, this man went down to his house justified rather than the other (former); for everyone who exalts himself will be humbled, but he who humbles himself will be exalted."

The parable means that even though the Indians in Blood Meridian and Little Bill in Unforgiven lead moral lives, that without besetting themselves humbled before God they suffer as well. In Blood Meridian the only God described is war. Quite a twisted way in which McCarthy uses the logic of Jesus in Judge Holden's ode to war.

Which brings us to the last passage. Should Bookstaber's hypothetical be taken with a dim view? Should the capital markets just be considered another game, one in which men put up bold stakes, though not as bold as a pound of flesh? Holden and Munny would hold that just because the client is in the right without a recourse there is little that he can do, except stop arguing and start mining for his pound of flesh. It seems as though the capitalist system follows along the logic of Munny and Holden up until a point, to quote Satjayit Das "we rip their f&cking faces off!" However, in the end the bankers are scolded, and settlements issued. A wizened person would state that there is still an temporal distortion though. The clients can be swindled and then have their monies returned but there is still a point in time between the swindle and the discovery that bankers can maximize and do. (e.g. Bonuses vintage 2006-2008)

At a party one evening I remarked to a friend "Ever get the feeling that the societal rules are arbitrarily effective pieces of figmentation? That is, it is the only idea of retribution or the fear thereof that deters you from doing whatever it is you feel you want to do. However, mitigating that fear is the idea that there is a temporal distortion and in that episode imagine what you can get away with until society catches up with you... that my friend is the basis of evil."

So as a society we have evolved from our anarchic roots. It is just that we have not yet perfected the ability to provide justice in the most timely of manner. There is one last point I would like to ponder. The last point I wanted to touch upon is how in a contract it is easy to assume that there are two parties to the contract. Much like the Judge points out in his duel example. However, in these times this is not so. There is always a third-party, i.e. the government, who has to enforce the contract or provide the means in which to rectify the obligations. This is important as it drives the distortion of justice inherent in society currently, as it is always reactive justice.

This just in from Vanity Fair.

A money manager I spoke to described his meeting late last year with Jane Mendillo, who in July 2008 became president and chief executive officer of Harvard Management Company. Knowing that Mendillo was trying to unload assets, he offered to buy back Harvard’s sizable stake in his private fund. As he recalls, the surreal dialogue went something like this:

He: “Hey, look, I’ll buy it back from you. I’ll buy my interest back.”

She: “Great.”

He: “Here, I think it’s worth—you know, today the [book] value is a dollar, so I’ll pay you 50 cents.”

She: “Then why would I sell it?”

He: “Well, why are you? I don’t know. You’re the one who wants to sell, not me. If you guys want to sell, I’m happy to rip your lungs out. If you are desperate, I’m a buyer.”

It doesn't matter who is correct, whether the assets are worth 1.00, 1.11, or 50 cents. When the margin call comes you must submit yourself to a gamble that subsumes correctness.

Liquidity, or not. The difference between market making and frequent trading

Liquidity is ephemeral. It is there until it isn't, a real chocolate teapot that disappears when it is most needed. I am not sure how much of this has reached main stream media (MSM) but in the trading world this story is huge and it deals with the current liquidity providers high frequency traders.

Let's think about logging into your E*Trade account, with a few clicks you can buy a lot or an odd lot of shares of your latest stock tip. In a few moments you have your confirmation and I wish you great success in your endeavor. This is how trading is done across the capital markets, no? Ummm... no. IPO's, bond trading to cite some examples is not as clean. The imaginary stock trade is facilitated by a market maker. You want to sell, she will buy. You want to buy, she will sell. At least this is how it worked in the old days. A quick aside, the reason there are market makers is that they take a spread on each transaction, the buy and sell offers are a penny to a few pennies apart, thus the market makers is incented to trade as often as possible but not take positions. They act as a wholesaler with an inventory of certain securities that they sell and buy to make a market. BTW, this is lucrative career.

Now though, 70% of the trades are facilitated by high frequency traders. (HFTs)
Now I don't want to beat on Goldman Sachs but they trade their own accounts (Principal) more than the next 6 firms combined. They act as suped-up Hoover running trades and being paid by the exchange to do so. One interesting fact dug out today involved much maligned CIT. The company was bailed out by its creditors, but during the period in which its future was up in the air the stock traded down below a dollar. Who cares, that is expected. Well, except that exchanges will not pay the liquidity rebate of .003 cents per share unless the stock is above a buck. Thus, as it trades around the dollar mark remember that it is not because of a fundamental value, instead it is following the fundamentals of high frequency trade economics.

So we have moved from a visible market mechanism, the bid spread amount to the exchange rebates for HFTs. While it also difficult to become a market maker it is near impossible to become a HFT. You need a space race-sized budget to build up your computer speeds, you need to secure space near the exchange as the trades are done in microseconds, in short you need to be RenTech or Goldman Sachs.

In summation, there are three main points buried in this post:
A) There is a conflict of interest at the exchanges as the exchanges allow these HFTs unprecedented access to the exchange that the lay retail and institutional investor cannot afford or have access to.
B) Is this the best way to run an exchange, through a hidden rebate to HFTs
C) If 70% of the trades are noise, or worse front run trades by the HFTs how much of the assets value is decided by the noise and how much by its inherent value surmised by the efficient markets hypothesis. (EMH)

Correlation in everything

PARKING rates are holding firm despite the economic downturn, according to Colliers International, a property company. European cities have some of the highest daily parking rates, with Amsterdam and London coming out on top. Tokyo is the most expensive place to leave your car outside Europe. Honolulu is second behind New York among America's cities. Drivers in London fork out the most for a monthly unreserved space. The cheapest parking in the survey is in India, where a spot in Chennai costs 96 cents a day. ~The Economist

Felix Salmon pointed this out in his blog links the other day and with a quick rebuke marked that the series relationship between daily parking rates and monthly parking rates was highly uncorrelated. Normally I would take his word at gospel but perhaps I should be more skeptical. (In general as opposed to explicitly when reading Felix's work.) So I quickly entered the data into a spreadsheet and looked at an x-y scatter plot. While it was true that the regression line did come out with a less than desirable r-squared figure of 59.97%, which in lay terms means that the line can explain almost 60% of the variance of the points from the "best-fit" linear regression line produced. So Felix is correct not much of a natural correlation, so much for those who love to extrapolate out series.

So let's extrapolate out the series to see what happens. Taking the daily rate and multiplying it by 30 days to see what happens. Obviously if you pay up front you should be expected to earn a discount. Also by purchasing in bulk and thus giving the merchant sticky expected cash flows, which the merchant can extrapolate to his peril, you should also receive a discount.

Now the series looks much more promising. Below is a graph of the monthly discount from paying up front versus paying the daily rate 30 times. You can see the discount's median is almost 64% and the average is about 57%. The series is also drawn from the above table so you can see that as the daily rate drops so does the discount, which is also expected because price levels matter. I am quite certain Felix wrote this in passing as he boarded his plane for Beijing but I think he may have written too quickly without a full analysis.