Month: February 2009

Economics still isn’t a formula

Everybody is citing the article in Wired on the Gaussian copula function.  Apparently, everybody had been applying some clever maths to finance decisions so they thought they had a mathematically valid way of making accurate predictions while eliminating most variables.  It probably was mathematically valid.  But was it ever economically valid?

The Austrian economics folks at the Mises Institute are basically saying that it’s difficult to imagine an Austrian economist, a reader of Human Action: A Treatise on Economics, to fall for the idea that a simple formula can predict the future.  Boingboing, similarly, has suggested that the moral of the story is ‘STOP MATHS NOW!’  Which isn’t to say maths is bad – it’s just that it’s not really economics.

My take is that the Misians are right (again) and this is a failure in the understanding of economics, not a failure in maths or the creator of the formula.  But I don’t have to make any comments on this because ‘Andrew’ has already said all I want to say in his comment on Boingboing:

#7 posted by Andrew, February 24, 2009 1:19 AM

Economics is not formulas. Economics is not higher math. Economics is not experimental science. Economics is not even quantitative. Economics is logic applied to the choices that people, and business, make constantly. The logic of marginal value, opportunity cost, uncertainty, and all the rest is as good as it’s ever been — it’s universal as long as time and resources are finite. It’s when you start to say that the demand elasticity of natural gas times the velocity of money, minus the consumer price index, is correlated to the relative humidity in china with r^2=.83, that you’ve fucked up irrevocably.

What’s this got to do with management?  In management terms, applying a formula is never the basis of a capability.  Like another great ‘Andrew’ said in a comment to my last post, the banks appear to have been saying ‘yes’ to anybody who asked for money – and now they are saying ‘no’.  This itself is the simplest of all formulas – and it doesn’t in itself give you that all important capability of being able to differentiate between good and bad risk.  And if you use a formula long enough you’ll loose the capability itself (if you ever had it).

I’m becoming convinced that the financial system is completely broken.  One of the reasons that managers didn’t put the breaks on use of the formula is sighted in the Wired article:

In hindsight, ignoring those warnings looks foolhardy. But at the time, it was easy. Banks dismissed them, partly because the managers empowered to apply the brakes didn’t understand the arguments between various arms of the quant universe. Besides, they were making too much money to stop.

(See also comment here)

Note that they were ‘making too much money to stop’ and yet you might ask the intelligent questions raised here:

And one question:
I’d like for the knowledgeable people here to tell me what would have the banks done with all the money they had to lend if they wouldn’t have gone for the bad risk? Isn’t everybody so loaded with debt right now that there is very little good risk left? Was this crisis even avoidable?

These raise an interesting point – what do you do with ‘too much’ money?  How, or why can there even be ‘too much’ money?  If you are expected to make a certain return, to create a certain level of growth in any market conditions, then you need to spend or lend your spare money.

This is the obsession with growth that I think must end.  We even define a recession in terms of a lack in growth – why does there always need to be growth?  Also, if the government is fiddling with interest rates and indirectly providing cheap loans how do you as a business deal with sort of price eroding competition?  Your forced to make dumb / risky decisions I guess – but perhaps you also start getting the wrong signals making it hard to make the right decisions.

The other point it raise is the different between earning money and creating value.  The money that was risked on risky loans is now gone.  Never mind the details but that value has been whipped from the economy.  But the destruction of value coincided with the making of money.  Again, something is wrong here.  In this sense people were being paid for taking risks.  This shouldn’t ever be the case – people should be paid for either creating value or because the risks they take paid off.

But there is more than one agent here.  There are the employees of the banks and the banks themselves.  Of course, you have to pay employees for turning up – even if they are risking money and eventually driving your business into the ground.  So it’s not the financial folks themselves that are taking the risks.  It’s the organisation.  It’s the bank itself.  It’s the process, structure, culture – in short, all the capabilities that make the organisation what it is – that by its very design choose the wrong people, had the wrong controls, gave incentives for the wrong behavior.

And yet – it’s the Banks that are getting bailout money!  I can’t understand this.  People don’t appear to realise that the institutional structure is temporary.  The exact nature of who owns banks, who runs banks, the boundaries between banks, and the intermediation of different agents (existing or potential) is all we have when it comes to a financial industry.  The only way a solution can possibly exist for any financial crisis is for the institutional structure that is overlaid over value to change.  The only process that will cause universal (or at least, on average) improvement is to change this institutional and agent structure so that it works more effectively and so that more capable ownership and control exists.

Bailouts to banks will effectively allow the current owners of banks to continue to own the assets -despite- the fact that they have proved they can’t managed them effectively.  This doesn’t stop at direct ownership – it also include the investors.  If people have invested in banks that are not managing value correctly they have failed to invest wisely.  A bailout helps them retain ownership -despite- making bad investment decisions.

If investors are investing in the wrong things, and if owners or corporations are managing assets ineffectively, or if risk is not being managed by a corporations capabilities the investment needs to not provide a return, the assets need to be moved (naturally, through sales) to somebody who can manage them, and different capabilities need to be engineered or given resources.

But – what is the magic formula for deciding all of this restrucing?  Well there isn’t one – it just has to be allowed to happen doesn’t it?

PS.  I’m not an economists so I don’t really know what I’m talking about.

Getting closer to Michael Costa

Some time ago I was trying to form my view on Michael Costa.  I never quite finished that train of thought – but I was definitely leaning towards liking him a lot.  

With that in mind I’m attend the following talk next Wednesday:

Michael Costa – What makes good or bad government?
Date: Wednesday 4 March 2009
Time: 6:30 for 7:00pm
Venue: Pazzo, 583 Crown Street, Surry Hills

Details are from Catallaxy.

Let me know if you are attending and I’ll see you there!

Money for nothing, tough at the top

I only just found this article from December 2008’s  It’s by Michael Lewis (the Liar’s Poker guy).  It more or less supports my vague theory that this financial crisis thing is little more than a skimming off the top of value that never really existed.

Even my wife, who’s never claimed any knowledge nor sympathy for capitalism, basically said this morning that the job of banks was to decide the best place for money to go – and that they weren’t doing a good job of it.

This seems to me a good description of the problem. But if that is the problem – then giving banks money is not the solution.  Lewis too, through the story of Steve Eisman, is basically saying that Wall Street wasn’t doing its job:

“I put a sell rating on the thing because it was a piece of shit,” Eisman says.  “I didn’t know that you weren’t supposed to put a sell rating on companies. I thought there were three boxes – buy, hold, sell – and you could pick the one you thought you should.”

And again:

Eisman says in his defense, “I did subprime first. I lived with the worst first. These guys lied to infinity. What I learned from that experience was that Wall Street didn’t give a shit what it sold.”

via The End of Wall Street’s Boom –

Now I have full sympathy for everyday people who have somehow been effected by this ‘crisis’ through job loss or loss of retirement funds (in the case where they weren’t making silly decisions to risk everything to the whim of a margin call).  But I can’t understand government bailout of companies.  Surely, the assets of the company would still be able to be redistributed to others who know how to manage them better?  And if there are no assets, what exactly is the government investing in?

It appears that there’s a structural change in the economy which people who know more than I do about these things think is long overdue.  I think it may be as simple as some sort of dis-intermediation of capital management.  I’m not sure how these things work now, or ever worked, so I shouldn’t really speculate.

But I will speculate.  I think that the specialisation of the ‘banker’, or the ‘money guy’, or the ‘financial analyst’ might be broken.  It might be that just like the specialisation of ‘management’ which I’m so interested in, this type of specialisation in financial knowledge – or rather the elevation of the specialisation of financial knowledge which has effectively turned democracy into a technocracy – has collapsed.

I have a theory that whenever a single specialisation becomes the dominate or controlling specialisation it turns the coordination into a technocracy.  I might be using technocracy in the wrong sense but I’m using it to mean that a single specialisation (i.e. a single branch of technical knowledge) becomes dominate.

In this case, rather than financial knowledge acting as just one input into decision making, and as just one service available to individuals, financial knowledge became the single dominate knowledge used in decision making.  This in itself was a problem because it interfered with true and proper determination of ‘value’.  But it would also have the effect or corrupting the body of knowledge itself (perhaps not in the textbooks, but ‘in use’).

Eventually, the knowledge of finance not only supersedes all other knowledge, but the finance knowledge actually disappears as it is replaced with what is convenient or beneficial to those in finance.  This process could be a simple as people entering financial jobs even though they have no passion or knowledge of such things because that is where the money is (literally in this case, but it doesn’t have to be that way).

This is basically the theory that caused me to develop the outline of the MWT Model 9 years ago.  But I think it’s also helps explain the reason for the structural changes in the economy which will come – if not, unfortunately, there ultimate shape.

The question is, will the structural change fundamentally stop any one discipline being elevated to the top (i.e. solve the root cause of the problem) or will some other discipline simply be elevated to the top?

TRIZ as a pattern language for problem solving

After watching Merlin Mann talking about the idea of creativity patterns today, I started reading through volume 16 of Make magazine.  On page 57 there is a brief but interesting article about TRIZ.

TRIZ is an evolving set of patterns for problem solving which was first developed in 1946 by Russian Genrich Altshuller.  It doesn’t appear to be fully available on-line.  In fact, it doesn’t appear to be fully developed into a single definitive framework at all.  Nevertheless it appears to have some interesting things to say about problem solving.

From the Make magazine article:

…Altshuller observed that the same problem types appeared time and time again, and yielded to corresponding generic solutions…

This echos with what Merlin was saying about creativity patterns in his Macworld talk.  But how is this different to just knowledge?  It isn’t, I guess, but these sort of endeavors open up the scope of what we believe it is possible to have organised knowledge about. They also standardise how knowledge is organised.  Standardisation is important (in the sense that it allows efficient communication).

The essence of the TRIZ system appears to be utilising a number of patterns of interventions into a system in order to remove a constraint (or ‘Contradiction’) without compromising the system. To me this feels similar to the generative sequence approach of Christopher Alexander.

Alexander’s generative sequences unfold using a standard set of interventions into structure (which is system-like, I guess).  Also, when the intervention is made you effectively check for ‘compromise’ when you re-evaluate the degree of life / wholeness in the resulting structure before moving on.

This idea of removing ‘contradictions’ in TRIZ  also has echos of all that Ayn Rand ‘check your premises‘ talk.

Interestingly, I have always found the idea that contradictions don’t exist as very helpful in problem solving.  Basically, I see them as a signal to break something up into smaller and / or different parts.  I see disagreements between people as similar types of problems – and the breaking down of concepts into more elementary components usually means agreement can be found.

Of course, it doesn’t really matter if contradictions do or do not exist – the question is whether acting as-if they don’t exist is a useful problem solving tool.  And I think it is.

So, patterns can help problem solving.  And patterns are a ‘just‘ a way of organising knowledge.  And problem solving is about making system or structure interventions and then making sure you haven’t destroyed the integrity of the whole.

Management of knowledge work is a lot like problem solving.  So it’s likely to be pattern-based too.  MWT Collaboration Architectures are patterns…

Merlin Mann discovers Christopher Alexander, stops procrastinating, and fumbles a little

Merlin Mann stops talking about productivity and starts thinking about creativity. I’ve always had the nagging feeling that the GTD 43Folders clan were all really just procrastinating. He’s also discovered Christopher Alexander.

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