Thursday, October 8, 2009

Boyko, We’re All Screwed!

I admit it was with some trepidation that I opened Stephen A. Boyko’s book We’re All Screwed! How Toxic Regulation Will Crush the Free Market System (W&A Publishing, 2009). I was sure that I was going to be met with simplistic right-wing rant. Instead, I was treated to an intellectually imaginative argument on behalf of what the author conceives to be a practical method of financial governance. I am no expert on regulation. Moreover, I have to confess that I’m not even particularly interested in the subject, so I can’t pass judgment on his proposal. But, as a person who relishes challenges to commonly accepted modes of thinking, I gleaned a lot from this book.

Boyko’s major thesis is that “segmenting governance into separate areas that apply to predictable, probabilistic, and uncertain regimes provides enhanced information correlation from which to issue best-practice commands.” (p. 56) This sentence is a mouthful, but the main point is that a one-size-fits-all approach to governance is doomed to failure. Rather, he suggests a troika—the predictable (for instance, money market instruments, U.S. Treasury), probabilistic (S&P 100 being the best example), and uncertain (small-cap, negative cash flow)—each with its own mode of governance. This segmentation is not incompatible with having a single financial regulator.

Central to Boyko’s segmentation is the accepted distinction between risk and uncertainty. Risk is quantifiable and has foreseeable consequences, uncertainty is indeterminate and has unforeseeable consequences. But Boyko goes further and, within the context of his argument, defines change as the movement in either direction between risk and uncertainty. “When uncertainty becomes risk, that’s learning or innovation; you have greater control over your underlying economic environment. On the other hand, when risk becomes uncertainty, there is either confusion (too much information), or ambiguity (too little information). Should the uncertainty become unstable . . . you have chaos.” (p. 61)

This relationship of change between risk and uncertainty is complicated by the fact that change has changed. “In the Industrial Age, change was binary—yes or no. A linear queuing theory drove change, and this theory had a first-move advantage. In the Information Age . . . change is now governed by wave and complexity theories. And unlike the Industrial Age, where usage depreciates an asset’s value, in the Information Age usage appreciates the value of intellectual property.” (p. 62)

In advance of his thesis Boyko draws on familiar literature, but he offers a unique perspective akin to a Rubik’s cube. Unfortunately, without the aid of the “how to solve a Rubik’s cube in under a minute” videos, we have to come up with our own solution to the matrix of risk, uncertainty, and changing change. And perhaps we can even re-craft the problem to our own liking. Boyko set out to address the issue of financial governance. I think that in the process he’s given hints about ways to rethink trading, investing, and portfolio management.


  1. It is an illusion to accept that risk is quantifiable! When entities taking risk are too large for effective regulation and intent only on short-term profit, there is no magic mathematics that can predict the effect of sudden shocks that always invalidate simplistic probabalistic computer modeling! When computers start spitting out nonsense solutions like giant negative numbers multiplied by the square root of minus one, then it is obvious (too late) that risk has become uncertainty with a vengence!

  2. That is precisely why you need the bright line of +/- cash flow to differentiate risk from uncertainty. Negative cash flow, NINJA, mortgages represent uncertainty regardless of whether they were securitized. They could not be effectively hedged due to non-correlative information. They were the result of the false construct that gave property rights to renters. Uncertainty is different from rather than a higher form of risk. Res ipsa loquitur.