Wednesday, January 25, 2017

Balleisen, Fraud

Fraud is endemic to capitalism. But to what extent should commercial and financial transactions be regulated to minimize its damage to society? Should the government try to protect investors and consumers through antifraud regulation or should caveat emptor rule the day?

In Fraud: An American History from Barnum to Madoff (Princeton University Press, 2017) Edward J. Balleisen explores regulatory cycles in the United States and how they affected business culture and society at large. In the process, he recalls some of the country’s most notorious scams and scammers.

Balleisen recognizes the difficult balancing act required to get regulation “just right,” neither too heavy-handed nor too light-handed. Regulators must understand, for instance, “the trade-offs between facilitating innovation and curbing deceit.” In the end, however, he believes that “inventive governance can stay abreast of all the new twists on old games, shut down the worst frauds, fortify consumers and investors against imposition, and sustain, at reasonable cost, the social trust necessary for modern capitalism.”

Since we may well be shifting to a new cycle, characterized by a lighter government hand, Balleisen’s book is especially timely.

Sunday, January 22, 2017

Thorp, A Man for All Markets

Edward O. Thorp is a legend in both the gaming and the quant worlds. The author of Beat the Dealer and Beat the Market, he went from math professor and blackjack whiz to renowned hedge fund manager. In A Man for All Markets (Random House, 2017), he reflects on his life and the power of thinking differently—and deeply.

Thorp learned how to puzzle things out for himself as a largely self-taught child. He also devised methods for learning how to learn. For instance, when at the age of 12 he set out to master Morse Code, required to get his ham radio operator license, he invested almost three weeks’ income from delivering newspapers in a “tape machine” to practice transcribing code. The machine’s speed was adjustable. Young Thorp’s plan “was to understand every tape at a slow rate, then speed the tapes up slightly and master them again.” He measured his progress against that of World War II army trainees. He writes: “I drew a graph of the hours I spent versus my speed and found that using my method I learned four times as fast per hour spent as did the army trainees.” That Thorp was uncommonly bright might also have contributed just a tad to this carefully recorded outcome.

Fast forward to Thorp’s time at the blackjack table. He recalls playing at one casino where the rules were excellent: “players could insure, split any pair, and double down on any set of cards. Even so, the cards ran badly, I lost steadily, and after four hours I was behind $1,700 and discouraged. Of course, I knew that just as the house can lose in the short run even though it has the advantage in a game, so a card counter can fall behind and this can last for hours or, sometimes, even days. Persisting, I waited for the deck to become favorable just one more time.” Soon enough the deck produced a 5 percent advantage, so Thorp made the maximum bet of $300, all his remaining chips. Dealt a pair of 8s, he pulled out his wallet to bet another $300 on the split hands. And, getting a favorable second card on one of the 8s, he dropped another $300 on the hand. The dealer busted, so Thorp gained $900. The deck continued to be favorable, “calling for big bets,” and the next deck was good as well. In a few minutes he was ahead $255 and quit for the evening.

As Thorp reflects, “for the second time, the Ten-Count System had shown moderately heavy losses mixed with ‘lucky’ streaks of the most dazzling brilliance. I learned later that this was a characteristic of a random series of favorable bets. And I would see it again and again in real life in both the gambling and the investment worlds.”

Indeed, at Princeton Newport Partners, which restarted its statistical arbitrage operation in 1992, Thorp expected “the statistical behavior of a large number of favorable bets to deliver [their] profit.” By 2000 they were placing a million bets a year, at an average trade size of $54,000, or “one bet every six seconds when the market is open.”

A Man for All Markets is an inspiring memoir. Not surprisingly, Thorp, in his final chapter, writes: “Education has made all the difference for me. Mathematics taught me to reason logically and to understand numbers, tables, charts, and calculations as second nature. Physics, chemistry, astronomy, and biology revealed wonders of the world, and showed me how to build models and theories to describe and to predict. This paid off for me in both gambling and investing.” And, to come full circle, he notes: “Much of what I’ve learned came from schools and teachers. Even more valuable, I learned at an early age to teach myself. This paid off later because there weren’t any courses in how to beat blackjack, build a computer for roulette, or launch a market-neutral hedge fund.”

Wednesday, January 4, 2017

Clark, The Tao of Charlie Munger

David Clark, who has written eight books on Warren Buffett, has moved on to Charlie Munger. The Tao of Charlie Munger (Scribner) is, in the words of the subtitle, A Compilation of Quotes from Berkshire Hathaway’s Vice Chairman on Life, Business, and the Pursuit of Wealth. Clark provides commentary.

Clark divided the 138 quotations he selected for this book into four categories: Charlie’s thoughts on successful investing; Charlie on business, banking, and the economy; Charlie’s philosophy applied to business and investing; and Charlie’s advice on life, education, and the pursuit of happiness.

Here are a couple of my favorites:

“It’s been my experience in life, if you just keep thinking and reading, you don’t have to work.”

“Any year that passes in which you don’t destroy one of your best loved ideas is a wasted year.”

There’s already a substantial body of literature about the ideas of Charlie Munger. And, of course, we have Poor Charlie’s Almanack. Do we need yet another book? Probably not. But even when I’m reading a quotation for the umpteenth time—for instance, that his children think he’s “a book with a couple of legs sticking out”—I still smile. And, by the way, he really is a reader. “It’s said that Charlie reads up to six hundred pages a day—which includes three newspapers a day and a weekly diet of several books.”

If you want to up your own personal daily page count, you might consider adding this book to your list.