Malcolm Gladwell's article entitled Blowing Up (April, 2002) has a nice description of how Nassim Nicholas Taleb's hedge fund named Empirica works:
What Empirica has done is to invert the traditional psychology of investing. You and I, if we invest conventionally in the market, have a fairly large chance of making a small amount of money in a given day from dividends or interest or the general upward trend of the market. We have almost no chance of making a large amount of money in one day, and there is a very small, but real, possibility that if the market collapses we could blow up. We accept that distribution of risks because, for fundamental reasons, it feels right.
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At Empirica, by contrast, every day brings a small but real possibility that they'll make a huge amount of money in a day; no chance that they'll blow up; and a very large possibility that they'll lose a small amount of money. All those dollar, and fifty-cent, and nickel options that Empirica has accumulated, few of which will ever be used, soon begin to add up.
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At Empirica, then, there are no Wall Street Journals to be found. There is very little active trading, because the options that the fund owns are selected by computer. Most of those options will be useful only if the market does something dramatic, and, of course, on most days the market doesn't. So the job of Taleb and his team is to wait and to think. They analyze the company's trading policies, back-test various strategies, and construct ever-more sophisticated computer models of options pricing.
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Empirica has done nothing but lose money since last April. "We cannot blow up, we can only bleed to death," Taleb says, and bleeding to death, absorbing the pain of steady losses, is precisely what human beings are hardwired to avoid. "Say you've got a guy who is long on Russian bonds," Savery says. "He's making money every day. One day, lightning strikes and he loses five times what he made. Still, on three hundred and sixty-four out of three hundred and sixty-five days he was very happily making money. It's much harder to be the other guy, the guy losing money three hundred and sixty-four days out of three hundred and sixty-five, because you start questioning yourself. Am I ever going to make it back? Am I really right? What if it takes ten years? Will I even be sane ten years from now?" What the normal trader gets from his daily winnings is feedback, the pleasing illusion of progress. At Empirica, there is no feedback.
Read the full article here.
Great quote:
By promoting home ownership with hundreds of "affordable home" programs, government drove up the costs. The ultimate irony is home prices are now crashing, thereby becoming more affordable, yet the government wants to halt the slide.
Interestingly, some observers lament that corporations and some individuals are holding their assets in "cash" rather than spending and investing those balances, apparently believing that this money is being "held back" from the economy. What is preposterous about this is that the "cash" that companies and individuals are observed to be holding is primarily in the form of government securities and base money created over the past couple of years, which somebody has to hold at every point in time until those liabilities are retired. This is not money that is waiting to be spent. It is a stack of IOUs representing resources that have already been squandered, and now somebody has to hold these pieces of paper until they are retired.
In short, instead of directing savings toward investments in real, productive assets that we would observe as physical output, fixed capital, and equipment (and claims on those assets in the form of corporate stocks and bonds), our economy has been forced to choke down a massive issuance of government liabilities in order to bail out bad debt. For every dollar of debt that should have defaulted, we now have two dollars of debt outstanding (the original debt, and a newly issued government security). What appears to be "sideline cash" is simply the evidence of past spending. Again, the crucial consideration is how the government spent the funds in the first place. Rapidly mounting evidence suggests that the answer is "not very well."
