Books – Page 127 – artdiamondblog.com

Financial Crisis Is “A Coming-Out Party” for Taleb and Behavioral Economists

(p. A23) My sense is that this financial crisis is going to amount to a coming-out party for behavioral economists and others who are bringing sophisticated psychology to the realm of public policy. At least these folks have plausible explanations for why so many people could have been so gigantically wrong about the risks they were taking.

Nassim Nicholas Taleb has been deeply influenced by this stream of research. Taleb not only has an explanation for what’s happening, he saw it coming. His popular books “Fooled by Randomness” and “The Black Swan” were broadsides at the risk-management models used in the financial world and beyond.

In “The Black Swan,” Taleb wrote, “The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup.” Globalization, he noted, “creates interlocking fragility.” He warned that while the growth of giant banks gives the appearance of stability, in reality, it raises the risk of a systemic collapse — “when one fails, they all fail.”

Taleb believes that our brains evolved to suit a world much simpler than the one we now face. His writing is idiosyncratic, but he does touch on many of the perceptual biases that distort our thinking: our tendency to see data that confirm our prejudices more vividly than data that contradict them; our tendency to overvalue recent events when anticipating future possibilities; our tendency to spin concurring facts into a single causal narrative; our tendency to applaud our own supposed skill in circumstances when we’ve actually benefited from dumb luck.

And looking at the financial crisis, it is easy to see dozens of errors of perception. Traders misperceived the possibility of rare events. They got caught in social contagions and reinforced each other’s risk assessments. They failed to perceive how tightly linked global networks can transform small events into big disasters.

Taleb is characteristically vituperative about the quantitative risk models, which try to model something that defies modelization. He subscribes to what he calls the tragic vision of humankind, which “believes in the existence of inherent limitations and flaws in the way we think and act and requires an acknowledgement of this fact as a basis for any individual and collective action.” If recent events don’t underline this worldview, nothing will.

For the full commentary, see:
DAVID BROOKS. “The Behavioral Revolution.” The New York Times (Tues., October 28, 2008): A31.

The reference to Taleb’s Black Swan book is:
Taleb, Nassim Nicholas. The Black Swan: The Impact of the Highly Improbable. New York: Random House, 2007.

Another review of Taleb’s book is:
Diamond, Arthur M., Jr. “Review of: Taleb, Nassim Nicholas. The Black Swan.” Journal of Scientific Exploration 22, no. 3 (Fall 2008): 419-422.

The Future Is “a Whirlpool of Uncertainty”

(p. B1) Nearly all of us try forecasting the market as if each of the past returns of every year in history had been written on a separate slip of paper and tossed into a hat. Before we reach into the hat, we imagine which return we are most likely to pluck out. Because the long-term average annual gain is about 10%, we “anchor” on that number, then adjust it up or down a bit for our own bullishness or bearishness.

But the future isn’t a hat full of little shredded pieces of the past. It is, instead, a whirlpool of uncertainty populated by what the trader and philosopher Nassim Nicholas Taleb calls “black swans” — events that are hugely important, rare and unpredictable, and explicable only after the fact.

For the full commentary, see:

JASON ZWEIG. “THE INTELLIGENT INVESTOR; Why Market Forecasts Keep Missing the Mark.” Wall Street Journal (Mon., January 24, 2009): B1.

The reference for Taleb’s book, is:
Taleb, Nassim Nicholas. The Black Swan: The Impact of the Highly Improbable. New York: Random House, 2007.

A brief, idiosyncratic review of Taleb’s book, is:
Diamond, Arthur M., Jr. “Review of: Taleb, Nassim Nicholas. The Black Swan.” Journal of Scientific Exploration 22, no. 3 (Fall 2008): 419-422.

Christensen Book Re-Thinks Basic Assumptions About Health Care Innovation

Source of book image: http://images.barnesandnoble.com/images/34000000/34009038.jpg

Christensen’s new book hit the shelves in December 2008. His ideas on health care are promising, if the special interests don’t get in the way. (I have not yet read the new book, but have read earlier versions of his proposals on how disruptive innovations can improve health care.)

(p. R2) BUSINESS INSIGHT: Your coming book, “The Innovator’s Prescription,” takes a look at health care. How likely do you think it is we’ll see substantial innovation in the structure of the U.S. health-care system?
DR. CHRISTENSEN: Well, one great benefit of the current economic crisis is that it will create pressure to find a real solution to the health-care problem. Right now, emergencies exist at companies like General Motors, which has got to drive the cost of its health care down. Every city and town in America would be bankrupt if they kept their books the way private-sector companies keep their books — because of the obligation cities and towns have taken upon themselves to provide health care for their retirees.
And so we really are in an emergency where it’s likely that employers and health-care providers are open to completely rethinking some of the basic assumptions that made innovation seem impossible. What we’re hoping with this book is that we can just bring a way to frame the problem that can help people reach consensus around a course of action that otherwise, at another time, would have seemed quite counterintuitive.

For the full interview, see:
Martha E. Mangelsdorf, interviewer. “Executive Briefing; How Hard Times Can Drive Innovation.” Wall Street Journal (Mon., DECEMBER 15, 2008): R2.
(Note: ellipses added.)

“A Splendid Birthday Present” for Charles Darwin

Source of the book image: http://images.barnesandnoble.com/images/34510000/34519930.jpg

(p. A13) . . ., on Feb. 12, biologists the world over will celebrate Charles Darwin’s 200th birthday. Throughout the year, at festivals galore marking his bicentennial, “On the Origin of Species,” a mere 150 years old, will be hailed as one of the greatest works in the history of the sciences.
. . .
Mr. Coyne begins with a succinct account of what is at stake. “Life on earth evolved gradually beginning with one primitive species — perhaps a self-replicating molecule — that lived more than 3.5 billion years ago; it then branched out over time, throwing off many and diverse species; and the mechanism for most (but not all) of evolutionary change is natural selection.”
Darwinism is thus a claim with several basic components, and the book is structured by carefully exhibiting the evidence for each. Making that structure explicit allows readers to recognize just where they are in the argument. As they follow Mr. Coyne’s parade of evidence — his discussions of the fossil record, of vestigial traits, of the ways in which living things constantly make novel use of the bits and pieces they have inherited, of the distribution of plants and animals — the components of Darwin’s thesis are sequentially supported. We have a list of things to be shown, they are shown and the truth of evolution is established.
. . .
Yet will any defense of Darwin, however painstaking and lucid, succeed in substantially modifying the public-opinion survey results? Mr. Coyne has seen the opposition first-hand, recounting his experience of talking to a group of businessmen about evolution and eliciting the reaction: “Very convincing — but I don’t believe it.” This sort of skepticism is often rooted in a sense that Darwinism somehow discredits morality — a perception that Mr. Coyne argues against, cogently, in a brief final chapter. But he does not seem to appreciate the depth of popular hostility toward Darwin.
. . .
Whether or not he succeeds in bringing Americans en masse to learn to love evolution, he has offered Darwin a splendid birthday present.

For the full review, see:
PHILIP KITCHER. “Bookshelf; Following the Evidence.” Wall Street Journal (Thurs., JANUARY 29, 2009): A13.
(Note: ellipses added.)

The reviewed book is:
Coyne, Jerry A. Why Evolution Is True. New York: Viking, 2009.

A classic paper on whether the speed of a scientist’s acceptance of evolution was related to the scientist’s age, is:
David L. Hull, Peter D. Tessner and Arthur M. Diamond. “Planck’s Principle: Do Younger Scientists Accept New Scientific Ideas with Greater Alacrity than Older Scientists?” Science 202 (November 17, 1978): 717-723.

Leeuwenhoek’s Great Discovery Was at First Rejected by the “Experts”

In the passage quoted below, Hager discusses the reception that Leeuwenhoeck received to his first report of the “animalcules” seen under his microscope:

(p. 42) He hired a local artist to draw what he saw and sent his findings to the greatest scientific body of the day, the Royal Society of London.

(p. 43) Van Leeuwenhoek’s raising of the curtain on a new world was greeted with what might kindly be called a degree of skepticism. Three centuries later a twentieth-century wit wrote a lampoon of what the Royal Society’s secretary might well have responded:

Dear Mr. Anthony van Leeuwenhoek,
Your letter of October 10th has been received here with amusement. Your account of myriad “little animals” seen swimming in rainwater, with the aid of your so-called “microscope,” caused the members of the society considerable merriment when read at our most recent meeting. Your novel descriptions of the sundry anatomies and occupations of these invisible creatures led one member to imagine that your “rainwater” might have contained an ample portion of distilled spirits—imbibed by the investigator. Another member raised a glass of clear water and exclaimed, “Behold, the Africk of Leeuwenhoek.” For myself, I withhold judgement as to the sobriety of your observations and the veracity of your instrument. However, a vote having been taken among the members—accompanied, I regret to inform you, by considerable giggling—it has been decided not to publish your communication in the Proceedings of this esteemed society. However, all here wish your “little animals” health, prodigality and good husbandry by their ingenious “discoverer.”

The satire was not far from the truth. Although very interested in the Dutchman’s discoveries, so many English scientists were doubtful about his reports that van Leeuwenhoek had to enlist an English vicar and several jurists to attest to his findings. Then Hooke himself confirmed them. All doubt was dispelled.

Source:
Hager, Thomas. The Demon under the Microscope: From Battlefield Hospitals to Nazi Labs, One Doctor’s Heroic Search for the World’s First Miracle Drug. New York: Three Rivers Press, 2007.

A Toast to Schumpeter on His Birthday (February 8, 1883)

Source: scan (and crop) of the cover of the May 23, 1983 issue of Forbes .

In the May 23, 1983 issue of Forbes there appeared a now-famous essay by the late and great management guru Peter Drucker in which he pointed out that 1983 was the centennial of the birth of both John Maynard Keynes and Joseph A. Schumpeter. He noted that in the decades since the great economists’ passing, the academic and policy worlds worshiped at the feet of Keynes, and all but ignored Schumpeter (hence the many candles in front of the Keynes portrait on the cover, and the single, small candle in front of the Schumpeter portrait).

But Drucker argued that the world had gotten it wrong. Schumpeter was more important because he had understood a crucial truth: the process of creative destruction is indeed the essential fact about capitalism.

The reference for the original Drucker essay is:
Drucker, Peter F. “Modern Prophets: Schumpeter or Keynes?” Forbes, May 23, 1983, 124-28.

The reference to the reprint of the Drucker essay is:
Drucker, Peter F. “Modern Prophets: Schumpeter or Keynes?” In The Frontiers of Management New York: Penguin Putnam, Inc., 1999, 104-15.

A typo-laden version of the essay has been posted on the web at:
http://www.peterdrucker.at/en/texts/proph_01.html

(Note: I thank Aaron Brown for alerting me to the neat cover that appears at the top of this entry).

“Atlas Shrugged is a Celebration of the Entrepreneur”

“The art for a 1999 postage stamp.” Source of image: online version of the WSJ article quoted and cited below.

(p. W11) Many of us who know Rand’s work have noticed that with each passing week, and with each successive bailout plan and economic-stimulus scheme out of Washington, our current politicians are committing the very acts of economic lunacy that “Atlas Shrugged” parodied in 1957, when this 1,000-page novel was first published and became an instant hit.
Rand, who had come to America from Soviet Russia with striking insights into totalitarianism and the destructiveness of socialism, was already a celebrity. The left, naturally, hated her. But as recently as 1991, a survey by the Library of Congress and the Book of the Month Club found that readers rated “Atlas” as the second-most influential book in their lives, behind only the Bible.
For the uninitiated, the moral of the story is simply this: Politicians invariably respond to crises — that in most cases they themselves created — by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs . . . and the downward spiral repeats itself until the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.
. . .
Ultimately, “Atlas Shrugged” is a celebration of the entrepreneur, the risk taker and the cultivator of wealth through human intellect. Critics dismissed the novel as simple-minded, and even some of Rand’s political admirers complained that she lacked compassion. Yet one pertinent warning resounds throughout the book: When profits and wealth and creativity are denigrated in society, they start to disappear — leaving everyone the poorer.

For the full commentary, see:
STEPHEN MOORE. “DE GUSTIBUS; ‘Atlas Shrugged’: From Fiction to Fact in 52 Years.” Wall Street Journal (Fri., JANUARY 9, 2009): W11.
(Note: ellipses added.)

A Salute to the Sudanese Medicine Men

One might expect that the Sudanese medicine men mentioned below, might have undermined the British physicians, as potential competition. So either there is more to the story than is sketched below, or else these Sudanese medicine men in 1939 placed the mission of saving lives, above their own narrow short-run self-interest. If it was the later, then they deserve our belated salute.

(p. 236) Meningitis was a vicious disease. The death rate had always been high, and nothing they did had much effect. The British physicians concentrated on nursing the sick and trying to limit the spread of the disease. The only thing different this year came in the form of three small sample bottles of sulfa that had been sent to their clinic for the treatment of strep diseases and pneumonia. Strep diseases were not the problem of the moment in Wau. This meningitis was caused not by strep but by the more common cause, a related germ called meningococcus. Still, they had the new medicine, they had nothing else, and they had nothing to lose. Someone decided to try it on a meningitis patient.
. . .
(p. 237) . . . There were twenty-one patients in the first group. The doctors hoped to save at least a few of them.
A few days later, all but one were still alive. The physicians immediately wired for more sulfa. Once it arrived, one of the British doctors stayed at the hospital while the other two went village to village, administering sulfa to every meningitis patient they could find. They asked the help of local “medicine men,” as they called them, tribal healers whose dispensation was needed before the natives would accept treatment. The Sudanese healers knew how deadly the disease was. They told their people that the physicians had “magic in a bottle.” They told them to take the shots. The physicians traveled day and night, injecting patients in grass huts, under trees, and along roadsides, The results, they wrote, were “spectacular.” Within a few weeks, they treated more than four hundred patients. They saved more than 90 percent of them. They knocked out the epidemic before it could get started.

Capitalism’s Defenseless Fortress

Photograph by Art Diamond.

(p. 143) . . . capitalism creates a critical frame of mind which, after having destroyed the moral authority of so many other institutions, in the end turns against its own; the bourgeois finds to his amazement that the rationalist attitude does not stop at the credentials of kings and popes but goes on to attack private property and the whole scheme of bourgeois values.

The bourgeois fortress thus becomes politically defenseless. Defenseless fortresses invite aggression especially if there is rich booty in them. Aggressors will work themselves up into a state of rationalizing hostility—aggressors always do.

Source:
Schumpeter, Joseph A. Capitalism, Socialism and Democracy. 3rd ed. New York: Harper and Row, 1950.

Photograph by Art Diamond.

Uncertainty About Government Actions Slows Recovery

In the commentary quoted below, Tyler Cowen makes the important point that recovery from the current economic crisis is being slowed by uncertainty about what the government will do next. While the uncertainty lasts, consumers will consume less, and investors will invest less.
Amity Shlaes has made a similar point about the Great Depression. Uncertainty about what policies FDR would try next, kept investors from risking their money in new entrepreneurial ventures.

(p. 5) The financial crisis is a result of many bad decisions, but one of them hasn’t received enough attention: the 1998 bailout of the Long-Term Capital Management hedge fund. If regulators had been less concerned with protecting the fund’s creditors, our current problems might not be quite so bad.
. . .
. . . Today, . . . , that ad hoc intervention by the government no longer looks so wise. With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed — as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.
. . .
While there are some advantages to leaving discretion in regulators’ hands, this hasn’t worked out very well. It has become increasingly apparent that the market doesn’t know what to expect and that many financial institutions are sitting on the sidelines, waiting to see what regulators will do next. Regulatory uncertainty is stifling the ability of financial markets to engineer at least a partial recovery.

For the full commentary, see:
TYLER COWEN. “Economic View; Bailout of Long-Term Capital: A Bad Precedent?” The New York Times, SundayBusiness Section (Sun., December 26, 2008): 5.
(Note: ellipses added.)

For the Amity Shlaes book mentioned above, see:
Shlaes, Amity. The Forgotten Man: A New History of the Great Depression. New York: HarperCollins, 2007.