Oct

1

I really enjoyed reading The Big Short by Michael Lewis. The book was about Burry and Eisen and a couple other hedgies who identified the problems with the subprime CDO bonds and found the worst of them and bought insurance on them from Bear and AIG to short them. Its a classic and well told story of the hubris of Wall Street and the big banks, the incompetence of the rating agencies. Its a classic story of massive misunderstanding and deception. It amazing how so many can be deceived by the Emperor's clothes. Goldman was really able to fool the rating agencies by gaming their models and assumptions to get AAA ratings. It really exposes the dangers of using prior history to predict future risk and the assumptions you put into models. Volker said in a recent speech that the statistical curves used to analyze the market are rubbish because the market is human and prone to panic. He says not even the fat tails describe what happens in euphoria and panic. The great part of the book was about the mispricing on the risk and odds. Pricing insurance at 100:1 when the risk was less than 10:1, and later almost certain shows some big problems in relying on assumptions built into models. I've seen people become so attached to their models it blinds them. The funny question Eisen's guys always asked was, "How are you going to f**k us on this deal." They were always asking what are we missing? The scary part was they bought much of their insurance from Bear, who went down and couldn't pay. This was where you short and Armageddon hits. Who is left to pay?

My sense is that there is another bubble building now and its going to blow badly sometime in the future. My sense is that the markets are more of a game theory situation than a normal curve. The motivations and what others understand or don't seem critical even in shorter term trading. The trading info shows where they are putting their money on the block. Normal distributions are necessary to understand where others are heading, but to me there is more to the game.


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