Black Swan Reveries

As a change of pace – away from my normal interest in literature and biography -- I read Nassim Taleb’s The Black Swan; The Impact of the Highly Improbable. He basically argues that experience and therefore planning counts for little. We are all governed by extraordinary effects of unanticipated extraordinary events and not by planning the minutia from the observed experience of the past. Essentially, our planning tools, the normal statistical methods we use are only effective in “Mediocristan" a world in which extremes are limited, such as the normal height of human beings, and therefore a random selection of that particular universe is anticipatable and measurable. He contrasts Mediocristan with "Extremistan" the world in which chaotic extremes reign and therefore a random sampling will not be representative. Hence, it is fruitless to plan for such extremes. So much for free will.

We are left with a world we can plan for “inside the box” but the true impact to that world occurs outside the box.

It’s sort of an in your face, edgy presentation by Taleb, very cynical in some respects. I empathize with the latter because of years of corporate planning. With the development of, first, VisiCalc, then Lotus 123, and now Excel, this kind of planning has been taken to such an extreme that the process itself probably keeps half of corporate America employed. It always amused me; I used to call it the battle of the spreadsheets – central corporate vs. the operating companies.

Part of that “planning” involves associating or connecting past events and “making sense” out of them. He calls that “naïve empiricism,” a “natural tendency to look for instances that confirm our story or our vision of the world….Alas, with tools, and fools, anything can be easy to find. You take past instances that corroborate your theories and treat them as evidence.” Even more profound is his observation: “We humans are the victims of an asymmetry in the perception of random events. We attribute our successes to our skills, and our failures to external events outside our control, namely to randomness. We feel responsible for the good stuff, but not for the bad. This causes us to think that we are better than others at whatever we do for a living.” Decades of corporate life leave me saying Amen to that.

But, isn’t the existence of the worlds of Mediocristan vs. Extremistan self-evident? Obviously, we can only think within the box when dealing with processes such as sales forecasting, budgeting, etc., basing them on the past statistics from Mediocristan. And a “black swan event” is going to have a profound impact on the world of Mediocristan. We mere humans do not have much control over an asteroid hitting our planet. Taleb’s problem with the foregoing is that we think we do.

Besides being a mathematician and philosopher, Taleb is a hedge fund manager. I was therefore interested in how he translates his philosophy to investment. Essentially, he takes the position that 85% of one’s portfolio should be allocated to “risk free investments,” specifically US Treasury Bills and the remaining 15% into very high risk investments that could have an exponential payoff in a Black Swan event from the world of Extremistan. So after a very convincing and sometimes disturbing philosophical argument the author seems to fall victim to the very blindness he decries. Are T-Bills “risk free,” especially as the US seems to be on a course to guarantee every debt and every major corporate shortfall, not to mention the twin time bombs of Social Security and Medicare/Medicaid as the baby boomers retire and unemployment rises? Now there is a Black Swan.

Fuel Efficient Cars Threaten Our Roads?

The Associated Press reports: “Oregon looks at taxing mileage instead of gasoline.”

Oregon is among a growing number of states exploring ways to tax drivers based on the number of miles they drive instead of how much gas they use, even going so far as to install GPS monitoring devices in 300 vehicles. The idea first emerged nearly 10 years ago as Oregon lawmakers worried that fuel-efficient cars such as gas-electric hybrids could pose a threat to road upkeep, which is paid for largely with gasoline taxes.

Not only are other states considering the same but Congress is as well!

Is this the apex of political stupidity / absurdity? Fuel-efficient cars pose a threat to road upkeep? Why not just mandate that the nation’s highways can only be used by SUVs? Here we are with an ideal opportunity – now that many have “adjusted” to $4.00 gasoline – to implement a federal fuel tax that would:

* support our decaying infrastructure and mass transit
* hasten the conversion to more fuel-efficient vehicles
* reduce our dependence on foreign oil from rogue nations
* promote the development of our nascent alternative energy industry, all domestic jobs

Instead, our backboneless political representatives seek what they think is the path of least resistance, one that has the resonance of big brother watching. The recent decline in oil prices is an opportunity to establish a nationwide gas tax to finally achieve important national objectives, ones that we've postponed for decades because of political expediency.

Another Ponzi Scheme

Tom Friedman made this observation but here’s some more documentation from the New York Times: http://www.nytimes.com/2008/12/18/business/18pay.html?em

While Bernie Madoff was “making off” with his illegal Ponzi scheme, ignored by the SEC in spite of sufficient smoking guns everywhere, Wall Street, the banking industry, and mortgage brokers, went blithely along with it’s own “legal” Ponzi scheme:
* Borrowing cheap money courtesy of the Fed
* Lending it out with exotic mortgage deals, including nothing down zero interest rate loans, the interest being added to the principal, to borrowers of little ability to pay back the loans, except if real estate values pyramid to infinity
* Packaging these subprime mortgages into CMOs to be sold to gullible investors throughout the world – emphasizing their safety because of “diversification” and AAA debt ratings conferred by rating agencies, based on chimerical insurance contracts issued by under capitalized firms.

Everyone in the Wall Street food chain got rich. As the Times article pointed out, in 2008 “Merrill handed out $5 billion to $6 billion in bonuses that year. A 20-something analyst with a base salary of $130,000 collected a bonus of $250,000. And a 30-something trader with a $180,000 salary got $5 million.” The head mortgage trader for Merrill, Dow Kim, had a salary of $350,000 but with his bonus he “earned” $35 million.

But these riches were based on income that really did not exist, the profits that we, as taxpayers are now trying to restore to our financial system via the bonanza bailout program. Meanwhile, Bernie Madoff is allowed to stay out of jail, putting up “his” Manhattan townhouse as bail, bought with funds of his clients, and Wall Street wiz kids walk around with what is really taxpayer money.

“As a result of the extraordinary growth at Merrill during my tenure as C.E.O., the board saw fit to increase my compensation each year.” — E. Stanley O’Neal, the former chief executive of Merrill Lynch, March 2008

On the Mark

Here are two must read entries recently posted by a fellow blogger, someone I’ve mentioned before. As Mark states in his mission statement: “Raise $7M from readers to launch a real mutual fund. By providing a transparent platform for a virtual growth mutual fund, I'll create a mechanism by which readers can view my thought process & results in creating a 3-year return. I'll invest in 30-50 positions with secular growth trends with economic commentary thrown in.” He’s been doing this for more than a year now but the recent economic turmoil has delayed the launch. In the meantime, his readers have benefited from his interesting commentary and frequently prescient predictions.

The posts below were written before yesterday’s Federal Reserve announcement of historic interest cuts to near zero and its pledge to buy stressed securities and perhaps even long-term treasuries. The question is whether this will indeed lead to borrowing and spending, especially if unemployment rates continue to ramp up and if business confidence does not improve. If successful, we then have to deal with the inflationary implications of money creation and a deficit in the untold $ trillions. (Is borrowing good? Isn’t that one of the reasons we got into this mess in the first place?)

In spite of FDR’s attempt to work our way out of the Depression with the New Deal, it finally took the enormous deficit spending of WWII and of course the employment of millions by the military and by the industries needed to support the war effort, thereby ending the worst economic downturn in our history. It also required people to rally, sacrificing, working towards a common goal.

In other words, it takes more than spending. Perhaps that is another distinction between today’s economic crisis and what we faced during the Depression. Can President-elect Obama successfully make our decaying infrastructure and need for energy independence our “war?” Will we pull together or pull apart?

http://www.fundmymutualfund.com/2008/12/13-outlier-2009-predictions.html
http://www.fundmymutualfund.com/2008/12/recovery.html

Madoff Bailout?

Why not? Every other deserving group gets one. Too big to fail! And, according to the WSJ, maybe through the Securities Investor Protection Corporation (SIPC) there may be a back door in covering some of the losses, although the SIPC only has $1.5 billion left in its coffers and there will have to be congressional action to increase the kitty.

When the tide goes out the muck materializes. For years Madoff reported steady returns from the firm’s “split-strike” conversion strategy, one of balancing puts and calls around a basket of large cap stocks and, presto, “steady” returns of some 7-9% no matter what the market does. Hint: when it's too good to be true....

Midas Madoff sucked his friends from the Palm Beach Country Club and Fund of Funds from around the world into the scheme (but, unfortunately many charitable and endowment funds as well). As one skeptical research firm, Aksia, reported to its clients concerning Madoff Securities, “We concluded that Friehling & Horowitz (Madoff’s audit firm) had three employees, of which one was 78 years old and living in Florida, one was a secretary, and one was an active 47 year old accountant (and the office in Rockland County, NY was only 13ft x 18ft large). This operation appeared small given the scale and scope of Madoff’s activities.” The entire audit trail consisted of paper transaction confirmations, which Madoff, himself, closely controlled. It finally took a market downturn of the magnitude of this past year, with redemption requests from Madoff’s clients, to finally expose the Ponzi scheme. The SEC couldn’t see this?

According to the Palm Beach Post, “investors needed at least $1 million to approach Madoff [and] being a member of the [Palm Beach Country] Club also helped. But even with those prerequisites there was little guarantee that Madoff would take the client.” Sort of the same deferential respect as demanded by the Soup Nazi in the Seinfield series.

The incident is yet another regulatory failure and another corrupt Joker in our economic house of cards.
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Copyright in the Internet Era

It is remarkable to witness the revolutionary changes in information dissemination, just during my working lifetime as a publisher, from the Gutenberg era to the Internet era over the course of only a few decades. I remember attending a conference at the New York Public Library in 1965 about the urgent need to use permanent durable, acid-free paper in all new publications. The NYPL’s collection was rapidly deteriorating, particularly those books and periodicals that were printed on groundwood pulp paper, the same as used in newspapers, and the library was beginning to spend as much on preservation as it was on acquisitions. Microfilm and microfiche (particularly “ultrafiche”) as well as mainframe computers, were being cited as possible solutions to preserving information. At the same time photocopying was becoming ubiquitous and libraries looked upon that as a possible method of disseminating information through library systems.

Today’s ambitious projects – basically Google’s objective to digitize just about everything (more than 7 million books scanned thus far) – makes the related copyright issues I was concerned with at the time, particularly The Williams and Wilkins Supreme Court decision (http://en.wikipedia.org/wiki/Williams_&_Wilkins_Co._v._United_States) look like a trivial warm-up act. I wrote an essay for a special 1974 issue of Confrontation – The Great Copyright Debate on that case (below). Focused on the then relatively “new” technology of photocopying, it seems antiquated, but the fundamental issues of fair use and the extent to which the rights of individuals or corporate authors, the creators of the information, can be usurped by the informational needs of the majority are even more alive in today’s Internet world. One only needs to check out Google’s ambitious project to understand the far-reaching impact the digital world is having on how we access information as well as who “owns” the information. http://googleblog.blogspot.com/2008/10/new-chapter-for-google-book-search.html.


Copyright
A Publisher's Viewpoint
By Robert Hagelstein

Nothing stirs the emotions of the educational and publishing communities more today then the copyright issue. For decades a tacit agreement between librarians and publishers (the "Gentlemen's Agreement" of 1939) had successfully governed photocopying by libraries of copyrighted materials. But that agreement was established before the advent of widespread use of relatively inexpensive electrostatic copying equipment and audio-visual duplicating equipment. It also preceded exponential information growth, increasingly expensive research materials, and higher education for the masses.

These factors have resulted in the large-scale copying of copyrighted audio visual and printed works by libraries, with the approval of the courts to the dismay and general disapproval of publishers and authors. Congress will ultimately decide whether such copying will continue.

On February 16, 1972, the United States Court of Claims found that the federal government was liable for infringement of copyrights held by Williams and Wilkins, a medical publisher. For years the National Library of Medicine had systematically copied, upon the request of researchers connected with those institutions, parts of periodicals (in some cases, complete articles) published by Williams and Wilkins.

On November 27, 1973, the Court of Claims reversed its historic opinion. The Williams and Wilkins Company appealed the reversal to the Supreme Court. Recently, the Supreme Court decided to review the case.

The Supreme Court's decision will undoubtedly influence the copyright revision bill, which for years has been under consideration by Congress. As the Court of Claims stated in its reversal decision, "the truth is that this is now preeminently a problem for Congress: to decide the extent photocopying should be allowed, the questions of a compulsory license and the payments (if any) to the copyright owners, the system for collecting those payments (lump-sum, clearinghouse, etc.), the special status (if any) of scientific and educational needs."

The issue has divided publishers and librarians, creating an adversary position where traditionally there has been one of cooperation. Publishers feel that the Williams and Wilkins reversal demands that they oppose almost any kind of library photocopying, while librarians are reportedly considering the decision as a green light to proceed with wholesale copying.

Robert Wedgeworth, Executive Director of the American Library Association, referred in the May 1974 issue of American Libraries to the Williams and Wilkins reversal as one "of our most impressive triumphs of the century." A letter from a librarian to Library Journal (February 15, 1973) states that "publishers and librarians are in adversary positions ... No amount of discussion will bridge that gap ... If you think you are on the winning side, why offer to compromise?" Publishers have been equally vocal and adamant concerning their position.

Though rights have been aired, there has been little discussion of the need to find a compromise solution-such as a rule for the use of copying equipment, and a means of compensating authors and publishers.

The rhetoric has also obscured recognition of the dissemination of knowledge as a common goal shared by all serious publishers and librarians. This recognition cannot be achieved without understanding of each group's respective roles, and the implications of what the lack of a compromise solution means.

The librarian's role is fairly clear. However, the inside workings of a library-acquisition, cataloging, and circulation of library materials-are complex. One can fully appreciate why--especially in a large academic library-the idea of keeping track of photocopies for the purpose of paying royalties is abhorrent.

Publishers of materials normally acquired by academic libraries must have highly specialized knowledge and formidable financial resources. Making information available in a structured manner so that it can be easily used is not a simple task. To ensure the participation of private industry in such an endeavor, the potential for a reasonable profit must be evident.

The burgeoning costs of research materials may prompt some to question why private industry is needed to publish information and to produce information systems. The Government Printing Office in Washington is capable of handling this responsibility, and libraries, as protectors and purveyors of information, can also be publishers.

The preservation of a truly free society, however, requires a diversity of information sources and opinions. Uncontrolled copying of information without proper compensation to authors and publishers would ultimately reduce the sources of information. Conceivably, more and more publishing would, out of necessity, be taken over by the federal government. Hence, the Government Printing Office, already one of the world's largest publishers, would be encouraged to support and control all kinds of research and writing. Government control of the dissemination of information is not in the best interest of librarians, publishers, authors, or of the public.

To prevent such a trend, a copyright law is needed which protects the rights of authors and publishers as well as librarians, providing for a method of compensation for photocopying copyrighted materials.

If the Court of Claims reversal were upheld and backed by Congress, not all publications and publishers would be equally affected. It is important to make a distinction here between trade publishing and information publishing. Trade publishing is the publication of books intended for a general market of readers, usually reached through bookstore distribution. The product of information publishing, however, is highly specialized and is destined for a relatively limited audience, especially libraries. Included in this category are scholarly and professional journals, information banks on microfilm or computer tape, scientific, technical, professional, and scholarly monographs, and proceedings and symposiums.

Since information materials are exclusively published for educational or research uses, commercial information publishers depend mostly on the education market for financial support. Trade publishers generally derive much of their income from other sources such as the sale of book club, paperback or movie rights. Therefore, any attempt to justify unlimited library photocopying as "fair use" because it is for "educational purposes only" would deprive the information publisher of its sole potential income source.

Although some forms of trade publications may be subjected to photocopying, it is unlikely, even if photocopying were condoned, that a novel or a general historical work would be systematically photocopied. Most libraries want to buy original editions for their collections, anticipating heavy use. Bound printed copies generally last longer than photocopies, bound or unbound. Because trade works are printed in much larger quantities for broader audiences, an original copy would probably be far less expensive than a photocopy. Furthermore, this kind of book is meant to be read in its entirety and does not lend itself to being photocopied in part only.

The converse is true of the information publication, which is especially structured so that it can be used in part. Because the audience for such a product is comparatively limited, unit costs and retail prices are higher; a photocopy, therefore, may indeed be far less expensive than an original copy.

Although the journal that you are reading is not an "information" publication per se, it can be grouped here because it is intended for a limited literary audience. Any kind of publication has certain fixed costs such as typesetting and overhead which are unaffected by the number of copies printed and sold. Confrontation may have cost $10 per page to typeset, yet you or your library may have paid only a few cents per page for it. If Confrontation were to become a casualty of uncontrolled photocopying with a resulting fifty percent circulation drop, that $10 per page would have to be absorbed by half the number of copies. Hence, the price would have to be raised. Photocopies would become less expensive in relationship to the escalating retail price. One can see why certain kinds of publications could become obsolete or prohibitively expensive.

An upholding of the Williams and Wilkins reversal by the Supreme Court and Congress could also indirectly encourage the growth of the cooperative library movement and photocopying of interlibrary loan material. The cooperative library system is a necessary means of dealing with information growth, and interlibrary loans by mail give wider access to little used materials. With photocopying equipment, however, one library could become a duplicator or a "publisher" of materials for another. Cooperative libraries could become publishing centers.

In 1949 ten universities formed a cooperative, which has grown to include seventy-eight institutions in a nationwide system called Center for Research Libraries. Two years ago the Center for Research Libraries received a $450,000 five-year grant from the Carnegie Corporation of New York to develop a national lending library of journals. If copying without restriction is allowed to persist, it is not impossible to imagine that someday the Center could be handling the publisher's traditional printing and distribution functions, purchasing the only copy of each journal issued by each publisher. Of course, the cost of each single copy to the Center would be the publisher's typesetting and overhead costs with a fair royalty for the author, plus a profit margin for the commercial publisher.

Another major cooperative was announced by the Research Libraries Group, which includes the New York Public Library, Columbia University, Yale University, and Harvard University. Joseph Rosenthal, who did the feasibility study on the group, although stating that he thought that publisher's sales loss would be "insignificant," did admit that publications that are "marginally economic will die out," and that those remaining would be more expensive should uncontrolled photocopying be allowed. The April 15, 1974 issue of Publishers Weekly states that "it has been widely reported that the consortium is taking the Court of Claims decision in that photocopying case as a go-ahead signal for wholesale copying."

Obviously, that is not to argue against cooperative library systems. They perform valuable services for smaller institutions, which would otherwise be deprived of access to library collections that only the largest universities can afford. However, by photocopying original materials instead of acquiring them, a library cooperative could compete with a private publisher, reprinting that publisher's materials. To discourage such activity and to compensate the creator of the information, publishers and authors should be in a position to grant reproduction rights and to collect royalties.

There is no simple solution to the problem; the endless discussion on copyright revision in Congress during these past few years attests to that fact. One criteria has frequently been applied to photocopying and possible copyright infringement: if photocopying saves the researcher the trouble of transcribing by hand, there should be no need for him to seek the copyright owner's permission (if such copying is not done for publication purposes). Copying should be prohibited, however, if it is done to enable the user to avoid purchasing the work. The former is an example of "fair use," the latter is not.

In 1968 the National Library of Medicine made 120,000 copies of journal articles, which amounted to about 1,200,000 pages. In 1970 the National Institute of Health made 86,000 copies from medical and scientific journals totaling 930,000 pages. This is what the United States Court of Claims had condoned.

Chief Judge Cowen stated in his dissenting opinion in the Williams and Wilkins reversal that "what we have before us is a case of wholesale, machine copying and distribution of copyrighted material by defendant's libraries on a scale so vast that it dwarfs the output of many small publishing companies… [the] defendant's photocopying ... meets none of the criteria for 'fair use…' While the library may look at the giving of a photocopy as a substitute for a loan, the user and would-be purchaser gets an exact copy of the original article which is a substitute for a purchased copy ... [they] are intended to be substitutes for, and serve the same purpose as the original articles; and serve to diminish plaintiffs potential market for the original articles ... "

A problem which has blocked a compromise solution --- one that has partially vindicated the libraries' position --- is the complex logistics of seeking permissions and processing payments for copying. It would be an overwhelming burden for each library to attempt to deal with each publisher's rights and permissions department. Also, keeping track of the exact number of copies and specific pages is a nearly impossible administrative task, especially when copying is done on a large scale.

It has been suggested that a central clearinghouse be established for processing permissions and payments for photocopying activities. This still could leave a complex bookkeeping function for libraries. Perhaps a more viable solution would be the establishment of an escalating pricing structure. There would be two prices for an order of the same book; the choice of price would be determined by the purchaser's option of photocopy rights. A lower price would be set for libraries and individuals who do not wish the right to photoduplicate the purchased book; a higher price would obtain for libraries which want the right to photocopy the work in whole or in part for their potential users. This latter price would be derived from a formula based on the number of potential users multiplied by the regular list price. (The number of potential users can be arrived at by using student enrollment if an academic library; library cardholders if a public library; or even the size of the library budget.) A cooperative library system would have to consider the multiple institutions it serves.

Representatives of the major library and publishing associations should be able to work out a fair and equitable formula. There is some precedent for such a system. One publisher has sold indexes to certain periodicals, basing the price on the number of periodicals held in the purchaser's collection, or on the library's periodicals budget.

Publishers and libraries must seek compromise solutions and make appropriate recommendations to Congress. If inflationary pressures continue to mount and orders for materials being copied remain static or begin to wane, the retail prices of these publications will undoubtedly rise. Those which are marginal will come under even greater pressure as prices rise. Even a slight loss of orders could condemn a host of journals, symposiums, and technical and reference works to extinction. As these information sources are smothered, pressures for government intercession would mount. Education would lose more than it gained.

The information explosion is indeed a reality. Modern techniques of storing and disseminating this information --- computers, microfilm, and photocopying equipment --- are necessary. Suitable copyright protection and appropriate licensing arrangements would ensure an adequate supply of information for a free society with growing information needs.

Anecdotal Headline Annotations

If I was handed a copy of today’s Wall Street Journal only a couple of years ago, I would have thought the headlines were a forecast of an ethical and economic Armageddon. How otherwise does one interpret the following captions, from just one day’s newspaper?

Governor Jailed in Alleged Crime Spree
In Illinois, Blagojevich Is Accused of Seeking to Sell Obama’s Senate Seat; Five-Year Corruption Probe

AIG Faces $10 Billion In Losses On Trades

The Stock Picker’s Defeat
The Fallen; Bill Miller. The declining fortunes of leading business figures. Second in a series.

Hard Times for Parmigiano Makers Have Italy Ponying Up the Cheddar
Government Tries a Bailout, ‘Just as There Was for Banks,’ to Help Struggling Producers

Fannie, Freddie Executives Knew of Risks

Restaurant Jobs, Like Tips, Shrink
Big US Employer Traditionally Has Served as a Fallback for Jobless, Immigrants

Panel to Criticize Handling of Bailout

Specifics of Stimulus Take Shape
Democratic Leaders Resist Growing Push for a Package Larger Than $500 Billion

Rangel’s Problems Dog Democrats

Pressure Mounts on Merkel for Bigger Fiscal Boost

Drop in Japan Tool Orders Exposes Global Spending Cutbacks

Developing Countries Feel Slump

Auto Bailout Moves Closer; Senate Battle Next Hurdle

China Urges Its Airlines to Curb Plane Orders

Pirate Attacks Keep Law Firm Buzzing

Sony to Cut 8,000 Jobs, Close Factories
Electronics Giant’s Turnaround Effort Undermined by Slumping Demand, Holiday Discounts

Resorts Feel Chill From Recession
Businesses and Consumers Curb Travel Plans; ‘AIG Effect’ Helps Create New Tone

GM Sees Sales Plunge in Brazil

NFL to Cut Jobs in Face of Recession

New York Times Holds Talks With Lenders

Safety Trumps Yield in Bill Sales
Investors Scoop Up 0% Short-Term Notes

Fed Weighs Selling Own Line Of Debt

Securities Firms Claw Back at Failed Bets

Some Commodities Investors Find Another Way to Lose Money

Reddy Ice Executives Gain On Prearranged Trading Plans

Tycoon’s Fall Is a Warning for Europe
Sanahuja Patriarch Loses Control of Metrovacesa; the Perils of Heavy Debt

Families Cut Back on Day Care As Costs – and Worries – Rise

These headlines are pretty much in order as they appear and although they are selective, there are no offsetting, positive ones. Perhaps that is merely a tendency towards yellow journalism to sell papers. But no wonder we all live in a state of anxiety without any real explanation as to how we have arrived at this point (although many commentators are adept to spinning plausible stories with the advantage of hindsight) and, certainly, without understanding how the forces behind these stories might play out in the future.