#finance

This is quintessential Levine: taking a concept that seems pretty straightforward at first blush (the worry that tech companies are becoming monopolies – duh, right?), and using very simple words and ideas to make you slowly realize that you haven’t thought this through, clearly.

I aspire to create content like this.

Bigness

Some banks are very big. Some people think this is bad. There is a traditional way to say “it is bad that this company is so big,” and that way uses the word “monopoly.” “This company is so big that it is a monopoly, which is bad.” It is useful to be able to say this, because the government has a lot of power to limit monopolies, to regulate their behavior and break them up.

It is not, however, particularly true of the big banks. A monopoly is a specific thing, a company that is so big that it dominates its market and can force out competitors and raise prices. The markets in which banks compete are, for the most part, extremely competitive.[5] If you want a mortgage, you pretty much pay the market rate for mortgages; JPMorgan Chase & Co. can’t charge you whatever it wants.

Still, people think it is bad that the banks are so big, for other reasons. They worry about risk concentration, about banks that are “too big to fail” taking too many risks and the taxpayers bearing those risks, about too much centralization of banking making it more fragile, about banks that are “too big to manage” doing dumb things and crashing the financial system. Those worries are controversial, but never mind that. Assume for now that they are correct. What should the government do about them?

One possibility is that the government’s antitrust regulators — at the Justice Department and the Federal Trade Commission — should go after the biggest banks for antitrust violations. The regulators could say “you are too big, you are a monopoly, we need to break you up into smaller pieces.” And then the banks would say “no,” and they would go to court, and the regulators could try to prove that the big banks are monopolists. And this would be hard to do, because they basically aren’t. It wouldn’t be impossible, though, I guess, because they are in lots of businesses and some of them are less competitive than others and there are probably some bad emails somewhere and so forth. The regulators’ odds of breaking up the big banks on antitrust grounds wouldn’t be zero. But they would be low.

The other possibility is that other government regulators should, in setting other regulations, take bigness into account and try to regulate and discourage it. Conveniently banking is a very regulated business, and there are regulators and prudential supervisors who can do all sorts of meddling in a bank’s business. So for instance if you worried that giant banks could be “too big to fail” and pose a systemic risk to the financial system, the banks’ capital regulators could put out a rule saying “very big banks need to have more capital to offset the higher risk they pose to the financial system.” That would both reduce the risk of big-bank failure and also create an incentive for banks to stay smaller or break themselves up. And in fact there is such a rule, for exactly those sorts of reasons; it is called the “G-SIB surcharge.”

Or if you worried that giant banks could be “too big to manage” and do dumb things, then the banks’ supervisors could tell a big bank that did a dumb thing “you can’t get any bigger until we’re satisfied you won’t do more dumb things.” They can just do that! The supervisors can just tell a bank not to get bigger, and it has to listen! They actually did it to Wells Fargo & Co., it’s kind of amazing. The theory wasn’t “Wells Fargo is a monopoly”; it was just “we don’t like what Wells Fargo has been up to so it can’t get any bigger.”

I should emphasize that banking is a very regulated business, and the government doesn’t have quite as many levers to pull with most other businesses. Still lots of businesses are regulated in lots of ways, and the same general principles apply:

If you think it is bad that a business is big, because it has a monopoly, sure, have the antitrust regulators go after it for antitrust violations. If you think it is bad that a business is big, for other reasons, have other regulators try to limit its bigness in ways that directly address those other reasons. In a pinch, if you think it is bad that a business is big, you could always have the other regulators try to limit its bigness in ways that don’t relate in any particularly logical way to those reasons. If you think that the bigness of social media companies is bad because they spread misinformation and undermine democracy, that is not really an antitrust problem,[6] and there is not exactly a Federal Truth Regulator that can promulgate misinformation rules. But maybe you can find some regulatory regime to shoehorn into that purpose. Maybe you’ve got a regulator in charge of, I don’t know, internet bandwidth or wireless spectrum or electricity usage or truth in advertising or whatever,[7] and you tell that regulator to turn up the heat on big social media companies. Not because you care about their electricity usage or whatever, but just to deter them from being big, because you think their bigness is bad. If all else fails, you can have the antitrust regulators try to break up the business because it is too big, even though it isn’t a monopoly. That may not work though. We talked yesterday about Facebook Inc. Lots of people think it is bad that Facebook is so big, but it is a little hard to put that in traditional monopoly terms. Is the problem of Facebook’s bigness that it can charge users monopolistically high prices for posting on Facebook? No; posting on Facebook is free. Is the problem that it can charge advertisers monopolistically high prices for advertising on Facebook? No. I don’t know if it can; I just know that I have never heard anyone make that complaint: If you don’t like Facebook, it’s not because you worry about advertisers overpaying.

Is the problem of Facebook’s bigness some other form of anticompetitive behavior that makes consumers (Facebook users) worse off? Sure, maybe; intuitively I suspect Instagram would be a nicer place if it was still independent than it is under Facebook’s ownership. But this stuff is a little hard to articulate, which is why the FTC failed to articulate it: It sued Facebook for antitrust violations, and this week a judge dismissed that lawsuit for failing to even say why Facebook might have a monopoly. “It is almost as if the agency expects the Court to simply nod to the conventional wisdom that Facebook is a monopolist,” wrote the judge. The conventional wisdom is that it is bad that Facebook is so big! But that does not make it a monopoly in the technical, legal sense of the term.

I suspect the main problem most people have with Facebook’s bigness is not about consumer choice but rather about Facebook’s political and social influence. You could imagine addressing that more directly than with antitrust law. And there have been suggestions for doing so — repealing Section 230, using election law to regulate Facebook, etc. — though I can’t say any of them strike me as great. Still it’s the right basic idea. Figure out what you don’t like about Facebook’s dominance and then regulate that, rather than just equating bigness with antitrust.

Anyway here’s this:

The Biden administration is developing an executive order directing agencies to strengthen oversight of industries that they perceive to be dominated by a small number of companies, a wide-ranging attempt to rein in big business power across the economy, according to people familiar with the plans.

The executive order, which President Biden could sign as soon as next week, would direct regulators of industries from airlines to agriculture to rethink their rule-making process to inject more competition and to give consumers, workers and suppliers more rights to challenge large producers.

The goal is to broaden the way policy makers approach business concentration in the U.S., going beyond conventional antitrust enforcement focused on blocking big mergers. For example, companies in industries controlled by a small number of big firms might face new rules for disclosing fees to consumers or for their relationships with suppliers, the people familiar with the effort said.

Seems right! Or not, I mean; I guess it depends on how you feel about big business generally. But if you feel bad about some big business specifically, addressing that in a specific way — rather than assuming that big business is exclusively an antitrust problem — seems like the way to go.

A small, stupid, simple idea (that’s been bouncing around my head): the price of a stock is a function of all the information about that particular stock (which should dictate its movement). If you believe the efficient market hypothesis (EMH) (which, granted, most people do not), then by extension this suggests that a stock’s price must also capture all the information in the world. Of course, most other information takes up an infinitely small part of that stock’s price (the less relevant, the smaller the part), but in some sense, the whole world is captured in every single stock.

Now, even if you don’t believe in the EMH, such a view might be instructive when considering the real world: essentially each stock is like a view of the infinite dimensional representation of the world. Under the EMH, a view (a projection) does not reduce the dimensions (i.e. no zero’d coordinates), whereas in real life, you’re most likely getting a projection into a pretty compact finite space.

What’s the end result of all this? It sort of feels like the word embedding stuff, but not really.11 The key difference there is that you assume words/stocks have some latent representation in some shared space, whereas here we assume all stocks derive from the same latent representation, but simply take on different views. The conjecture that comes out of this is that, essentially, there’s a very high dimensional vector that corresponds to the world, and each stock is simply one view into that world. The goal is then to learn this vector, as well as the projections associated with each stock. The question is then: is this a solvable problem?

More formally, let \(Z_t\) be this latent representation of the world (at time \(t\)). For simplicity, let’s assume that \(Z_t\) is finite-dimensional, \(\in \mathbb{R}^{n}\). Then, each stock \(X^{i}_{t}\) corresponds to a view of \(Z_{t}\), namely \(X^{i}_{t} = P^{i}(Z_{t})\), where \(P^{i}\) is some projection matrix (possibly varies with \(t\), but if it does, we probably need to assume that it is slowly-varying). We are given the \(\left\{ X^{i}_{t} \right\}_{i, t}\), and our goal is to estimate \(\left\{ Z_t \right\}_{t}\) and \(\left\{ P^{i} \right\}_{i}\).

The above formulation still subscribes to the linear world, whereas nowadays we want to express things as non-linear functions, allowing us to take full advantage of deep learning. However, it’s unclear to me whether or not it’s even possible to frame this in a way that’s conducive for deep learning. Of course, every time there’s talk of a latent representation, it feels like you should be able to solve it with neural networks.

Here’s something:

Okay sure whatever. Here’s my advice to Apple, though: If you are going to announce that Apple Wallet will now be a crypto exchange, you should buy Bitcoins first. Apple has close to $200 billion of cash and marketable securities; you gotta put at least tens of billions of dollars into Bitcoin. Then you put out a press release like “we’ve thought about it for a while and it’s the official position of Apple that Bitcoin is the good money now, everyone should use Bitcoin.” Then the price of Bitcoin like … really really really predictably doubles immediately? Then you could sell some of your holdings for a huge easy profit, though you might want to hang on to some of them for when the next giant company does this and it doubles again.

I should never be allowed near a public company; isn’t financial engineering so much more fun than, like, making phones?

[…]

Basically we are in a time, for Bitcoin, where mainstream acceptance is the obvious catalyst to drive the price higher:

Michael Novogratz, the founder of cryptocurrency investment firm Galaxy Digital, sees Bitcoin more than doubling to $100,000 by the end of the year, spurred higher as more companies allow customers to use the token to make purchases. …

“You’re going to see every company in America do the same thing,” Novogratz said Monday in a Bloomberg Television interview. Between corporations adding Bitcoin to treasury funds and the city of Miami also considering adding the cryptocurrency to its balance sheet, “It doesn’t have to be a lot. It’s the messaging that matters, you’re seeing the herd here, and it’s coming.”

If you are in a position to provide that mainstream acceptance—if you are a giant normal mainstream company whose acceptance of Bitcoin would be big news—then you are in a position to profit from it.

Then more recently:

We have talked a lot recently about the Reddit-fueled rally in meme stocks like GameStop Corp. One thing I have said about this rally is that it reflected Reddit traders’ correct understanding of a simple market dynamic, which is that if they all bought the same stock at once then it would go up. So they did. Institutional Bitcoin adoption, as we have also discussed, has a somewhat similar dynamic: Each time a big institution says “we like Bitcoin now,” Bitcoin goes up, because widespread mainstream institutional adoption is clearly bullish for Bitcoin at this point.

[…]

With the meme stocks the natural thing was to worry about the endgame for that process; you can’t have a stock price that is divorced from fundamental value forever. With Bitcoin, you … can? Like if the endgame for Bitcoin was “universal adoption by corporations and institutions as a digital store of value,” then that sounds like a good and permanent and somehow fundamental result?

It’s all so weird. Like, I think a first-order reasoning says that there’s this curious asymmetry right now in terms of Bitcoin, being outside the perimeter, and it sort of feels like there’s really only upward trajectory (since you can’t really have a company make the opposite statement, that they’re going to “promise never to touch Bitcoin”, which, I don’t even know if that would decrease the price). So really the only possible random events are those that push the price upwards, in which case, in the long run, it’s just going to go up. Of course that ignores the possibility of it dropping.

Finally, here’s the weird conundrum of Bitcoin:

What makes Bitcoin worth $47,000 is not that its code is somehow worth that amount; what makes it worth $47,000 is that people are willing to buy it for that price. And the reason that they’re willing to buy it for that price is—in part, in increasingly important part—that it fits in with the rest of the financial system, that the traditional systems of trust that make up the mainstream financial system have accepted and incorporated Bitcoin. (I mean, the asset-management bits of the financial system; you still can’t, like, spend Bitcoins.[5]) Nothing can really be a reliable store of value until you can custody it at BoNY Mellon. Now you can.

It really does feel like GME – one of those paradoxes that just keeps giving, until it doesn’t, but BTC sort of can hold on for much longer.

Relevant to my interests:

Insurers who sell directors’ and officers’ liability policies particularly hate it, since they often pay out these settlements: They thought they were insuring companies against the risk of accounting misstatements, but it turned out they were also insuring them against the risk of climate change and data breaches and everything else that can go wrong. There is a feeling that this can’t all be securities fraud, that securities fraud cases should be about securities fraud, and that climate change or sexual harassment should be litigated somewhere else.

The argument for how everything that affects stock prices is securities fraud is pretty straightforward:

The shareholders claim that they relied on Goldman’s statements—about managing conflicts, putting customers first, etc.—in buying Goldman’s stock; they also claim that every shareholder who bought Goldman stock between early 2007 and mid-2010 effectively relied on those statements, because those statements were incorporated into the price of Goldman’s stock. That is, if Goldman had instead said “we have lots of conflicts of interest but we don’t care, and we gouge our customers ruthlessly and illegally,” its stock would have been lower,[5] so anyone who bought during the class period was defrauded by paying too high a price. (This is called the “fraud-on-the-market” theory and comes from a 1988 Supreme Court case called Basic v. Levinson.)

How delightful. Basically, since stock prices reflect all information that’s available, this gives lawyers an avenue to form class-action lawsuits.

Matt summarises:

If it’s securities fraud to (1) have a code of ethics (or a policy on environmental, social and governance issues) and (2) also do something bad, then some companies will respond by not having codes of ethics. (Since that is easier and more reliable than not doing anything bad.) That is not an entirely good result! You want companies to promise to do good things! Ideally to do them too, but that is harder.

src: FT, article

Core Idea:

• fallibility: “in situations that have thinking participants, the participants’ view of the world is always partial and distorted”
• reflexivity: “these distorted views can influence the situation to which they relate because false views lead to inappropriate actions”

Reflexivity:

• thinking participants:
  • cognitive function: understanding the world (world -> mind)
  • manipulative function: affecting the world (mind -> world)
• knowledge = true statements
• “if there is interference from the manipulative function, the facts no longer serve as an independent criterion by which the truth of a statement can be judged”
  • e.g. “This is a revolutionary moment.” That statement is reflexive, and its truth value depends on the impact it makes.11 I mean, I get what he’s trying to do, but I think he’s delving too deeply into epistemology for no good reason. It’s not about the veracity of a statement, but about the power of words to be self-fulfilling (i.e. have consequences down the road)

In the real world, the participants’ thinking finds expression not only in statements but also, of course, in various forms of action and behavior. That makes reflexivity a very broad phenomenon that typically takes the form of feedback loops. The participants’ views influence the course of events, and the course of events influences the participants’ views. The influence is continuous and circular; that is what turns it into a feedback loop.

Feedback loops:

• can be either positive or negative
• negative: brings view and situation closer together, positive: further apart22 is this right? at the very least that’s not how I thought about it.
• negative = self-correcting (and leads to equilibrium)
• positive = self-reinforcing
  • cannot go on forever, because the view would be too far from reality

src: Economist

• value investing: using price-to-book ratio (or price-earnings ratio) as a measure of value to determine under-valued stocks
  • easy in the old days of the industrial era, where assets were tangible.
  • good track record of passing over bubbles (i.e. dot-com boom), since those stocks had bad ratios. but then missed the boat on the recent tech boom.
    • the idea being that if you stick to fundamentals, these stocks will ride out any irrational exuberance.
  • now, developed economies are dominated by the service sector, tech companies dominate the market. their assets are intangible, so the metric of price-to-book means you miss out on tech stocks (à la Buffet).
    • software
    • patents
    • ideas
    • supply chains (somewhat in between the two)
    • skills/knowledge/know-how
    • culture (Bridgewater Associates?)
• recently, value stocks have underperformed the market, lending empirical credence to the above
  • 
• new value (via the book “Capitalism without Capital”):
  • digital goods, intangible, have infinite scalability, since not limited to physical space
    • network effects
  • higher sunk costs: intangibles are harder to both measure and transfer around, given their ethereal nature
  • ideas have spillover, since they’re easy to replicate.
  • synergies abound in the realm of ideas, as it’s easier to experiment, very little start-up cost
• all of this is difficult to measure/extrapolate from a company’s books (again with the measurement problem)
  • more at stake, since network effects give rise to winner-takes-all

In an economy mostly made up of tangible assets you could perhaps rely on a growth stock that had got ahead of itself to be pulled back to earth, and a value stock that got left behind to eventually catch up. Reversion to the mean was the order of the day. But in a world of increasing returns to scale, a firm that rises quickly will often keep on rising.

• how does one determine some intrinsic value in today’s market?
  • differentiating between bubbles and true value is much harder now.

src: MS

This is a fascinating and complex issue, that is a hallmark of Levine’s insight.

1. Capital markets function as capital allocation, but they are also markets, so they serve the dual function of price discovery. If they are anywhere near efficient, this means that it is tending towards some optimal allocation of capital, and prices should reflect that. If things are mispriced,11 This feels almost tautological though, since there is no true price in practice. But the whole point of fundamental analysis is that, just like in statistics, there actually is some true price (parameter). then opportunistic fund managers should be able to make a profit, thereby correcting the price.
2. Recently, people have moved to index funds, which is a form of passive investment.

src: paper via EconTalk.

Using tools from extreme value theory (EVT), Cirillo and Taleb [1] determined that pandemics are patently fat tailed (with a tail exponent patently in the heaviest class: \(α < 1\)) — a fact that was well known (and communicated by Benoit Mandelbrot) but not formally investigated.

Pandemics are fat-tailed.

Random variables with unstable (and uninformative) sample moments may still have stable tail properties centrally useful for inference and risk taking.

RVs with undefined first (and second) moments are still parameterizable (e.g. Cauchy, and stable distributions).

From Wiki:

Many—notably Benoît Mandelbrot as well as Nassim Taleb—have noted this shortcoming of the normal distribution model and have proposed that fat-tailed distributions such as the stable distributions govern asset returns frequently found in finance.

For matters of survival, particularly when systemic, under such classes as multiplicative pandemics, we require “evidence of no harm” rather than “evidence of harm”.

Basically, if you have a fat-tailed distribution, and don’t have enough data to determine the properties of this particular sample, then expect the worst (since your sample moments are uninformative).

He then goes on to explain how, with fat-tailed distributions, confidence levels of the moments are too large to be practically useful (since second moments are so large).

src: talk at Microsoft Research

src: MS

Simple but surprising:

• If you can buy better or faster data than everyone else, you have a big advantage and can make a lot of money.
• If everyone can buy better or faster data, then everyone has to: If you don’t, then you have a big disadvantage compared to the people who do, and you can lose a lot of money.
• Either way, the person selling the better or faster data can make a lot of money.

Further elaboration:

But there is also a contrary viewpoint that actually it has been particularly useless and overrated in these weird times. Here, for instance, is this guy:

Anthony Lawler, head of GAM Systematic, said his firm used alternative data but added that such information had not been behind his funds’ gains last year, nor had it driven markets this year.

“Daily credit card data or footfall data didn’t lead the recovery in [stock] prices. What led the recovery was investor sentiment, animal spirits and a belief in a better future,” he said. “For none of that could you use innovative photographic, credit card or shipping data.”

“We remain of the view that alternative data is creating value for the data providers, but not yet the investors.”

That’s a good quote, but the point I want to make is about the word “yet.” You’d sort of expect a life cycle in which (1) initially alternative data is promising but not very useful, so hedge funds buy it but it doesn’t work very well, so it creates value for data providers but not for investors, (2) then alternative data becomes more refined and useful, so hedge funds buy it and it works, so it creates value for data providers and for investors, but (3) then alternative data becomes ubiquitous, so hedge funds all buy it and the advantage of using it is competed away, so it once again creates value for data providers but not for investors.

• Peloton stocks have been doing very well recently, and it got me curious. essentially it’s like gym class, but at home (which, given the current quarantine is perfect timing). you have to pay for the equipment, and I’m assuming the classes themselves are a subscription service.
• what’s crazy to me is how much people spend on these gyms. it’s like that luxury physical gym chain, Equinox.
  • this also relates to popularity of Lululemon, and how going to the gym has become something very different these days.
  • relating also to how affluence is signaled now: it used to be the case that it was material goods, from luxury bags and silverware (suburbia). now, it’s lifestyle affluence, from yoga and meditation retreats to athleisure wear.
• with the quarantine, we will see more things like this: virtual classes
  • education feels like a big deal. all this online tutoring that we’ve done, it should be even more important nowadays.
  • how do we take advantage of the new infrastructure and technology to make it different?
• I’m glad that I’m able to do all of this on my own volition/desire.