Holiday Tonic II

December 19, 2008:

As I came over Windy Gap
They threw a halfpenny into my cap,
For I am running to Paradise;
And all that I need do is to wish
And somebody puts his hand in the dish
To throw me a bit of salted fish:
And there the king is but as the beggar.

My brother Mourteen is worn out
With skelping his big brawling lout,
And I am running to Paradise;
A poor life do what he can,
And though he keep a dog and a gun,
A serving maid and a serving man:
And there the king is but as the beggar.

Poor men have grown to be rich men,
And rich men grown to be poor again,
And I am running to Paradise;
And many a darling wit’s grown dull
That tossed a bare heel when at school,
Now it has filled an old sock full:
And there the king is but as the beggar.

The wind is old and still at play
While I must hurry upon my way,
For I am running to Paradise;
Yet never have I lit on a friend
To take my fancy like the wind
That nobody can buy or bind:
And there the king is but as the beggar.

— William Butler Yeats, Running to Paradise

Things may go quiet here at the Volcano Lair for a bit. I am sure you will all get along just fine without me.

Happy holidays. Be good.

© 2008 The Epicurean Dealmaker. All rights reserved.

The Three Faces of Bernie

Will the real Bernie Madoff please step forward?

Stories, news articles, and rank speculation continue to rocket around the mainstream media and the blogosphere concerning everyone's favorite bubeleh, Bernie Madoff. As of this writing, real information about the nature, extent, and Bernie's motivations for what appears to be the investment shitstorm of the century¹ remains in short supply, so it is difficult to get a good handle on the former knacker's character. (I do not know the man personally, but he always seemed balbatish to me.)

Since nature—and human perversity—abhors a vacuum, commentators, kibbitzers, and assorted know-it-alls have jumped in to offer their opinions on the great man. Currently, there seem to be three leading theories in circulation:

1) Bernie as goniff

Goniff: Crook, thief, burglar, swindler, racketeer²

As in Snidely Whiplash, dastardly ur-villain of stage and (small) screen, who preferred to act out his antisocial tendencies by tying Little Nell to railroad tracks and rubbing his hands in gleeful anticipation of her impending dismemberment. While perhaps most satisfying to the enraged victims of his shenanigans, this image seems most at odds with the known facts about the life and public personality of Mr. Madoff, who previously resembled one on whose tongue butter would not melt.

So, barring further disclosures—such as the discovery of paste-on handlebar mustaches next to falsified trading records in a locked safe in Madoff's 17th floor volcano lair—I suggest we put this characterization aside.

2) Bernie as Destroyer of the Jews

As in Pharaoh, one distinctly unpleasant Austrian housepainter, or the Senator who voted last month against sending TARP money to Israel. We can probably put this characterization down to understandable hyperbole, brought about by some big shot's momentary rage triggered by an unsettling phone call from his accountant. Otherwise, it does seem a bit much. While fifty billion clams is a lot of shellfish to have lost in your sock drawer, at last report Bernie's victims still seem to have their freedom and their health, which is far more than one can say for millions of their less fortunate ancestors.

That being said, the Madoff Scheme does seem to have been one of the largest affinity frauds ever perpetrated. While Bernie did not limit his predations to Jews, he does seem to have delivered several Members of the Tribe a rather heavy blow, at least in the pocketbook. Representatives of certain Palm Beach country clubs, New York synagogues, and Jewish charities might be forgiven if they view old Bernie as the Jewish Neutron Bomb: a device which vaporizes its victims' liquid wealth while leaving them, their creditors, and their rapidly depreciating real estate intact.

Given that some contend that investors who withdrew funds or collected dividends from Madoff's firm before the scandal broke might be required by a court receiver to repay those monies so investors who lost it all can be compensated, he certainly has set the stage for some long drawn-out, vicious infighting. It could turn out to be the most titanic struggle of Jew against Jew since Bialystock v. Bloom.

3) Bernie as shlemiel

Shlemiel: Clumsy bungler, an inept person, butter-fingered; dopey person

As in Alfred E. Neuman and pathetic shmendriks everywhere. This theory, for which I am developing a growing fondness, contends that Bernie did not start out to swindle his clients, but rather got caught up in spiraling losses and/or overwhelmed by shoddy record keeping. Once he found himself in the soup, he figured it would just be easier to make things up, rather than trying to make things right.³ There is some preliminary evidence for this, but the size and extended timeframe of the fraud does seem to indicate Bernie got pretty comfortable camping out on the dark side.

In any event, given the pathetic behavior of Madoff's investors and other enablers, I am sure we will have plenty of other candidates to choose from as the biggest shlemiel of the bunch. Leading candidates include the SEC, hedge fund-of-funds Fairfield and Tremont, Bramdean Asset Management's "Superwoman" Nicola Horlick, and any individual, charity, or institution foolish or greedy enough to place all or most of their money under Bernie's control. The only question will be whether these players should be considered shlemiels or shlimazels.

Shlimazel: Luckless person. Unlucky person; one with perpetual bad luck (it is said that the shlemiel spills the soup on the shlimazel!)

I know Bernie is waiting for all this to be resolved, too. In the meantime, I imagine

Er drayt sich arum vie a fortz in russell⁴

Stay tuned, campers. It's going to be a busy Chanukah.


¹ Don't relax yet: the century is young.
² Today's Yiddish definitions and usage brought to you courtesy of Thomer M. Gil. Any errors of emphasis or usage are completely his fault, as my own native knowledge of Yiddish is strictly limited to reruns of Mike Meyers skits.
³ Thereby ignoring the Law of Holes, which states that if you find yourself in a hole with a shovel in your hand, stop digging.
⁴ He wanders around like a fart in a barrel (aimless).

© 2008 The Epicurean Dealmaker. All rights reserved.

Plus ça Change ...

But the most absurd and preposterous of all, and which shewed, more completely than any other, the utter madness of the people, was one started by an unknown adventurer, entitled "A company for carrying on an undertaking of great advantage, but nobody to know what it is." Were not the fact stated by scores of credible witnesses, it would be impossible to believe that any person could have been duped by such a project. The man of genius who essayed this bold and successful inroad upon public credulity, merely stated in his prospectus that the required capital was half a million, in five thousand shares of 100£ each, deposit 2£ per share. Each subscriber, paying his deposit, would be entitled to 100£ per annum per share. How this immense profit was to be obtained, he did not condescend to inform them at that time, but promised that in a month full particulars should be duly announced, and a call made for the remaining 98£ of the subscription. Next morning, at nine o'clock, this great man opened an office in Cornhill. Crowds of people beset his door, and when he shut up at three o'clock, he found that no less than one thousand shares had been subscribed for, and the deposits paid. He was thus, in five hours, the winner of 2,000£. He was philosopher enough to be contented with his venture, and set off the same evening for the Continent. He was never heard of again.

— Charles MacKay, "The South Sea Bubble," Memoirs of Extraordinary Popular Delusions and the Madness of Crowds

Bernie Madoff was a piker. A piker on a grand scale, I grant you, but a piker nonetheless.

Cold comfort, I know. But look on the bright side: it's a banner day for misanthropes.

© 2008 The Epicurean Dealmaker. All rights reserved.

Mission Statement

In an era of faceless organizations owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner's name is on the door. Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark.

— Bernard L. Madoff Investment Securities LLC website

* * *
Only two things are infinite, the universe and human stupidity, and I'm not sure about the former.

— Albert Einstein

Well, the dog has caught the car. Now what?

© 2008 The Epicurean Dealmaker. All rights reserved.

Why So Serious?

"Do I really look like a guy with a plan? You know what I am? I'm a dog chasing cars. I wouldn't know what to do with one if I caught it. You know, I just ... do things. The mob has plans, the cops have plans, Gordon's got plans. You know, they're schemers. Schemers trying to control their little worlds. I'm not a schemer. I try to show the schemers how, pathetic, their attempts to control things really are."

— The Joker, The Dark Knight

Felix Salmon is getting "bailout fatigue." I am sure he is not alone.

He is tired and frustrated with the Fed's and the Treasury's ad hoc approach to the financial crisis, and the appearance that they are pissing away the $350 billion Congress advanced to them with no rhyme, reason, or accountability. He wants a plan, and he wants one now. Give us a strategic plan for the next installment of the TARP, he urges: give us a roadmap.

But we already have a map, Felix. Unfortunately, we sailed right off the edge of it some time ago, into uncharted waters.

Here be monsters.

* * *

Many commentators, myself included, have pontificated ad nauseam on the social, political, economic, and institutional sources of our present travails. I will not punish you further in that regard. However, I think it worth exploring, briefly, one or two deeper facets of the pickle we find ourselves in today.

One of the most remarkable intellectual breakthroughs, or paradigm shifts, in the markets over the past quarter century has been the widespread mathematization of finance. Due to the pioneering work of thought leaders like Fama and French, Miller and Modigliani, Black, Scholes, and Merton, traditional practices like security valuation and portfolio selection have been completely transformed, and huge new markets have been constructed out of whole cloth. Underlying many of these developments has been the sophisticated adoption of the concepts of probability and the tools of statistics to define and describe the behavior of securities, derivatives, and markets.

The mathematization of chance, in this context, has been an extremely powerful and useful tool. Vast swathes of our intellectual landscape have been colonized by statistical methods and concepts, and finance has proved pleasingly susceptible to such treatment. So susceptible, in fact, that trillions of dollars of new financial instruments and markets have sprung into existence on the back of it. Without the tools and techniques of statistical finance, many securities and markets would simply not be possible. Without the ability to model and manipulate the workings of chance through mathematics, we simply could not be where we are today.

However, these powerful new tools came prepackaged with a potentially dangerous cognitive trap. Probability is a notoriously slippery concept to get a handle on. Few people understand it well.

It is my belief that many quants, hedge fund managers, and investment bankers came to believe—consciously or not—that, by explicitly embracing and accounting for chance, they had tamed it. They spent countless millions of man hours designing and implementing elaborate mathematical models and risk control systems based on aleatory principles that could predict, with remarkable accuracy, the variation in return and behavior of securities and derivatives under normal circumstances. They spoke confidently about "value at risk" and "maximum expected daily trading loss" as if they knew what they were talking about. As if those terms actually meant anything. And then they trotted off to their bank, or their prime broker, or the Discount Window to borrow a couple more turns of leverage against their proprietary positions.

But you cannot tame chance. That is what makes it chance. At base, implicitly attributing the kind of predictability these individuals seemed to ascribe to chance was a fundamental error, a category-mistake.

To use an example from the not-so-distant past, could the principals at now-defunct hedge fund Long Term Capital not see that pegging the odds of losing all their capital in one year at 10²⁴-to-1 against was ludicrous on its face? (And I am not arguing that Myron Scholes and the other LTCM propeller heads picked the wrong distribution for their probability estimates, as if settling on a Levy skew alpha-stable distribution with α = 1.8 and β = 0.93¹ would have been more accurate than a lognormal one.) In all intellectual honesty, how could they possibly know? Hubris, yes, but more importantly epistemic blindness was at play here.

For even if you have guessed (or calculated) the probabilities correctly, giving one-in-ten-million odds that a life-destroying asteroid will hit Earth in the next ten years does you no good when a Manhattan-sized meteorite is discovered hurtling toward Rio de Janeiro the following day. In retrospect, it seems pretty clear that it is far more important to plan how you intend to deal with an unlikely event when and if it does happen than to shrug and say it will probably never happen. Disaster planning and scenario testing are far more valuable risk management practices than fine-tuning the estimated volatility inputs to your CDO trading model.

Perhaps some of the lapsed mathematicians and physicists on Wall Street who designed these complicated securities and derivatives and created the programs to model their behavior understood this. Perhaps not all of them were blinded by the power of statistical methods or the efficacy and accuracy of probability-based theories of physical behavior like quantum mechanics into believing their elegant formulations were complete and accurate descriptions of securities and markets dependent on human beings. But somewhere between the PhDs programming Ito's lemma in C++ in the basements of investment banks and hedge funds and the Executive and Investment Committees approving proprietary trades, this understanding got lost.

And the shit, as they say, eventually hit the fan.

* * *

So does that mean we should throw away 25 years of finance theory, and scrap billions of dollars of software and systems designed around its principles? Should we go back to throwing sheep knuckles in a dirt circle to make decisions under uncertainty? Of course not.

But we need to rediscover a little more respect (and fear) for the ineluctable and irreducible operations of chance in our lives, including in the markets. We need to keep reminding ourselves that having a 95% confidence level that our hedge fund will not lose more than 100 million dollars in a day does not mean it won't lose $500 million tomorrow, or $75 million a day for ten days in a row. We need to rediscover that well-understood probabilities are usually more stable in the long run, so the whipsaw of short term events doesn't blow us up before we can profit on our longer-term investments.

And it's a good idea to have a plan, a direction in which you'd like to go. But its always a better idea to have back-up plans as well, alternate routes you have mapped out in case your main chance doesn't work out as expected. Keep those in your back pocket, so you don't frighten the Congressmen or limited partners you rely on into paralyzed immobility. But keep them nevertheless.

And hope—pray—that some whackadoodle with the means and the understanding to do it doesn't decide to show everyone just how tentative our hold is on reason and predictability in the financial markets.

That way madness lies.

* * *

Watch out, you might get what you're after
Cool baby, strange but not a stranger
I'm an ordinary guy
Burning down the house

Hold tight, wait 'til the party's over
Hold tight, we're in for nasty weather
There has got to be a way
Burning down the house

Here's your ticket pack your bag; time for jumpin' overboard
Transportation is here
Close enough but not too far, maybe you know where you are
Fightin' fire with fire

All wet, yeah you might need a raincoat
Shakedown, thieves walking in broad daylight
Three hundred sixty five degrees
Burning down the house

It was once upon a place sometimes I listen to myself
Gonna come in first place
People on their way to work say baby what did you expect
Gonna burst into flame

My house, S'out of the ordinary
That's right, Don't want to hurt nobody
Some things sure can sweep me off my feet
Burning down the house

No visible means of support and you have not seen nothing yet
Everything's stuck together
I don't know what you expect staring into the TV set
Fighting fire with fire

Burning down the house

— Talking Heads, Burning Down the House

¹ Don't worry, kiddies, that's just a for instance. There won't be a quiz or anything.

© 2008 The Epicurean Dealmaker. All rights reserved.

The Source of De Nile

[Scene: A therapist's office. A cellphone rings.]
Mrs. Ari: "Ari? I told you to turn that off."
Ari Gold: "I did turn it off, but this is the emergency line. This is the Bat Line, baby."
Therapist: "Do you need to get that?"
Ari: "I do need to take this, yeah."
Mrs. Ari: "No he doesn't. I ask for one hour out of the day. For his undivided attention. And I can't even have that."
Ari: "You can have it if you wanna live in Agora fucking Hills, and go to group therapy. But if you want a Beverly Hills mansion, and you want a country club membership, and you want nine weeks a year at a Tuscan villa, then I'm gonna need to take a call when it comes in at noon on a motherfucking Wednesday!

— Entourage

In case you hadn't noticed, the gravy train is over.

This is bad news for investment bankers, private equity moguls, and hedge fund professionals, of course. It is also bad news for the lawyers, accountants, consultants, and commercial and residential real estate brokers who depend upon them for their livelihood.

But it is even worse news for their wives and mistresses, and the largely parasitic community of wealth suckers who feed upon the steady flood of ill-gotten gains which these women¹ have been siphoning out of their husbands' bank accounts and pumping into the community for years. Luxury goods retailers, twee French bistros, personal drivers, personal trainers, personal shoppers, and the women manning the cosmetics counter at Henri Bendel should all begin to worry that theirs will be a much bleaker and more impecunious future.

I don't think the strappy Manolo sandal has dropped for everyone yet, though.

With few exceptions, Girlfriend and her "retail therapy" enablers seem to be in a state of denial similar to the one their Sugar Daddies passed through over a year ago. I don't care how many €150,000 crocodile Birkin bags Russian oligarch wives buy, Bernard Arnault didn't build LVMH into a €16 billion retail juggernaut by selling one-of-a-kind baubles to the ultra-rich. The €175 billion luxury goods industry depends on armies of women from the middle class on up not only to lust after its wares, but also to buy them.

You can understand why Mrs. Big Swinging Dick might be having a little trouble coming to terms with today's realities, though. The poor thing has been far too busy spending BSD's money for the last several years to worry about where it was coming from or whether it would continue indefinitely. Given that it now seems that hubby didn't have the answers to those questions either, it is a little much to expect her to have worried her immaculately groomed little head about it herself.

Besides, after years of telling her maid to wash the blood off the soles of her man's wingtips every night, I think she knew better than to ask.

* * *

It's not just the Ladies Who Lunch and their hangers-on who are going to have to bite the bullet.

In the same way, nightspots in Manhattan have become dependent on horny young investment bankers, dangling scantily clad Ukranian and Czech hotties as bait to draw in undersexed youngsters able to spend $300 on a bottle of Ketel One on the off chance they might get lucky before some Managing Director calls them back into the office to spread the S&P 500. A recent unscientific survey in the trendy Meatpacking District by Yours Truly revealed that the only things inhabiting the tables and banquettes reserved for bottle service were dust bunnies and a couple of Somali pirates. Likewise, art dealers and auction houses have gotten hooked on the crack cocaine of laundered hedge fund profits, and real estate developers seem to have built enough inventory in downtown Manhattan to house five times the total number of future employed junior investment bankers for the next twenty years.

It's not all grim, however. Felix Salmon thinks there will be a bull market in escapism. Journalists and bloggers alike—your Dedicated Bloggist included—are certainly long schadenfreude, but I feel compelled to remind everyone that this is a very rapidly depreciating asset. I think the average Joe and Josephine are getting close to their fill of industry exposés and critical profiles of the former Titans of Finance. There is only so much you can read (or write) about Dick Fuld or Ken Griffin before you collapse from sheer boredom.

I have high hopes for Hollywood, though. There's always the sequel to Wall Street to look forward to, although I imagine it could use a serious trip to the Rewrite Department about now. I don't know: perhaps we will even get our own big budget musicals, with Fred Astaire and Ginger Rogers dancing blissfully on the rooftop of 15 Central Park West while unemployed i-bankers and hedge fund traders down on the street burn CDO and SIV documentation in oil drums to keep warm.

In the meantime, though, retailers of aspirational goods and services are going to take it in the shorts.

Silk lamé or not.

¹ I make no apologies for the apparent sexism of my remarks. Notwithstanding my best efforts, the proportion of the fairer sex who actually hold professional positions in the finance industry (outside the Human Resources Department, natch) remains vanishingly small. Until and unless I see substantially more evidence that women are manning up and bringing home the big bucks themselves, rather than relying on their or someone else's hubby to do so, I will continue to assume that bankers, PE guys, and hedgies should be referred to with male pronouns. Go ahead, ladies, prove me wrong. As I have warned the missus from the beginning, I am more than willing to chuck her, the i-banking grindstone, and everything else to become some Amazon's boy toy if one ever shows up. To date, Mrs. Dealmaker has remained disappointingly unworried by my threats. (Memo to self: Next time, marry a dumb blonde.)

© 2008 The Epicurean Dealmaker. All rights reserved.