Eugene Linden
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OUR CONFEDERACY OF DUNCES

            The Darwin Award confers mock recognition on individuals killed by their own stupidity, thereby improving the gene pool by removing themselves from it. If there existed such an award at the national level, the U.S. of today would be ...

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Megacities

BY EUGENE LINDEN


Monday, Jan. 11, 1993
By the millions they come, the ambitious and the down-trodden of the world drawn by the strange magnetism of urban life. For centuries the progress of civilization has been defined by the inexorable growth of cities. Now the world is about to pass a milestone: more people will live in urban areas than in the countryside. Does the growth of megacities portend an apocalypse of global epidemics and pollution? Or will the remarkable stirrings of self- reliance that can be found in some of them point the way to their salvation?

KINSHASA, ZAIRE -- HOME TO 4 million people -- is no place to live. The city's social fabric has been fraying for years, but in September 1991 it started to unravel completely. The crisis began when a group of elite government troops, angry because they had not been paid for months, went on a looting spree that was quickly joined by civilians. During the next few days, nearly $1 billion worth of property, from clothes to computers, was pillaged. After the rampage, foreign businessmen -- and foreign money -- fled the city. The economy collapsed. Since the government now has almost no money to buy supplies and spare parts from abroad, all the services that make urban life bearable are breaking down. Buses and trains stall, fuel supplies are uncertain, electricity is unreliable and water quality is in jeopardy.

To the people of Kinshasa, the chaos brings much more than inconvenience and financial loss. The real threats are epidemics and starvation. Antibiotics and other medicines are scarce, and diseases such as malaria and tuberculosis are spreading rapidly. Strikes and sabotage by disgruntled workers hamper the flow of flour, vegetables and manioc to the city.

For Jonas Mutongi Kashama, whose well-kept, one-room home belies his desperate straits, the disintegration of Kinshasa means that for long periods his family must subsist on one meal every two days. Mutongi is actually one of the lucky ones, since, after six months of unemployment, he found work as an accountant. Even so, with the jobless rate at 80%, he must support out-of-work relatives on a tiny salary that is constantly eroded by an annual hyperinflation rate of more than 3,000%. "If things do not change, we will die," says Mutongi with quiet resignation.

"Is Kinshasa an aberration or rather a sign of things to come?" asks Timothy Weiskel, a Harvard anthropologist. His answer: Many of today's cities will go the way of Kinshasa. After all, he points out, the rise and fall of great cities has been part of civilization's cycle since humans first began to congregate in large numbers some 6,000 years ago.

Then there is Curitiba, Brazil, a surprisingly good place for 2.2 million people to live. It has slums and shantytowns, just like Kinshasa. But Curitiba's government has relied on imagination, commonsense planning and determination to deliver enviable services, including a bus system that quickly gets people where they want to go and public housing projects that are still immaculate 20 years after being built.

If Curitiba has a theme, it is self-reliance. The city is not rich, but it makes the most of the resources it has. Recycling, for example, is practically a religion. Jogging paths in the city's many parks are lit with lamps made from Fanta soda bottles, and the offices of Curitiba's environmental department were built in part with old telephone poles.

Most important, the government knows how to tap the energy of the people. In some communities of former squatters outside the routes of sanitation trucks, residents take their own garbage to designated sites and in exchange receive bags of surplus vegetables from the city. A woman named Lindamir Vas Floriano says that before this so-called green-exchange program, her hilly neighborhood was completely carpeted with trash and plagued by disease. Now the area is almost litter free, and the people are noticeably healthier.

Kinshasa or Curitiba: two visions of the future for most of the world's people. Which shall it be?

THE DAWNING AGE OF MEGACITIES

In the coming years, the fate of humanity will be decided in places like Kinshasa and Curitiba. Faster than ever before, the human world is becoming an urban world. Near the end of this decade, mankind will pass a demographic milestone: for the first time in history, more people will live in and around cities than in rural areas.

Explosive population growth and a torrent of migration from the countryside are creating cities that dwarf the great capitals of the past. By the turn of the century, there will be 21 "megacities" with populations of 10 million or more. Of these, 18 will be in developing countries, including some of the poorest nations in the world. Mexico City already has 20 million people and Calcutta 12 million. According to the World Bank, some of Africa's cities are growing by 10% a year, the swiftest rate of urbanization ever recorded.

Is the trend good or bad? Can the cities cope? No one knows for sure. Without question, urbanization has produced miseries so ghastly that they are difficult to comprehend. In Cairo, children who elsewhere might be in kindergarten can be found digging through clots of ox dung, looking for undigested kernels of corn to eat. Young, homeless thieves in Papua New Guinea's Port Moresby may not know their last names or the names of the villages where they were born. In the inner cities of America, newspapers regularly report on newborn babies dropped into garbage bins by drug-addicted mothers.

But cities remain the cradle of civilization's creativity and ambition. To focus on the degradation is to miss the deep well of pride and determination that inspire the urban poor to better their lives. In Bombay, high school girls learn about sanitation, nutrition and immunization so that they can pass on this information to illiterate neighbors. In Bangkok a program called Magic Eyes has reduced street trash by 85% through the gentle method of encouraging children to hum a jingle about sloppiness when they see their parents litter. In Mexico City cash-starved peasants band together to form cooperatives that guarantee credit for people who might otherwise never be able to afford a home.

History issues grim warnings about the future of cities. Since the beginning of civilization, they have risen to greatness only to collapse because of epidemics, warfare, ecological calamities, shifts in trade or social disorder. Calah, Tikal and Angkor are among the fabled places that disappeared into the sands or jungles of time. Surviving cities have undergone wild swings of fortune. Alexandria, Egypt, may have housed several hundred thousand people at its peak in Roman times, but when Napoleon entered it in 1798, it had shrunk to 4,000 souls. Since then, it has again boomed to nearly 3 million and faces grave ecological threats. The gleaming city that Arab poet Ibn Dukmak compared to "a golden crown, set with pearls, perfumed with musk and camphor, and shining from East to the West," is slowly sinking into the unstable, sewage- contaminated Nile Delta.

During earlier periods of urban collapse, the fact that human society was largely rural tempered the effects of catastrophes. When the black death wiped out 80% of Europe's urban population, more than 95% of the people lived in the country. But if the world enters a new age of epidemics, few will escape unaffected.

CITIES AND CIVILIZATION

Workers laying a new sewer line in a Cairo suburb uncover foundations of a 4,600-year-old working-class neighborhood; a subway project in Rome reveals a long-dead Pope's toothbrush; improvements in Red Square during the twilight of the Soviet empire unearth wooden homes built before Moscow had its first prince in the 13th century. In the next millennium, construction workers in Cairo, Rome and Moscow will no doubt be puzzling over traces of current cultures. As the triumphant remake the world's cities, the shards of the vanquished are literally trodden into the ground.

These layers of sediment become pages in urban history, which, in large measure, is the history of civilization. The need to preserve foods and seeds at trading centers in ancient Mesopotamia and Anatolia focused human ingenuity on the problem of storage and led eventually to the development of armories, banks and libraries. Along a treacherous path paved with bloodshed and pestilence, cities evolved as the repositories of humanity's collective intelligence: the record of culture and science that enables a civilization to benefit from the lessons of the past.

But the development of cities fostered competition among humans and alienation from nature. The price of a city's greatness is an uneasy balance between vitality and chaos, health and disease, enterprise and corruption, art and iniquity. The Elizabethan London that nurtured Shakespeare, after all, was a fetid dump cloaked with coal dust.

This delicate balance always threatens to tip, and when it does, cities can | spiral into an anarchy that defies all attempts at reversal. From Belfast, where religious hatred spawns terror, to Los Angeles, where the acquittal of four white policemen accused of beating a black motorist triggered last April's rampage of looting and arson, city dwellers have paid a horrible price when ethnic and political tensions boiled to the surface. When fighting began in Beirut in 1974, merchants spoke confidently of a return to normality within months. Few Lebanese expected that strife would still rule their lives 18 years later.

Yet the catalytic mixing of people that fuels urban conflict also spurs the initiative, innovation and collaboration that move civilization forward. The late social critic Lewis Mumford once remarked that "the city is a place for multiplying happy chances and making the most of unplanned opportunities." Curitiba's mayor, Jaime Lerner, bases his whole approach to urban planning on this idea. "If life is the art of encounter, then the city is the setting for encounter," he says. Curitiba has multiplied the chances for encounters by providing its citizens with an abundance of pedestrian walks and parks. Even the bus terminals make cozy and comfortable meeting places. The mayor's public housing program mixes both low- and middle-income people in a largely successful effort to discourage ghettos.

Ironically, the very programs that have made Lerner one of the most popular mayors in Brazilian history threaten Curitiba's future. Says Ashok Khosla, president of the New Delhi-based Society for Development Alternatives: "Each city contains the seeds of its own destruction because the more attractive it becomes, the more it will attract overwhelming numbers of immigrants." Luciano Pizzato, a federal Deputy from Curitiba, notes that during the next 10 years, Brazil's population will grow by 40 million people -- an increase the size of Argentina's population. "You cannot create facilities for a new Argentina in 10 years," says Pizzato, who fears that Brazil's poor will make Curitiba their destination of choice.

It is easy to understand why Brazilians would migrate to Curitiba, but why do people keep streaming into a Kinshasa or a Karachi, Pakistan? What is the irresistible lure of the megacity? To the outsider, a neatly swept native village in Africa, Asia or Latin America may look more inviting than a squalid urban squatter settlement. But until recently even the most wretched city slums have offered better access to paying jobs, more varied diets, better education and better health care than what was available in rural communities.

THE MEDICAL AND ENVIRONMENTAL TOLL

No one knows how big some cities are or how rapidly they are expanding. Estimates of Mexico City's population vary from 14 million to 20 million, depending on whether demographers calculate the figure according to the 1990 census (which some believe drastically undercounted), or whether the number is determined by estimates of water use. Still, the fastest urban growth is in those areas that are poorest and least prepared.

Karachi, for instance, may be swelling by 6% a year. Estimates of its population range from 8.4 million to 11 million, a figure that could rise to 19 million by the year 2002. That increase would be the same as adding on New York City's population in a decade. But Karachi makes do with a central sewer system not significantly improved since 1962. The city provides 30% less water than needed, forcing the poor to drink from untreated supplies often contaminated with hepatitis virus. An epidemic of the disease has been raging for more than a year. Those taking medicines often get sicker because unscrupulous local manufacturers sometimes boost profits by adulterating pills and potions with motor oil, sawdust and tainted tap water. Says Mohammad Farooq Sattar, 32, the former mayor, who started his career as an M.D.: "Karachi is a city very much in need of a doctor."

So are many other cities. The era of the megacity could bring the triumphant return of microbes that have toppled empires throughout history. Says Harvard public-health expert Jonathan Mann: "We only have a truce with infectious disease, and if a city's infrastructure gets overloaded, the balance can tip back to microbes at any time." The cholera epidemic that hit Latin American cities last year, hospitalizing more than 400,000 people and killing at least 4,000 in a few months, shows how quickly a disease can move when it finds a foothold in crowded slums.

Large cities are breeding grounds for novel, antibiotic-resistant strains of old germs and for entirely new kinds of microbes. Not since the bubonic plague has the world encountered anything like the AIDS virus, which has infected at least 10 million people. No one knows exactly where AIDS originated, but it has become an epidemic in the cities of Africa, Europe, Asia, Latin America and the U.S. In addition to its own deadly impact, AIDS fosters the spread of other diseases. The tuberculosis germ, for example, attacks weakened AIDS victims and uses them as a beachhead for invading healthy populations.

The possibility that AIDS evolved in the African rain forests has raised the nightmare prospect that as humans continue to cut back tropical forests, other opportunistic new viruses may emerge to fasten on human hosts. "Imagine a virus like AIDS that was transmitted by droplets in the air rather than sexually, and which led to death in months rather than years. In these circumstances we might not have time to study the disease before it ravaged cities," says Uwe Brinkmann, a Harvard epidemiologist.

Inadequate sanitation often provides new pathways for infectious agents. In Mexico cysticercosis, caused by a tapeworm that invades the human brain, used to be transmitted primarily by improperly cooked pork. Now people are getting the disease from vegetables grown in fields irrigated by water containing effluent that flows into the Tula River from Mexico City. Brinkmann estimates that more than half of the 300 million urban poor in the developing world are in a permanently weakened condition because they carry one or more parasites.

The threat of disease is heightened by urban pollution. Brinkmann notes that in industrial countries, as much as 50% of the population will suffer from a rash or other skin disease during the course of a year, compared with maybe 2% in the 1950s. "Is this an indication that pollutants have weakened human immune defenses, leaving city dwellers more vulnerable to otherwise benign diseases?" the epidemiologist asks. Many of the effects of environmental degradation are far from benign. In Upper Silesia, Poland, indiscriminate dumping of toxic wastes has so poisoned the land and water that 10% of the region's newborns have birth defects, from missing limbs to brain damage.

Nowhere is pollution more palpable than in Mexico City. When the wind is still, the fumes of 3 million cars and 35,000 industrial sites become trapped by the high ring of mountains that surrounds the city. Last February a cloud of smog pushed ozone readings above 0.35 parts per million on some days, severe enough to harm even healthy people and four times the level considered safe under, say, California law. In recent years Mexico City has started to shut down polluting factories, introduce lead-free fuels, get rid of diesel- powered buses, mandate emission controls on new cars, and even decree that vehicles be driven only six days a week. But with the number of cars growing 7% a year, ozone pollution still worsened 22% between 1990 and 1991. Today the city is looking at electric cars and new pollution controls for buses and industry. The situation is desperate enough that the ordinarily sensible mayor, Manuel Camacho Solis, has entertained daffy ideas such as the installation of 100 giant fan complexes, each 13.3 hectares (33 acres) in size, to blow pollution out of the area.

Even the best-managed cities have trouble coping with the crush of population growth. Tokyo is overwhelmed by its own trash -- 22,000 tons each day -- despite massive recycling and incineration programs. Ironically, Japanese fastidiousness is a big part of the problem. In a city where taxi drivers wear spotless white gloves, Tokyo consumers want wrappers around virtually anything they buy.

At the present discard rate, Tokyo will run out of dump sites by 1995. The city has been building artificial islands in Tokyo Bay to hold garbage, but cannot continue to do so without threatening both the fishing and shipping industries. Some critics argue that in its obsession with technology, the government has chosen the wrong tack. Notes Keisuke Amagusa, editor of the journal Technology and People: "The government is focusing on garbage collected and not doing anything to reduce the garbage created."

The pell-mell expansion of cities creates risks not just for their residents but for every human being. As cities grow, so does the demand for standardized, easily transportable foods. Farmers in the countryside respond to this demand by planting a narrower range of crops, which in turn increases the likelihood of major disruptions of the food supply by pests and droughts. Particularly in the developing world, cities act as destructive parasites on the surrounding countryside. Urban thirst for fuel wood and building materials leads to deforestation, which can destroy an area's watershed and thus cause flooding and soil erosion. In many cases, the impact of urban centers extends across the seas. Demand for plywood building materials in Japanese cities drives the decimation of Borneo's forests.

With every kind of threat, the stakes are higher than ever before. A repeat of Tokyo's devastating 1923 earthquake today might cause worldwide economic stagnation as rebuilding the city soaked up hundreds of billions of dollars of Japanese capital. If global warming causes a sharp rise in sea levels during the next century, as many scientists predict, the coastal megacities may have to build giant dikes to prevent disastrous flooding, but only a few urban areas can afford such an undertaking.

Ideally, it might be better to disperse humanity more evenly around the countryside. But people have flocked to cities for thousands of years, and the lure of the bright lights runs so deep that it cannot easily be overcome by government policies. With the world's population growing by nearly 100 million a year, the forces driving urban expansion are irresistible.

WILL CITIES LOSE THEIR ALLURE?

Yet there are signs that urban growth can be slowed. Four decades ago, Mexico City was a relatively attractive place, with only 4 million people and not much traffic along its spacious boulevards. Since then the population has quadrupled, and the congestion has become stifling. In recent years the city's immigration rate has declined while the flow of people to smaller Mexican cities has increased. This trend suggests that the combination of crowding, poor sanitation, noise and pollution can eventually become intolerable.

In rich countries as well, many cities are not quite the magnets they used to be. In return for the highest combined city and state taxes in the U.S., residents of New York City get deteriorating bridges and roads, racial tension that frequently ignites violence, schools in which students must worry about gun battles erupting in the hallways, subway stations that double as public urinals, and streets full of panhandlers. Last summer one house in a middle- class neighborhood in Brooklyn was burglarized on five separate occasions, and the police did nothing to stop the robberies.

Not surprisingly, the city has been losing its middle class and is in danger of losing many of its professionals. A New York Times poll showed that 60% of the people sampled were thinking of leaving. "If the ability to believe in the future is what separates a growing from a dying civilization, then New York is in deep trouble," says Stephen Berger, a former executive director of the Port Authority of New York and New Jersey.

For all its problems, though, New York still has a superb infrastructure for housing, transporting and employing large numbers of people. "It's far easier to fix New York," says Berger, "than to rebuild it in Des Moines." More important, cities such as New York and Tokyo will never lose their role as % marketplaces of ideas. Even as electronic communications increasingly link people over long distances, they still crave face-to-face encounters.

Kenzo Tange, the revered Japanese architect, points out that in his country there is no substitute for sizing up business associates in meetings and at social occasions. Tange thinks the Tokyo area, though choked with nearly 30 million people, will remain the focal point of Japan's economy simply because the city houses the headquarters of two-thirds of the country's major companies. In Japan and around the world, many of the most creative minds in business, finance, fashion, the arts and the media will keep wanting to brainstorm in the megacities.

THE REVIVAL OF SELF-RELIANCE

Experts began predicting the violent collapse of Third World megacities more than a decade ago. Urban planner Janice Perlman recalls the skepticism she encountered in the mid-1980s when she first proposed Mega-Cities, a project to promote the exchange of ideas and innovations among the world's biggest urban areas. She was told that her proposal was futile because such cities as Jakarta and Mexico City would be torn apart by disease and disorder within a few years.

The first modern urban apocalypse could easily have started at 7:18 a.m. on Sept. 19, 1985. That was when an earthquake measuring 8.1 on the Richter scale rocked Mexico City. Hundreds of thousands were left homeless, water mains broke, the threat of epidemics loomed, and the government fumbled helplessly in dealing with the crisis.

But instead of obliterating the city, the earthquake tapped a wellspring of self-reliance that astonished officials and outside observers alike. Neighborhoods and communities organized themselves to rescue those buried, clean up the rubble and restore services. Since then, a chastened government has tried to do a better job of harnessing local initiative. Says Mayor Camacho: "We have learned to take advantage of mass mobilization."

The awakening of self-reliance in the urban poor is a global phenomenon. In Karachi, architect Akhter Hameed Khan rallied the people of the Orangi district around a self-help initiative to upgrade their sanitation. With 800,000 residents from five of Pakistan's major ethnic groups, the neighborhood is periodically racked by violence. Still, working lane by lane, beginning in 1980, Hameed Khan and his co-workers in the Orangi Pilot Project proved to the district that with a tiny investment ($40 a house), it could install its own sewerage system. Since then, roughly 70% of the 6,347 lanes have been linked to the system. The people of Orangi can now see for themselves the difference between the neat lanes in the project and the garbage-strewn open sewers of neighboring alleys. Hameed Khan's programs, particularly initiatives to improve the role of women, have stirred some fundamentalist mullahs in this Islamic country to call for his death, but the 78-year-old social activist resolutely continues his efforts to make Karachi more livable.

The World Bank, which generally finances giant projects, increasingly supports small community-based initiatives. One such project is the Kampung Improvement Program in Jakarta. Its success grew out of a decision to give squatters title to plots of land. In return, the new landowners agreed to help build footpaths, improve drainage and reduce garbage. "Instead of thinking of themselves as temporary boarders, the poor began to look at their community as their home," says Josef Leitmann, a World Bank urban planner. "A simple change in psychology produced a change in physical surroundings."

The cities obviously need more money. In many countries the help that urban areas receive from the national government has dwindled steadily. Moreover, during the past decade, foreign aid shifted more and more to rural problems even as people moved to the cities. Now, with urban areas producing half the world's income, and governments nervous about restive urban populations, agencies such as the World Bank have begun to focus more on cities once again.

But money by itself will not prevent the collapse of megacities. The troubles of a Karachi or a Jakarta will not disappear if planners from the World Bank rush in to build housing projects and a freeway system. Humanitarian aid in the form of food and medicine can be a godsend, but it will not give a city prosperity.

Ultimately, the responsibility for making cities livable rests with their governments and their people. Too often those governments, whether in New York City or Kinshasa, become corrupt systems for dispensing benefits to agencies, employees and political supporters. If, as in Curitiba, governments can learn again how to serve the public, they can regain a mighty power -- the power that comes from harnessing the combined imaginations and enterprise of millions of human beings.

The historical cycle of urban growth and collapse will be hard to break, but hope can be found in the stubborn self-reliance shown by people in some of the world's poorest cities. Like the cumbersome bumblebee that flies in the face of aerodynamic theory, the megacities will have to defy gravity and invent a sustainable future for themselves. Since the fate of the world is entwined with the fate of its cities, humanity has no other choice.

contact Eugene Linden

Short Take

I’ve just read Black Edge, by Sheelah Kolhatkar, which is about the huge insider trading scam that characterized Steve Cohen’s SAC Capital at the height of its power. I’m going to offer the thoughts it prompted in two parts. The first will delve into the trade itself, and the second will explore the fallout from this insider trading scandal and subsequent events in the market.

Part One:

A good part of Black Edge focuses on one specific instance of insider trading at SAC Capital: Mathew Martoma’s quest for advance knowledge of the results of trials on the efficacy of Elan Pharmaceutical’s experimental drug to halt Alzheimer’s disease. The drug, bapineuzumab, was designed to attack the amyloid plaques that Elan’s scientists viewed as the cause of cognitive decline. In his quest for “black edge” (illegal inside information) Martoma and his compatriots compromised the integrity of the procedures for drug trials and ruined the life and reputation of a distinguished scientist.  Even that wasn’t enough for them. SAC also had access to vast amounts of biotech expertise, both from PhDs on their payroll, and the expert networks they paid handsomely to give them access to researchers with direct access to the studies and trials.

 

In the short run, this inside information paid off for SAC as Martoma’s advance knowledge of the results allowed the hedge fund to reverse a billion dollar position and make a profit of over $180 million versus certain losses of hundreds of millions had they not gotten advance information on a disappointing field trial. In the long run, while Steve Cohen skated, the insider cases led to $1.8 billion in fines, the dissolution of SAC, and jail time for Martoma.

 

In retrospect, it was all so stupid. SAC could have come to the conclusion that Elan’s drug was not going to work without resorting to anything illegal.

 

Instead of deploying all this massive intellectual firepower on getting advance word on the results of the trials, the analysts might have started by asking how solid were the assumptions on which the therapy was based: namely, whether attacking the plaques would halt or reverse the progress of the disease.

 

Even in 2008 and 2009, there were a number of researchers at distinguished universities who questioned that basic assumption. The alternate theory was that the plaques were not the cause of the disease, but rather an analogue of scabbing, the result of the body’s attempt to protect the brain from infection.

 

 In subsequent years, this alternate view has gained some traction, with some now arguing that Alzheimer’s is akin to an autoimmune disease in the sense that as the environment in developed countries has become more antiseptic, protective devices in the brain have turned on the brain itself as the infections they evolved to fight have disappeared. In any events a drumbeat of failed trials with drugs attacking amyloids has discredited this approach. As Tara Spires-Jones, of Edinburgh University’s Centre for Cognitive and Neural Systems put it in an interview with Britain’s Independent, “Most of the trials have been based on the assumption that amyloid is important in causing Alzherimer’s diseas, as opposed to something that happens alongside it. That assumption, I think, is probably wrong…”

 

Even in 2007, SAC’s analysts should have known that many attempts to fight Alzheimer’s by fighting the formation of plaques had failed. Given all the time the fund spent analyzing the drug and trials it must occurred to someone to ask whether Elan was barking up the wrong tree. Maybe someone there did just that, but there’s no indication that the decision makers ever questioned the assumptions upon which the drug was built.

 

Maybe that wouldn’t have mattered. SAC wanted certainty. Clearly, detailed advance knowledge of the results of a field trial is more compelling than a dissenting theory on the nature of the disease. Had SAC questioned the assumptions of the study, they never would have amassed a position in Elan, and they probably wouldn’t have had sufficient certainty to short the stock prior to the results being announced.

 

What can be drawn from this? There are implications about the pressures of the markets – SAC employees felt that had to cheat to maintain performance – but there are also implications about the culture of world of investing.  Alzheimer’s is a horrifying disease, but the book makes a strong case that neither Cohen, nor anyone else at SAC, gave a rat’s ass whether the drug worked or not; they only cared about knowing the results before anyone else and about how other traders would view the data when it came out.  The same probably applied to every other fund playing Elan.

 

It isn’t news that the markets are amoral, but this amorality has real world consequences. The punishment the market meted out to Elan (and other companies with failed trials) makes all but the largest companies risk averse about investing in therapies for difficult diseases. There is a short-term logic to this from an investor’s point of view, but, increasingly, the market sets research priorities, and the market’s priorities – controlling costs and maximizing short-term profits – may not serve the needs of society. Researchers know that breakthroughs often come from learning from failed previous attempts.  So where will breakthroughs come from as fewer and fewer companies risk failure?

 

Part Two:

 

Further thoughts on Black Edge by Sheelah Kolhatkar

The insider trading scandal at SAC confirmed a widely held suspicion among ordinary investors that Wall Street is a rigged game where powerful players can cheat with impunity.  Regardless of the truth of that suspicion, the widely held perception that this is the case has had its own reverberations. In a delicious irony, one of the derivative effects of the market crash and subsequent insider trading scandals has been to make more likely a future in which black edge is less useful.

 

Bear with me.

 

What happened with Elan revealed a contradiction at the heart of the markets. SAC was driven to seeking black edge by the ruthless competition of the markets. In the minds of their analysts and portfolio managers, access to publicly available information wasn’t enough because competing funds had their own PhDs pouring over the same information. Moreover, competing funds also had access to the same expert networks (which might be viewed as “grey edge”) as did SAC.

 

In such a situation, we’d expect that different analysts would take different perspectives on the prospects of the drug and the trials. I would have expected that at least some analysts would question whether the assumptions behind the drug were correct. The market says that wasn’t the case. Rather the hedge fund world was massively longs before the release of the trial results, and Elan’s subsequent 66% price drop suggests that the herd mentality applied on the way down too.

 

So market efficiency drove SAC and some others to seek black edge, while the subsequent drop exposed a herd mentality and deep inefficiency that made the market anything but a black box that continuously adjusts prices for all information.

 

The result for the markets is analogous to the evolutionary theory of punctuated equilibrium: markets will proceed smoothly until some event produces rapid change. Because, as the crash of 2008 demonstrated, the big price-change inducing event can come from any number of directions inside or outside the economy, many investors are giving up on analysis of individual stocks and moving to passive investment funds and ETFs. The size of this shift is staggering. The amount of managed money in passive strategies has risen from an estimated 6% in 2006 to as much as 40% today (these figures vary depending on definitions of what a constitutes passive strategy).

 

That latter figure may be larger given the relationship between value investing and money moved by algorithms and quantitative strategies.

 

Quantitative types try to beat their peers by focusing on changes in pricing or volatility, and/or seeking an edge through speed and data crunching, rapidly identifying anomalies, and then trading at warp speed. Many hundreds of billions of dollars now take this route into the markets. And results have proven that this approach can work; some of these funds have done fabulously well.

 

So, stepping back, it becomes clear that the trillions of dollars invested through passive strategies and ETFs basically piggybacks on the decisions of active managers relying on traditional analysis of individual companies and sectors. Moreover, the hundreds of billions of dollars of money invested in quantitative, momentum, derivative, and volatility strategies, also piggybacks and even amplifies, the decisions made by traditional investors as those decisions become evident in price movements.

 

So the response to the pain inflicted by past booms and busts and insider trading scandals has created a situation today where the huge amounts of money moves in sync with an ever smaller base of active managers. Value investing based on analysis of individual companies has become an ever-smaller tail wagging an ever larger dog.

 

Perversely, this, in turn, has created a situation where in the next crash, Steve Cohen, the quant and momentum funds, and even the Warren Buffets will ultimately have no edge. All it will take to set the next crash in motion is for a fair number of investors to say, “gee I think I should shift more to cash.” Then the passive investment funds will be forced to sell, and they will sell regardless of the merits of any individual stock. This will cause volatility to rise and the billions of dollars of investments tied to volatility will also start selling, and as this is happening, the algorithmic traders, the momo guys and the others looking for direction to exploit will jump in juicing the sell off.  The trigger might be some external event, or something as banal as a simple change in mood, but no insider will have any better insight as to when this occurs than anyone with access to a newspaper.

 

As a coda, it’s worth noting that Steve Cohen has now been cleared to manage other people’s money. At the end of Black Edge the author quotes a savvy market player as saying that the day Cohen could do that, money would come pouring in. Well, according to the New York Times, that day is here and money is not pouring in. Maybe this is because his fees are too high, or because the insider trading scandal has made him tainted goods. Or maybe, it’s because investors doubt that he can achieve his former results without black edge.



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