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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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I'm Not Hopeful About COP21 in Paris


Monday November 30, 2015

[A version of this appeared Nov. 29 in Yale Climate Connections]

 

 

Starting November 30, some 45,000-plus interested parties converge in Paris to try to influence the final form of what is supposed to be a universal agreement among nations on how to address the unfolding threat of climate change. As the date looms, the prospects are not encouraging.


The first thing to keep in mind is that only the climate gets final-say: the measure that matters most for what comes out of Paris will be the reaction, over time, of the climate itself. Countless unambiguous signals, ranging from disappearing arctic ice to sea level rise, tell us that human-induced changes in climate are already happening. It’s too late to stop global warming; the world’s nations can only try to prevent its worst effects by drastically reducing further emissions of greenhouse gasses. The world may yet do so, but not solely as a result of any agreement that comes out of Paris.

Most of the horse-trading and language that will go into this agreement will be irrelevant to how much carbon dioxide, methane and other greenhouse gasses ultimately rise into the skies. At least that’s the grim conclusion that can be drawn from the history of most U.N. actions devised to address environmental problems, as well as from the signals coming from the ongoing negotiations themselves. Consider the sad history of the Kyoto Protocol, a treaty intended to address the climate threat, with roots extending back to the 1980s. It was finally negotiated in 1997, and went into effect in 2005. Big nations by and large failed to meet the targets, and China, now the world’s largest emitter of greenhouse gasses, was not even bound by its commitments. Moreover, the most successful reductions came not from the treaty, but in the ordinary course of modernizing the outdated and comically inefficient industries of the former communist bloc nations after the collapse of the Soviet Union.

Even as it was being negotiated, few experts believed that Kyoto by itself would forestall global warming. It was pitched to doubters with the argument that once in place, the treaty could be strengthened. It wasn’t. More often, it was either evaded or ignored.


Another troubling sign is the wrangling over money, which conjures up another international environmental effort: The U.N.’s Tropical Forestry Action Plan (TFAP), an effort to slow destruction of the world’s rainforests, was hatched in the 1980s. The program was sold to donors as a way to slow deforestation in these fragile ecosystems, but it was sold to recipients as a way to channel additional money for economic development. The result: in a number of African nations, TFAP actually accelerated logging.

In the case of climate change, one has to wonder how much of the money that is supposed to go from the developed countries to emerging nations will simply be viewed as a new source of development aid (at least those funds that are not simply relabeled existing commitments) that will be channeled into politically favored projects, with little or no impact on emissions.


Shifting the world’s energy sector away from fossil fuels requires investment, and it’s understandable that poorer nations will try to seek funds from richer countries, and that all nations will try to dodge their own responsibilities. That’s what nations have always done. That this wrangling continues even as this supposedly historic meeting convenes, however, bespeaks the lack of urgency that for some surrounds this issue. It’s a depressing indicator of how low climate change ranks on various national agendas that only a tiny number of politicians bother even to pander on the issue.

If Paris were somehow to lead to a robust agreement, how many years will pass before it’s put into place by various countries needing to do so? And then, how many years will it take before its “binding” commitments go into effect? The leisurely timetable and mild demands of the Kyoto Protocol won’t cut it given the pace at which climate is changing.


An aura of unreality surrounds the whole process. Somehow negotiators settled on 2 degrees Centigrade, 3.6 degrees Fahrenheit, as an acceptable amount of warming (by the way, Earth has already warmed by nearly 1.3 degrees F from pre-industrial levels). Despite its nearly iconic status, it’s a target that wrongly presumes that scientists can pin-point how much warming will result from a given amount of GHG emissions, or that economists and social scientists can nail, with precision, the economic and social costs of a given degree of warming. They can’t.

The magical and mystical two degrees number dates back to 1990 for policymakers and was advanced as far back as the 1970s. A lot has changed in climate science in the years since. Until the mid-1990s, for instance, most scientists felt that climate changed in a stately, linear way, over hundreds if not thousands of years. Now, the climate community has come to realize that climate can change quite abruptly, and that climate transitions are characterized by tipping points and non-linear (read unpredictable) responses.

Take, for instance, the question of thawing permafrost. Several times the amount of additional greenhouse gasses humans might “safely” release into the atmosphere remain trapped in permafrost in the northern hemisphere. When the magic two degree number first gelled into consensus, few were considering whether a rise of two degrees might trigger irreversible thawing of that permafrost, leading to runaway warming. Indeed, IPCC estimates of future GHG emissions contain no figure for future permafrost contribution to the carbon budget.

Based on a study of ancient permafrost thawing, Anton Vaks of Oxford University in England estimates that the tipping point might be a rise in global temperatures of 1.5 degrees centigrade. Oops!

More than a decade ago, I helped edit a report on rapid climate change sponsored by an elite group of institutions and a major re-insurer. The idea was to model the implications of rapid climate change for the insurance industry, but what the participants discovered was that the non-linearity that characterizes so much of the climate system made realistic loss estimates impossible. The study reverted to using linear projections – a classic case of looking for the keys under the street lamp because that’s where the light is.

So, the Paris Congress of Parties, COP, now finds itself with participants haggling over an agreement that will take years to come into force, and one that can’t even be called a treaty because that would require ratification by an adamantly opposed Republican majority controlling the U.S. Congress. The agreement will involve unenforceable commitments that few will seriously strive to abide by, and transfers of money that rich nations don’t want to spend. All to avoid a 2 degree rise in global temperatures that few serious observers think will be adequate to prevent a rapidly unfolding climate catastrophe.

Clearly, the world needs a Plan B, and the good news here is that it’s well under way – only it’s not a plan, but rather the actions of millions of consumers, investors, and companies. Alternative energy technologies seem to be going viral as prices fall, and economies are becoming less carbon-intensive, a process driven by simple economics and technological change. It’s heartening too that major investors and finance groups are banding together to help grease the wheels of the transition to a climate-friendly economy.

We can only hope that the jury – which is to say the climate – is still out on whether change will come in time. Ultimately, only the climate will give us the verdict that matters most.

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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