Eugene Linden
home   |   contact info   |   biography   |   publications   |   radio/tv   |   musings   |   short takes   

Lastest Musing
Trump, the Toxic Legacy of the Financial Crisis

Today, the Lost Angeles TIMES published my oped as part of a a package on the first anniversary to Trump's election. Space was limited, so I tho...

continue

Featured Book

The Ragged Edge of the World
Buy from Amazon

more info

Articles by Category
endangered animals
rapid climate change
global deforestation
fragging

Books

Winds of Change
Buy from Amazon

more info
Afterword to the softbound edition.


The Octopus and the Orangutan
more info


The Future In Plain Sight
more info


The Parrot's Lament
more info


Silent Partners
more info


Affluence and Discontent
more info


The Alms Race
more info


Apes, Men, & Language
more info

BRING BACK THE DRAFT -- BUT MAKE IT EQUITABLE


by Eugene Linden There is one sure-fire way to bring an eerily disengaged American public into the debate about whether to invade Iraq: bring back the draft. In 1971, even though I opposed the Vietnam War and received an honorable discharge from the Navy by reason of conscientious objection, I still supported the draft. When I went to Vietnam shortly afterward as a journalist, one lesson my reporting on fragging and the demoralization was that it the U.S. was to have a draft army, we needed an equitable draft (I'll get back to that in a minute). Today, as we prepare for war with Iraq, we need the draft more than ever. We need the draft because a democratically conscripted army acts as a restraint on the impetuous use of force. People think long and hard about the merits of military action if they or their children are the ones who are going to have to kill or be killed. That's true of family members of today's professional army of course, but those directly affected are now a much smaller subset of America. Launching a war is perhaps the most important decision a democracy can make, and it ought to be the result of a national consensus with risk and sacrifice shared equally. My encounter with the military was of my own making since I voluntarily had joined NROTC after turning down an offered appointment to West Point. Although I ended up opposing the Vietnam war, I always respected the military. In my conscientious objection statement I argued that I would willingly defend my family and country, but not kill people overseas because of the untested logic of some arcane geopolitical theory (the domino theory -- remember that?). I was prepared to go to jail if I lost my case, but it never came to that. Instead I went to Vietnam as a journalist where I had the opportunity to see first hand what happens to an army when a draft is not equitable and the army's conscripted members don't understand what they are fighting for. Demoralized soldiers began to turn on their officers and sergeants. Even as U.S. involvement wound down, fraggings (the word used to describe attempts to kill superior officers), became near epidemic in the rear echelons far away from the dangers of the front. Fraggings were complicated, sometimes involving racial tensions and drugs, but the skewed demographics of the draft set the stage for many of these attacks. During World War II, the draft fairly equitably scooped up everybody with a pulse. An oil-field roughneck might be fighting next to a teacher or a musician. This meant that when tensions rose with the noncoms and officers, there was usually someone in the platoon who could act as a voice of reason before things got out of hand. By the time Vietnam rolled around, the more educated young men became pretty good at gaming the system. If you couldn't get out of military service altogether (Bill Clinton, high number in the draft lottery), chances are you could find a haven in the reserves (George W. etc), or at least avoid the units that did the fighting. This left the line units manned by the least articulate soldiers who were most prone to act on their frustrations. Moreover, the soldiers were as alienated from the sergeants as they were from the officers. Time and again, when I spoke to soldiers who'd witnessed attacks or attempted to kill their superiors, they told me, "nobody said, 'don't do it.'" The inequitable draft skewed the debate about the war at home as well. Once you avoided Vietnam, your Vietnam problem was over, at least as a life and death matter. A politician who got his kid into the reserves might still support the war while insulating his family from the risks. For me, one lesson of Vietnam was that an equitable draft would have much spurred debate about the merits of that war much more quickly. The corrupt rulers of Vietnam would have fallen sooner to be sure, but at the cost of fewer Vietnamese and American lives. For the military, however, the lesson of Vietnam was to switch to a professional army, thereby reducing the potential for both internal dissent and demoralization, as well as the incentives that would engage ordinary citizens in the debate about where and when the U.S. should go to war. This trend has reached an extreme as the U.S. prepares to invade Iraq. The possibility of war has inspired debate in Europe, the middle East and Asia, but Americans seems eerily disengaged from the looming prospect of conflict. An equitable draft would make sure we all paid attention.

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.



read more
  designed and maintained by g r a v i t y s w i t c h , i n c .
Eugene Linden. all rights reserved.