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

Lastest Musing
In Memorium: Koko the Gorilla

Koko the gorilla died on June 19. She and a female chimpanzee named Washoe (who died in 2007) played an outsized role in changing how we view animal intelligence. Their accomplishments inaugurated deep soul-searching among us humans about the moral basis of our relationship with nature. Koko and Was...

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

THE BAY OF PIGS: DISASTER AND TRIUMPH


Tuesday March 08, 2011

 

Eugene Linden
 
At first I thought it was a version of the granfalloon, the term Kurt Vonnegut invented to describe a striking but meaningless encounter: my brother-in-law, Jim Rasenberger and I both have books coming out within two weeks of each other. My book, The Ragged Edge of the World, is a farewell tour (the places are disappearing, not me) of the most remote reaches of the planet, and it tries to evoke life at that moveable frontier where wildlands and native peoples collide with modernity. His book, A Brilliant Disaster, examines the Bay of Pigs fiasco on its 50th anniversary.  To judge by their covers, the books are utterly different, but we thought it fun to schedule a joint book party midway between the two publication dates, For the sake of family harmony, if nothing else. The more I think about it, however, the more I realize that the two books investigate two aspects of the same thing: individual brilliance and collective stupidity.
 
            Jim looks at the foreign policy expression of this enduring puzzle as he explores the iconic American example of the fiasco that ensues when some of the smartest and most powerful men in the country-- the best and the brightest as David Halberstam indelibly called them-- become blinded by ideology and arrogant self-assurance (although the Iraq War is a strong contender to replace this example).  I look at what this syndrome has wrought as the march of progress continues to consume wildlands and peoples despite decades of evidence that this march-- more like a stampede, really-- leaves nothing but wastelands and disenfranchised peoples in its wake. There’s an element of black humor in both books. I tell this story through tragicomic vignettes, while, with the arch perspective of time, Jim lets the black humor of self-delusions of the times speak for themselves.
 
            Our two books converge in a more immediate way: in one chapter, I also write about the Bay of Pigs. Where for Jim, the Bay of Pigs provides a symbol of an epic fail of the intelligence and foreign policy apparatus, I look at some of the positive results of that failure. Today, the Bay of Pigs is a triumph of conservation and one of the natural wonders of the Western hemisphere. The Bay marks one boundary of Zapata Swamp, an Eden-like wetland the size of Delaware, with boundless bird-life and shimmering pure rivers. It is one of a string of great parks that make Cuba’s natural systems among the best protected in the world.
 
            How this happened is an object lesson in the ironic twists of history. The island stands today as a shining example of how a desperately poor country can preserve its natural systems. This is no endorsement of communism, a system that seems to have been designed to convert resources into pollution with minimum economic benefit. Karl Marx was focused on the control of the means of production, and was blind to environmental consequences (which is uncomfortably similar to  unregulated free-market capitalism which is focused on the private control of the means of production and simply ignores environmental consequences).
 
            The reason Cuba has not suffered the ecocide visited on the landscape by other communist governments has to do with three things: the collapse of the Soviet Union, the American embargo, and, most importantly the accident of history that an illiterate farmer who saved Castro’s life during the Cuban Revolution, turned out to be a nature lover. Elevated to be one of three Commanders of the Revolution, Guillermo Garcia Frias, provided political cover for an entire generation of conservationists and scientists who now have key positions in parks and environment.  The collapse of the Soviet Union starved Cuba of funds from its former patron, and the ongoing U.S. economic embargo has forced Cuba to be both innovative and sustainable, since it has lacked access to cheap fossil fuels. For the Bay of Pigs and Zapata Swamp this means that very few pollutants flow into the area from surrounding agricultural lands.
 
            The unexpected connections that link our two books prompt another question: what might have happened had the U.S.-sponsored invasion succeeded in 1961?  Without question, many Cubans would have gotten rich as developers exploited Cuba’s gorgeous coasts, lagoons and beaches. The mob would have gotten its casinos back, and Cubans of all stripes could experience the joys of fast food and the consumer society. But Zapata Swamp, which in structure is similar to the Everglades, would long since have been channeled, converted, polluted, and otherwise exploited like most other wetlands in the hemisphere, including the Everglades. So maybe The Brilliant Disaster Jim describes was for the best. Despite the many other benighted policies of this police state, Cuba may be one of the best-prepared nations to navigate what looks like a fossil fuel constrained future that the rest of the world may soon have to deal with. Sometimes good can come from having a superpower as an enemy.
 

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.