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...
The Ragged Edge of the World
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rapid climate change
Winds of Change
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Afterword to the softbound edition.
The Octopus and the Orangutan
The Future In Plain Sight
The Parrot's Lament
Affluence and Discontent
The Alms Race
Apes, Men, & Language
How the world waited too long to rescue the shield that protects earth from the sun's dangerous UV rays
BY EUGENE LINDEN
Monday, May. 10, 1993
It is hailed as the greatest success yet in the defense of Planet Earth. Many a President and Prime Minister present themselves as the saviors of the ozone layer -- the leaders who rescued the fragile atmospheric shield that protects all living things from the sun's dangerous ultraviolet rays. This airbrushed view of history starts in 1985, when scientists realized that an ozone hole had opened over the South Pole -- the result of an atmospheric assault by man- made chemicals called chlorofluorocarbons, which are commonly used in refrigerators and air conditioners. Soon after this disturbing surprise, the diplomats of the world were at the negotiating table. By 1987 they had reached a preliminary agreement to phase out production of CFCs, and by 1990 they had set 2000 as the target year for a total ban. Now most countries expect to beat that deadline by many years because substitutes for CFCs are coming on line more rapidly than expected. The central player in the drama -- the unwitting villain turned hero -- was Du Pont, the American chemical company that invented CFCs, dominated global production and eventually led the way in developing substitutes. In 1990 the U.S. Environmental Protection Agency gave Du Pont an award for stratospheric ozone protection.
There is only one problem with this fabled success story: the rescuers may have arrived too late. No matter how quickly manufacturers halt the production of CFCs, billions of pounds of the chemicals already produced will continue to seep into the atmosphere and rise inexorably to attack the ozone layer. Worse, measurement after measurement since the mid-1980s has shown that ozone loss has been greater and more rapid than scientists predicted. Last month in Science magazine, researchers disclosed new satellite readings showing that in 1992 the average concentration of ozone in the upper atmosphere around the globe was 2% to 3% lower than any previous reading and 1.5% below what computer models predicted. That news came just a week after the World Meteorological Organization reported that ozone levels over some northern parts of Europe and Canada fell as much as 20% this winter.
The amount of CFCs in the atmosphere will keep rising until at least the year 2000; after that it may slowly fall, but ozone destruction will continue for several decades in the 21st century. Some optimistic scientists predict that the impact on the heavily populated middle latitudes will be tolerable: at worst, a 6% ozone loss during the summer months, which could cause a 12% increase in ultraviolet radiation. But these forecasts are based on the same computer models that have consistently underestimated the problem. Given the volatile and poorly understood chemistry of the upper atmosphere, no one can predict how severe the ozone depletion will be. Even a modest rise in the level of UV radiation could increase the risk of getting skin cancer or cataracts, damage crops and other plant life, and possibly affect climate patterns.
Did the world really act as fast as possible to meet the threat? The answer, unfortunately, is no. The eventual rescue operation was the last chapter in a long saga of confusion, wishful thinking, indecision and delay. For nearly a decade before the 1987 ozone treaty, nations were warned of the danger but did nothing. In the U.S. those who had the power to take action instead engaged in self-delusion: the Reagan Administration at first dismissed the ozone threat as a nonissue, while Du Pont and other manufacturers underestimated future sales of CFCs, making the hazard seem minimal.
The story is more than a matter of historical interest; the world may pay dearly for the delay. What happened with ozone is a cautionary tale that is relevant to how countries deal with other global environmental issues, such as the scientific forecasts of global warming. So far, leaders have put off dealing with that danger, just as they did with the ozone problem.
The alarm first sounded back in 1974, when Sherwood Rowland and Mario Molina of the University of California at Irvine warned about the destructive impact that CFCs could have on the atmosphere. Before banning these important industrial chemicals, however, scientists had to confirm that CFCs did in fact attack ozone and that society produced enough of the chemicals to create a ! problem. Within a few years, most scientists accepted that CFCs were a real threat, though uncertainties remained. In 1978 the U.S. banned the use of CFCs in aerosol sprays and began pushing for international controls.
The election of Ronald Reagan, abruptly interrupted these American efforts. The EPA was taken over by a pro-business team that did not like regulations and distrusted international agreements. Anne Burford, who headed the EPA in the early 1980s, regarded ozone depletion as an unsubstantiated scare story. Many demoralized professionals resigned, leaving the agency with few people who had any background on the issue.
Du Pont, which poured $15 million into developing substitutes during the late 1970s, all but halted its research shortly after Reagan's election because no further regulation was on the horizon. Earlier, Du Pont had publicly committed itself to stop production of CFCs if "reputable evidence" showed they posed a hazard to the ozone layer. The company, however, set a tough standard for what constituted "reputable evidence." Du Pont challenged Rowland at every turn in the 1970s, and he believes the company's aggressiveness sent a chilling message to other scientists in the field.
One of the crucial questions for policymakers was whether CFCs would remain in the atmosphere for a long time. Asked today when it was proved that CFCs could hang around for many decades, Du Pont scientists readily acknowledge that the issue was largely put to rest in the '70s. As late as 1982, however, a Du Pont scientist was still arguing in print that CFCs were short-lived.
In what turned out to be a masterstroke of lobbying, Du Pont took the lead in organizing the Alliance for Responsible CFC Policy in 1980. It was an unusual trade organization, since it brought together both producers and users of a product, groups that usually have opposing agendas. The manufacturers realized that representatives from small American businesses spread through every congressional district would have far more impact on lawmakers than a few giant chemical companies. "I remember a parade of CFC users coming through," says U.S. Senator John H. Chafee of Rhode Island, "telling me what I was going to do to their refrigeration business if they were denied these marvelous CFCs." Partly because of the alliance's lobbying, support for additional U.S. limits on production dried up in Congress.
Despite the antiregulatory mood, there is little doubt that the U.S. and other governments would have taken action if policymakers had received unambiguous scientific signals on the dangers of CFCs. But soon after the Reagan Administration came into power, some scientists began to question how serious the problem would be. One section of a 1983 National Academy of Sciences update on ozone suggested that if CFC production remained flat, total ozone loss might not be as severe as previously expected.
Du Pont and the alliance immediately seized on the no-growth scenario. Influential atmospheric specialists, such as Robert Watson, who recently moved to the White House staff from NASA, were persuaded that the CFC industry would not be expanding. Watson recalls that Du Pont spokesmen appeared at meeting after meeting arguing that the CFC market was "mature." With these reassurances, some scientists felt less immediate need for further regulations.
The industry vociferously countered opponents' suggestions that the CFC market was, in fact, growing. When Ralph Cicerone, an atmospheric chemist at U.C. Irvine, gave a talk at Columbia University in 1984, his assertion that the CFC market was expanding drew what he remembers as a heated "personal attack" from Du Pont manager Donald Strobach, who served as science adviser to the alliance. Cicerone had data from the EPA and the Rand Corp., but Strobach said that his figures were scandalously wrong and that Cicerone was being irresponsible.
Actually, Cicerone was correct. After a sharp drop in world production during the deep recession of 1982, output resumed a climb that had begun in the late 1970s. In March 1983 the Chemical Marketing Reporter predicted 4% to 5% growth each year in CFCs through 1987. Actual production outpaced predictions: output increased roughly 7% a year.
Du Pont officials insist they did not know the market for CFCs was going to grow until 1986. In March of that year, frustrated EPA officials arranged a showdown that participant Alan Miller, then an attorney with the Natural Resources Defense Council, described as "analysts at the O.K. Corral," and confronted the industry with three independently produced studies showing that without regulation, CFC production would grow. Says F. Anthony Vogelsberg, a Du Pont environmental manager: "You have to understand what we were looking at. If you smoothed the data between 1980 and 1983, you had a flat market . . ." Du Pont argued that the market in the developed world was mature, but it is farfetched to suggest that the world's largest manufacturer of CFCs did not realize there was tremendous untapped demand for refrigeration among the huge populations in the developing world. Moreover, the market for CFC113 (used to clean electronic circuit boards) was exploding.
The dispute over the potential of the CFC business eventually hurt Du Pont's credibility. Watson, who earlier believed industry assertions, now says bitterly, "We listened when they said this was a mature business, but we now know that they were stating lies."
In September 1986 Du Pont suddenly broke ranks with other manufacturers and reversed its position. It admitted that the CFC market was growing and acknowledged the need for international controls on production. At about this time, the chemical giant resumed its research into CFC substitutes. Once the company changed its mind, it moved quickly. In 1988 Du Pont pledged to get out of the business by 2000. But humanity may pay a price for the years of delay; between 1978 and 1988, nearly 19 billion lbs. of CFCs were produced worldwide.
At a time when environmental policymakers are being accused of wasting resources on exaggerated threats, such as dioxin contamination, the ozone story shows what can happen when the world underestimates problems. It also underscores the difficulty of imposing environmental regulations that clash with economic interests, especially in the face of scientific uncertainty. If policymakers wait until there is unarguable evidence of danger before they act, it may be too late to prevent serious environmental damage.
This dilemma is now being faced on a related issue, that of carbon dioxide emissions and the global warming they could cause. Even though scientists are still debating how bad the warming trend might be, President Clinton has pledged that the U.S. will draw up a plan to get emissions of carbon dioxide and other greenhouse gases back to 1990 levels by the year 2000. But will the plan, which may be opposed by utilities, automakers and a host of other business interests, make it through Congress? Corporate forces have already come up with their own version of the CFC alliance, called the Global Climate Coalition. One of the founding members: Du Pont.
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.
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?
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.