Holiday reading: Paper Promises by Philip Coggan

Ah, the good feelings of having been away for a couple weeks.  Now it’s back to work.

Worth a read.  Source:

Worth a read. Source:

Among the spires of York (great place to visit, by the way), I took the opportunity for some light holiday reading.  As mentioned in my About page, the books I favour tend to favour financial history.  This trip’s selection was Paper Promises: Money, Debt and the New World Order by Philip Coggan.  Overall, a great read for folks like me: plenty of history, easy reading – bordering on ‘page turner’ material.  Some thoughts:

  • The author is a long-time financial journalist; most recently the Buttonwood columnist for The Economist.  That was a big draw for me, as I’m a fan of the magazine’s writing style.
  • An early focus for the book was the path of using precious metals for money over time.
    • One strand I hadn’t considered before was the impact of the Industrial Revolution and rapid productivity gains on prices: there was a huge increased demand for money as more and more goods were produced and traded, which would’ve meant disastrous deflation unless more gold/silver arrived in Europe at about the same time (thanks to new mines, this is what happened).
    • The gold standard, as many Americans think of the early 20th century, was actually an exercise in fiat money anyway: only a small proportion of the paper money supply was kept in gold.  The repeal of the US gold standard in 1971 happened because the bluff was called, in a way!
    • Early experiences with paper money (e.g. France in early 1700s) were pretty disastrous; I wonder what will happen in future, when the temptation to print to cover growing liabilities rises considerably…
  •  I really liked the narration around the 2007-2008 crisis, in particular answering the question “Where did all the money go?”  Great exposition around the conundrum that perceived ‘value’ for things like housing and other assets assumes they can be sold without moving the market; if everyone wants to sell houses at the same time, the lost ‘value’ when selling at a discount never actually existed…it was merely an imagination of the person holding the house.
  • The final part of the book reflects on post-crisis financials, particularly the intergenerational transfer of wealth that I’ve touched upon before.  Things are not looking well for many governments’ finances.
  • In sum: well worth reading, though the final part of the book is a bit dated already (so policy prescriptions might raise eyebrows).  Loved the writing style and history.

Prophetic and reasoned: hedge funds and financial complexity

OK, one more post on the book I mentioned last time.  The conclusion of this 2007 book has one of the best paragraphs I’ve read on the financial system – with the benefit of 20/20 hindsight, of course (emphasis mine):

Market crises are not born from nature. They are not transmitted by economic or natural catastrophe. The machinery of the market itself can take a small event and distort it. The more closely we try to follow the ideal, thereby adding complexity and more tightly coupling the actions of the market, the more frequently crises will occur. Attempts at that point to add safety features, to layer on regulations and safeguards, will only add to the complexity of the system and make the accidents more frequent. And when blowups happen in the future I can guarantee that the focus will be directed improperly: not at the issues of market design but at hedge funds where the events are observed. They will be implicated for the simple reason that they are engulfing more and more of the risk-taking landscape. The perception of hedge funds being what it is, they will take the blame and become subject to increased regulation. But blaming hedge funds is a little bit like The Simpsons episode in which a meteorite hits Springfield and the townspeople gather, shouting, “Let’s burn down the observatory so this never happens again!” True, the hedge funds are the institutions that have the appetite for the risk; but there is nothing inherent in hedge funds, nothing that they represent as a unified set, that makes them the singular cause of anything.


  • A lot of financial alchemy transforms one type of risk (e.g. liquidity risk) into another type of risk (e.g. correlation risk).  An example from 2007 was the proliferation of RMBS CDOs and their synthetic cousins: they took a simple, illiquid asset (a mortgage) and created a liquid asset with a sting in its tail (the CDO).  The latter risk wasn’t obvious until the horribleness of 2008 occurred.
  • The fallout from the credit crunch/financial crisis did indeed focus on hedge funds, both the investor-funded versions and the bank-funded prop desks.  But this was misguided, in my opinion: the gains made by Paulson and others were massive, but were only a symptom of underlying issues with the US housing market.  Remember: once these liquid RMBS CDOs were widespread, and default correlation assumed constant, we believed there was no longer need for mortgage underwriting scrutiny.
  • Regulators have had a field day with adding considerably more safety checks/switches since the crisis; the uncertainties around Dodd-Frank and several other pieces of legislation (e.g. how will they ever implement and police so many new rules?) may lead us back to crisis.  For example, we now have banks which have cut lending to shore up capital positions; ‘shadow banking’ to fill the gap in credit; hedge funds specifically designed to arbitrage the capital treatments of different sources of bank capital; etc.  How will it end?

In sum: in many situations, more rules may not equal better risk management.  Probably good to know for trading, as well as life in general.

What cockroaches can teach traders: reading list

A well-defended cockroach. Source: Google images.

A well-defended cockroach. Source: Google images.

The latest on my reading list is A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation by Richard Bookstaber.  It’s a bit dated, but right on the mark for what was to come in 2008.

The author’s experiences with risk management in a world of increasing financial complexity is the main theme of the book.  Now that I’m nearing the end, I’ve found a tasty morsel of advice for systematic traders – or, indeed, just about anyone.  Seek simplicity and robustness in system design/management.  The author uses biological systems for his metaphors; in this case, the very simple defence mechanism of the cockroach results in lots of false positives (i.e. the roach is too conservative), but is therefore well equipped to handle the unknown unknowns of the world.  His counterexample is a fish in Lake Victoria: very specialised for its environment – but gets wiped out when a foreign species is introduced.  Though the fish was perfectly designed for its environment – optimal in a lot of ways – it was ill-prepared for external shocks.

This reminds me of several folks’ ideas of systematic trading: why can’t we just program the algorithm to take all the (in hindsight) obvious precautions to avoid losses?  Well, aside from the observation that many of the precautions actually cost us in the long-run, a hyper-specific trading system is basically useless going forward.  The markets continue to make fools of us all; therefore we need to choose systems which have more robust (read: simplistic) trading and risk management.  Not only will that probably keep us profitable as markets change, they will probably be better equipped to survive external shocks.

As an example (but not meant as a plug): trend-following strategies are beautiful to me.  They’re extremely simplistic trading rules, with built-in risk management.  The latter is usually pretty blunt (e.g. stop-losses, or just signal reversals), but means good risk control in a variety of cases.  That’s probably why trend-followers have been around for decades, quietly churning decent – though maybe not show-stopping – performance through crises and more normal times.

What I’m reading: Time to Think

What better way to spend the holidays than reading on topics far away from the day-to-day.  In my case, the main themes for the break were Britain/Wessex during the middle ages (i.e. around 870-900 AD) and communication/leadership.  It seems a bit silly to read on the latter topic, given my only ’employee’ is a (very well behaved) Mac Pro, but I’ve enjoyed learning about listening/managing/general ‘woo-woo’.

The most recent book I read on the communication topic is Time to Think by Nancy Kline.  A key observation from the book is that, particularly in a work environment, folks feel the need to constantly be heard – whether that means interrupting others, making suggestions of varying helpfulness, etc.  Expediency is the key, without regard to forethought.  The result is a lack of thinking, particularly that which is clear and useful.

So the fix for this problem is pretty simple: listen carefully, and listen more.  Though the author goes into some formulaic approaches for encouraging thinking at team meetings and one-to-one sessions, that main idea carries throughout.  Having used some of the techniques at home, I can truly say that simple solution works remarkably well (though is actually pretty difficult for me to action – I’ve a tendency to jump to conclusions and/or complete sentences).

Thinking upon the book’s messages in my past career, I can now see a similarity between the managers I really enjoyed and their ability/willingness to listen carefully to my (sometimes idiotic) ideas and respond appropriately.  Yes, a lot of ideas were eventually thrown in the proverbial bin, but the main point was I felt like I was valued and I contributed.  Strange how listening leads to the feeling of being valued, which leads to better ideas.  Or at least more job satisfaction.

In sum: a challenge for you, the reader.  The next time you find yourself in a conversation with a significant other or colleague about an important topic:

  1. Look him/her in the eye and listen carefully (no interruptions!!) until he/she is finished.
  2. Ask if there’s anything else he/she would like to say before making ANY comment.  Then listen more.
  3. When you do make a comment, begin with encouragement (even a ‘very interesting’ will do).
  4. That’s about it.