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Month: April 2012

Wall Street Math – Article by Douglas French

Wall Street Math – Article by Douglas French

The New Renaissance Hat
Douglas French
April 11, 2012

There’s plenty of blame for the financial crisis being spread around. Those on the left say Wall Street wasn’t regulated enough, while those on the right claim government mandates required lenders to make bad loans. The argument is made that the Federal Reserve was too loose, while the other side says Bernanke wasn’t loose enough. Some blame greed. Others blame Wall Street’s investment products. And then there’s mathematics.

Wall Street has become a numbers game played at high speed by powerful computers trading complex derivatives utilizing even more complex mathematical modeling. Writing for the Huffington Post, Théo Le Bret asks the reader to

Take the Black-Scholes equation, used to estimate the value of a derivative: it is actually no more than a partial differential equation of the financial derivative’s value, as a function of four variables, including time and “volatility” of the underlying asset (the derivative being a ‘bet’ on the future value of the asset). Differential equations are well-known to physicists, since such fundamental properties of nature as the wave equation or Schrodinger’s equation for quantum mechanics are given in the form of differential equations, and in physics their solutions seem to be very reliable: so why is this not always the case in finance?

Mr. Le Bret quotes Albert Einstein for his answer: “as far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.”

Murray Rothbard put it another way:

In physics, the facts of nature are given to us. They may be broken down into their simple elements in the laboratory and their movements observed. On the other hand, we do not know the laws explaining the movements of physical particles; they are unmotivated.

Rothbard goes on to make the point that human action is motivated and thus economics is built on the basis of axioms. We can then deduce laws from these axioms, but, as Rothbard explains, “there are no simple elements of ‘facts’ in human action; the events of history are complex phenomena, which cannot ‘test’ anything.”

Using the models that work so well for physicists, mathematicians on Wall Street got it spectacularly wrong in the mortgage and derivatives markets, just as mathematical economists can never predict the future with any accuracy. Motivated human behavior cannot be modeled.

But the mathematicians or “quants” underscore all of Wall Street’s financial engineering, a process that takes a few pieces of paper and folds their attributes together to make new products, most times hoping to avoid taxes and regulation. Author Brendan Moynihan describes this engineering in his book Financial Origami: How the Wall Street Model Broke.

Origami is the traditional Japanese art of paper folding wherein amazing shapes and animals are created with just a few simple folds to a piece of paper. Moynihan cleverly extends the metaphor to the financial arena, pointing out that stocks, bonds, and insurance are pieces of paper simply folded by the Wall Street sales force into swaps, options, futures, derivatives of derivatives, and the like.

The author is adept at describing derivatives in terms a person can understand. Health-insurance premiums are a call option to have the insurance company pay for our medical care. Auto insurance premiums are like put options, allowing the insured to sell (put) his or her car, if it’s totaled, to the insurer at blue-book value.

Nobel Prize winners have played a big hand in the creation of derivatives. Milton Friedman’s paper on the need for futures markets in currencies paved the way for that market in 1971. But as Moynihan points out, it was Nixon’s shutting of the gold window that created the need to mitigate currency and inflation risk.

Nobel Laureate Myron Scholes was cocreator of the Black-Scholes-Merton option-pricing model. He and cowinner Robert Merton used their model to blow-up Long Term Capital Management.

But it was little-known economist David X. Li’s paper in the Journal of Fixed Income that would provide the intellectual foundation for Wall Street’s flurry into mortgages. “On Default Correlation: A Copula Function Approach” became “the academic study used to support Wall Street’s turning subprime mortgage pools into AAA-rated securities,” writes Moynihan. “By the time it was over, the Street would create 64,000 AAA-rated securities, even though only 12 companies in the world had that rating.”

Robert Stowe England, in his book Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, says Li’s model “relied on the price history of credit default swaps against a given asset to determine the degree of correlation rather than rely on historical loan performance data.”

“People got very excited about the Gaussian copula because of its mathematical elegance,” says Nassim Nicholas Taleb, “but the thing never worked.” Taleb, the author of The Black Swan, claims any attempt to measure correlation based on past history to be “charlatanism.”

Subprime mortgages were bundled to become collateralized mortgage obligations (CMOs), which are a form of collateralized debt obligation(CDO). CDOs weren’t new; the first rated CDO was assembled by Michael Milken in 1987. But instead of a mixture of investment-grade and junk corporate bonds, in the housing bubble, CDOs were rated AAA based upon Li’s work.

Mr. England wryly points out, “A cynic might say that the CDO was invented to create a place to dump lower credit quality or junk bonds and hide them among better credits.”

England quotes Michael Lewis, author of The Big Short: “The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America.” For Wall Street it was a machine that “turned lead into gold.”

Wall Street’s CDO mania served to pump up investment-bank leverage. England explains that if level-3 securities were included (level-3 assets, which include CDOs, cannot be valued by using observable measures, such as market prices and models) then Bear Stearns sported leverage of 262 to 1 just before the crash. Lehman was close behind at 225, Morgan Stanley at 222, Citigroup at 212, and Goldman Sachs was levered at 200 to 1.

Leverage like that requires either perfection or eventual government bailout for survival.

The CDO market created the need for a way to bet against the CDOs and the credit-default-swap (CDS) market was born. Bundling the CDS together created synthetic CDOs. “With synthetic CDOs, Wall Street crossed over to The Matrix,” writes England, “a world where reality is simulated by computers.”

It’s England’s view that the CDO market “was the casino where the bets were placed. Wall Street became bigger and chancier than Las Vegas and Atlantic City combined — and more.” According to Richard Zabel, the total notional value of the entire CDS market was $45 trillion by the end of 2007, at the same time the bond and structured vehicle markets totaled only $25 trillion.

So the speculative portion of the CDS market was at least $20 trillion with speculators betting on the possibility of a credit event for securities not owned by either party. England does not see this as a good thing. It’s Mr. England’s view that credit default swaps concentrated risk in certain financial institutions, instead of disbursing risk.

In “Credit Default Swaps from the Viewpoint of Libertarian Property Rights and Contract Credit Default Swaps Theory,” published in Libertarian Papers, authors Thorsten Polleit and Jonathan Mariano contend, “The truth is that CDS provide investors with an efficient and effective instrument for exposing economically unsound and unsustainable fiat money regimes and the economic production structure it creates.”

Polleit and Mariano explain that credit default swaps make a borrower’s credit risk tradable. CDS is like an insurance policy written against the potential of a negative credit event. These derivatives, while being demonized by many observers, serve to increase “the disciplinary pressure on borrowers who are about to build up unsustainable debt levels to consolidate; or it makes borrowers who have become financially overstretched go into default.”

Mr. England concludes his book saying, “We need a way forward to a safer, sounder financial system where the power of sunlight on financial institutions and markets helps enable free market discipline to work its invisible hand for the good of all.”

Polleit and Mariano explain that it is the CDS market that provides that sunlight.

The panic of 2008 was the inevitable collapse of an increasingly rickety fiat-money and banking system — a system where the central bank attempts to direct and manipulate the nation’s investment and production with an eye to maximize employment. In a speech delivered to the Federal Reserve Bank of New York, Jim Grant told the central bankers that interest rates should convey information. “But the only information conveyed in a manipulated yield curve is what the Fed wants.”

Wall Street’s math wizards convinced the Masters of the Universe that their numbers don’t lie, believing they could model the Federal Reserve’s house-of-mirrors market. Maybe the numbers don’t lie, but the assumptions do.

Advising about mathematical economics, Rothbard wrote, “ignore the fancy welter of equations and look for the assumptions underneath. Invariably they are few in number, simple, and wrong.” The same could be said for Dr. Li’s model and Scholes’s model before him.

Until the era of unstable fiat-money regimes ends, the search for scapegoats will continue — because the crashes will never end.

Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply and Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master’s degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. French teaches in the Mises Academy. See his tribute to Murray Rothbard. Send him mail. See Doug French’s article archives.

This article was published on and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.

What People Mean When They Talk About Freedom – Article by Bradley Doucet

What People Mean When They Talk About Freedom – Article by Bradley Doucet

The New Renaissance Hat
Bradley Doucet
April 11, 2012

Most people I talk to believe that freedom is important. They generally want to be free, and they want others to be free as well. The disagreements only begin when we start discussing what, exactly, we mean by “free.” These disagreements over the meaning of liberty underlie a good part of the much-hyped polarization of politics in the western world.

One meaning, or set of meanings, is reflected in Freedom House’s annual Freedom in the World survey, whose findings for 2009 are available here. Freedom, according to this survey, is “the opportunity to act spontaneously in a variety of fields outside the control of the government and other centers of potential domination.” If that seems a little vague, the organization’s website gets more specific, breaking freedom down into two broad categories: political rights and civil liberties. Political rights allow people to “vote freely for distinct alternatives in legitimate elections, compete for public office, join political parties and organizations, and elect representatives who have a decisive impact on public policies and are accountable to the electorate.” Civil liberties include “freedoms of expression and belief, associational and organizational rights, rule of law, and personal autonomy without interference from the state.”

In the latest survey, fully 47 countries, ranging from Canada to Barbados, from the United States to Uruguay, get a perfect score of 1 for political rights and a perfect score of 1 for civil liberties. Only nine countries, including North Korea, Somalia, and Sudan, get the worst possible score of 7 on both counts. To get a sense of the spread, Argentina gets a pair of 2s, Turkey gets 3s, Kenya gets 4s, Ethiopia 5s, and Iran and Zimbabwe 6s.

Setting the Bar Too Low

This survey, however well-intentioned, suffers from two glaring deficiencies. First, it sets the bar way too low. By no stretch of the imagination are there 47 countries in the world that deserve perfect scores for freedom, even if we accept Freedom House’s criteria. Are civil liberties really perfectly safe in England, with surveillance cameras on every other street corner? Should the American Civil Liberties Union close up shop in an age of warrantless wiretaps, enhanced interrogation techniques, and jail time for smoking a joint? And here at home, how many Canadians really imagine that our proroguing Prime Minister is fully accountable to the public? I’m not saying I’d rather live in Zimbabwe—or Argentina, for that matter—but even in these relatively free countries of the Anglosphere, there remains plenty of room for improvement.

The other glaring defect in Freedom House’s survey is that it completely ignores economic freedom. There is no mention, for instance, of red tape, which costs small- to medium-sized Canadian businesses over $30 billion a year. No mention, either, of the eminent domain abuse that is rampant in the United States, robbing small property owners of their homes and shops in order to help some developer with deep pockets.

The Economic Freedom Network—with members in over 70 nations around the globe, including Canada’s own Fraser Institute—provides a picture of economic freedom in the world with its annual report. By its definition, economic freedom exists when property acquired “without the use of force, fraud, or theft is protected from physical invasions by others” and when individuals “are free to use, exchange, or give their property as long as their actions do not violate the identical rights of others.” More specifically, according to its latest report, to have high economic freedom, a country has to protect private property, enforce contracts, and have a stable monetary environment. “It also must keep taxes low, refrain from creating barriers to both domestic and international trade, and rely more fully on markets rather than the political process to allocate goods and resources.”

Compare and Contrast

Many of the countries that score highest in economic freedom are also at the top of the list in Freedom House’s survey of political rights and civil liberties, and conversely, most of the least free score dismally on both surveys. In fact, a graph in the Economic Freedom Network’s report shows this strong positive correlation. But there are some notable exceptions. Hong Kong and Singapore, first and second respectively for economic freedom with scores of 8.97 and 8.66 out of a possible 10, are only middling according to the Freedom House survey; and the United Arab Emirates (7.58) and Bahrain (7.56), 19th and 20th for economic freedom, are quite repressive on other counts, both scoring 5.5 according to Freedom House (with 7 being the worst possible combined average score).

Would I rather live in Singapore than in Canada, which placed 8th for economic freedom with a respectable score of 7.91? The trade-off in terms of civil liberties would probably be too high. But I would gain something in exchange for my loss. According to the Economic Freedom Network’s report, countries with higher economic freedom have substantially higher per capita incomes, higher growth rates, longer life expectancies, better environmental performance, and less corruption. The poor are also better off in absolute terms in countries with higher economic freedom, and no worse off in relative terms.

As a libertarian, I value both civil and economic liberty. I fault the authoritarian segment of the political right for running roughshod over the former, but I also fault an equally authoritarian segment of the political left for trampling the latter. But beyond this, I fault both sides of the spectrum for fetishizing political rights. Democracy is a tool, and it can be a useful one, but what good are elections if our representatives are not checked by a strict constitution from taking away our civil and economic freedoms? What good is accountability if the people don’t know or appreciate what is being taken away from them? Looking at it from the opposite perspective, if we cared enough and were wise enough to guard our civil and economic freedoms properly, would it matter very much anymore who administered the machinery of government? Yet without constitutional limits and the will to enforce them, political rights amount to the “freedom” to force others to do what we want—a power that interest groups will fight tooth and nail to wield.

As I am regularly reminded when I discuss libertarianism with my fellow Canadians, this is a pretty good place to live. Canada scores better than or as good as most places on the planet in terms of political rights, civil liberties, and economic freedom. This is a fact, and I am grateful for it. But does that mean we shouldn’t try to make life even better? Why are we so complacent, so ready to accept “pretty good” as good enough? Why are so many intelligent, educated people uninterested in even exploring what history’s great thinkers have had to say about liberty? Few Canadians, I wager, have even heard of Benjamin Constant, for instance. A champion of individual freedom two centuries ago, he viewed political rights as a collective kind of freedom, present in the ancient world, which was “compatible with… the complete subjection of the individual to the authority of the community.” Yes, Canada is a pretty good place to live, all things considered. When individuals are no longer subjected to the dictates of their fellows, free to live as they see fit and responsible for the consequences of their own actions, it will be a great place to live.

Bradley Doucet is Le Quebecois Libré‘s English Editor. A writer living in Montreal, he has studied philosophy and economics, and is currently completing a novel on the pursuit of happiness. He also writes for The New Individualist, an Objectivist magazine published by The Atlas Society, and sings.

Update to Resources on Indefinite Life Extension – April 8, 2012

Update to Resources on Indefinite Life Extension – April 8, 2012

The New Renaissance Hat
G. Stolyarov II
April 8, 2012

TRA’s Resources on Indefinite Life Extension page has been expanded today with links to the following additional articles from the recent past:

– “Discovery in Salamanders Could Lead to Human Limb Regeneration” – Maria Konovalenko – November 1, 2010

– “Aging Reversed in Mice: Have Scientists Found Key to Immortality?” – Sammy Rose Saltzman – CBS News – November 29, 2010

– “Kazakhstan President for Life Asks for More Life” – Joshua Norman – CBS News – December 7, 2010

– “Researchers jumpstart nerve fibers to reverse stroke damage” – Maria Konovalenko – December 10, 2010

– “Here is the Research Needed to Combat Aging” – Maria Konovalenko – December 13, 2010

– “President of Kazakhstan urges scientists to unlock the secret to immortality” – Maria Konovalenko – December 13, 2010

– “Stem cells used to grow functioning human intestine” – Maria Konovalenko – December 15, 2010

– “The main result of the year – The first regenerative medicine surgery in Russia” – Maria Konovalenko – December 30, 2010

– “Food Freezing Technology Preserves Human Teeth. Organs Next?” – Constance J. Woodman – Singularity Hub – January 23, 2011

– “Freezing without cryoprotectants” – Maria Konovalenko – January 29, 2011

– “True DIY Biology: Man Designs and Produces Own Aortic Implant” – Maria Konovalenko – February 3, 2011

– “One Drug to Shrink All Tumors” – Sarah C. P. Williams – Science Magazine – March 26, 2012

– “Are Cancer Stem Cells Ready for Prime Time?” – Suling Liu, Hasan Korkaya, and Max S. Wicha – The Scientist – April 1, 2012

– “‘Backpacking’ bacteria to deliver nanomedicines in the body” – – April 2, 2012

– “Scientists report major breakthrough in age-related macular degeneration prevention” – – April 8, 2012

I encourage you to explore these articles and discover how science has been advancing in recent years with the aim of eventually extending your longevity and health.

ECM Distributed Computing Project and Mr. Stolyarov Discover Factor for 118^67 + 67^118

ECM Distributed Computing Project and Mr. Stolyarov Discover Factor for 118^67 + 67^118

The New Renaissance Hat
G. Stolyarov II
April 6, 2012

I am pleased to announce that my participation in the ECM distributed computing project (organized via Yoyo@home) has resulted in the discovery of a hitherto unknown factor for a large number. I am credited with the discovery here.

Did you know that the number 118^67 + 67^118 (see its long form here) has a multiplicative factor of 2091937057168244837833711997693707725557784572281 – a formidable 49-digit number?

Well, now you know, because of all the computing power I have devoted to the ECM project since late 2011. Finding such large factors of even larger numbers is a rarity. My computer had to examine 1546 project workunits (each involving an attempt to factor a large number) before finding one that resulted in a new discovery. I have thus far accumulated 277,345.88 BOINC credits for the ECM project.

ECM is a free distributed computing project that anyone can participate in. Its goal is to find factors for large numbers using the method of Elliptic Curve Factorization. It is highly rewarding to be able to devote otherwise idle resources to an endeavor for the convenient discovery of previously unknown truth.

Piano Composition #6, Op. 10 (2002) – Video by G. Stolyarov II

Piano Composition #6, Op. 10 (2002) – Video by G. Stolyarov II

Mr. Stolyarov wrote this original composition in Spring 2002. This work resembles a light, brisk march and conveys a sense of purpose and aspiration.

Download the MP3 file of this composition here.

See the index of Mr. Stolyarov’s compositions, all available for free download here.

The artwork is Mr. Stolyarov’s Abstract Orderism Fractal 32, available for download here and here.

Remember to LIKE, FAVORITE, and SHARE this video in order to spread rational high culture to others.

Piano Composition #7, Op. 12 (2002) – Video by G. Stolyarov II

Piano Composition #7, Op. 12 (2002) – Video by G. Stolyarov II

Original piano composition by Mr. Stolyarov, created in 2002 and played in the Finale 2011 software using the Steinway Grand Piano instrument. The melody is brisk, uplifting, and refined.

Download the MP3 file of this composition here.

See the index of Mr. Stolyarov’s compositions, all available for free download, here.

The artwork is Mr. Stolyarov’s Abstract Orderism Fractal 38, available for download here and here.

Remember to LIKE, FAVORITE, and SHARE this video in order to spread rational high culture to others.

Technology as the Solution to Existential Risk

Technology as the Solution to Existential Risk

The New Renaissance Hat
G. Stolyarov II
April 2, 2012

What is the relationship between technology and existential risk? Technology does not cause existential risk, but rather is the only effective means for countering it.

I do not deny that existential risks are real – but I find that most existential risks exist currently (e.g., risks from asteroid impacts, a new ice age, pandemics, or nuclear war) and that technological progress is the way to remove many of those risks without introducing others that are as great or greater.  My view is that the existential risks from emerging technologies are quite minor (if at all significant) compared to the tremendous benefits such technologies would have in solving the existential risks we currently face (including the biggest risk to our own individual existences – our own mortality from senescence).

My essay “The Real War – and Why Inter-Human Wars Are a Distraction” describes my views on this matter in greater depth.

In short, I am a techno-optimist, one who considers it imperative to restore the Victorian-era ideal of Progress as a guiding principle in contemporary societies. The problem, as I see it, is not in the technologies of the future, but in the barbarous and primitive condition of the world as it exists today, with its many immediate perils.

As a libertarian, I believe that the entrepreneurship and innovation in even semi-free markets can address existential risks far more effectively than any national government – and bureaucratic management of these efforts would only hamper progress while incurring the risk of subverting the endeavors for nefarious objectives. (The National Security Agency’s recent attempt at a total surveillance state is a case in point.)

But fears of technology are our greatest existential risk. They have a real potential of halting progress in many fruitful areas – either through restrictive legislation or through the actions of a few Luddite fanatics who take it upon themselves to “right” the wrongs they perceive in a world of advancing technology. I can point to examples of such fanatics already exploiting fears of technologies that are not even close to existing yet. For instance, in a post on the LessWrong blog, one “dripgrind” – a sincere and therefore genuinely frightening fanatic – explicitly advocates assassination of AI researchers and chastises the Singularity Institute for Artificial Intelligence for not engaging in such a despicable tactic. This is the consequence of spreading fears about AI technology rather than simply and calmly developing such technology in a rational manner, so as to be incapable of harming humans. Many among the uneducated and superstitious are already on edge about emerging technologies. A strong message of vibrant optimism and reassurance is needed to prevent these people from lashing out and undermining the progress of our civilization in the process.  The Frankenstein syndrome should be resisted no matter in what guise it appears.

Gains for Ron Paul at the Douglas County Republican Convention in Nevada – and Outrageous Rigging in Carson City

Gains for Ron Paul at the Douglas County Republican Convention in Nevada – and Outrageous Rigging in Carson City

The New Renaissance Hat
G. Stolyarov II
April 1, 2012

Ron Paul has been gaining ample numbers of supporters as delegates to the Nevada State Republican Convention. I am proud to have participated in the March 31 Douglas County Republican Convention, which was civil and administered quite fairly. Both my wife Wendy and I have been selected as delegates to the Nevada State Convention, along with a sizable number of other supporters of Ron Paul (a majority, by some accounts). As an added bonus, I had the opportunity to speak in favor of individual liberty on a variety of issues during the discussions of the proposed Douglas County GOP platform.  It pleased me that speakers were recognized in a procedurally impartial manner, and each side of an issue was always able to express its views.

Nearby in Carson City, however, there was foul play and subversion of the legitimate process by those who wished to rig the outcome. I encourage you to read Doug Wead’s description of some of the outrageous usurpations of power by those in charge at that unfortunate convention. The contrast between the civility and good order in Douglas County and the overt abuses at the Carson City convention is stunning. In any event, with the majority of the delegates from Clark County, a sizable contingent from Douglas County, and all of the delegates from Nye County, Ron Paul will have a good number of delegates on his side at the State Convention on May 5.