Beware Ben Stein's Twisted Math

by: Roger Ehrenberg January 29, 2008    
Roger Ehrenberg

Roger Ehrenberg

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"How To Lie With Statistics" is the title of a legendary book written in 1954 by Daniel Huff. In short, it explains to the layperson how they can be misled by the way information is presented, how those serving up the figures can be economical with the truth and to generally be on guard when consuming numbers, charts and graphs.

Well, my bells were going off as if I were in the midst of a five-alarm blaze as I read Ben Stein's piece in yesterday's New York Times. It is articles like these for which Mr. Huff's book was written: reader beware. Because if you take Mr. Stein's figures on their face, you might actually believe his thesis. However if you dig down a few layers and think a little bit, it doesn't take long for you to realize that what he is saying is the same weak-minded analytical drivel that he has been dishing out with such frequency of late.

I don't know why, but what I do know that articles like these are dangerous because they contribute to a perception - no, a mania - that Wall Street is rotten to the core. And this is simply not true. Do problems exist? Of course, they do everywhere. But the extent of Mr. Stein's indictment is both factually inaccurate and actually destructive of the conversations we should be having on how things should be fixed (like, say, the post I wrote yesterday concerning lessons we can learn from the recent crisis). In any event, the article was truly a drivel-fest and worthy of much scorn and derision.

In short, Mr. Stein's thesis is that traders push the market around, plant stories with the press, get the hype machine going, and make a ton of money on the backs of dumb retail investors like you and me. Sure Ben, I'm sure every trader out there wishes it were only that easy. Unfortunately it isn't. Your deep-seated conspiracy theories are coming to the surface again, Ben. There are the little issues of the depth of liquid markets (in terms of being effective in pushing it around except around small moments in time, i.e., the close) and the shallowness of illiquid markets (in terms of how do I get out without giving up all my ill-gotten gains?).

The world has gotten very flat when it comes to the liquid markets, and if certain traders are trying to push the market in irrational ways there are always those who are willing to take the other side and push back just as hard. Eventually the market settles where it should based upon fundamentals, but for short periods of time it can deviate for any number of reasons. But to say that a trader's core strategy is to establish a position, devote massive energy to hype it and then have the ability to profitably exit is a pure flight of fancy. It's just not that simple. Sorry.

Now here is one of those number "facts" you've got to view with a jaded eye.

Note that the losses in United States markets alone are on the order of about $2.5 trillion in recent weeks. How can a loss of roughly $100 billion on subprime — with some recoveries sure to come as property is seized and sold — translate into a stock-market loss 25 times that size? The answer is trader realism.

Ok, now maybe it's just me, but I've come to believe that the subprime issue has moved well beyond subprime portfolios themselves, no? In fact, I've written about this, and others have written about this extensively. Falling housing prices. Less purchasing power. An over-leveraged and distressed consumer. Locked credit markets. Falling corporate profits. Broken bank balance sheets. Diminished earnings expectations. Might this, when you capitalize the impact of these adverse events, equal 25x the subprime losses? I'd say so. And this doesn't even take into account the possibility of subprime losses far exceeding the $100 billion mark. This isn't called trader realism, Ben. It's called reality.

Here is yet another example of twisted math:

The losses in the stock market since the highs of October 2007 are about 14 percent. This predicts — very roughly — a fall in corporate profits of roughly 14 percent. Yet there has never been a decline of quite that size for even one year in the postwar United States, and never more than two years of declining profits before they regained their previous peak.

Here we've got the issue of a "stock" versus a "flow," namely, the difference in accounting parlance between those things that are measured at a point in time (i.e., a balance sheet) versus those that occur over time (i.e., financial projections). How does one equate a present value decline with an annual measure of a like amount? I'm not sure how Ben found economics so easy in school as his powers of numerical reasoning are sorely challenged. A 14% drop in the value of the stock market (a stock) equates to a fraction of the present value of an expected 14% decline in corporate profits into the future (a flow). Why he attempts to link these two disparate concepts is a mystery to me. I'm still scratching my head over this one.

And his grand conclusion in the wake of such analytical and logical rigor:

In other words, traders are sending stocks down by a fantastically larger amount than is warranted by a recession or the losses in subprime. How and why does it happen? As someone said in the movie: “Forget it, Jake. It’s Chinatown.” It’s just Chinatown in trader-land, where money is made and there is no perspective.

So when you see the market gyrating wildly downward and hear some pundit saying it’s because of this or that data or this paradigm or that ratio, remember trader realism. The traders move the market any way they want, any way they think they can make money, and then they whisper a reason to journalists later in the day. Then the journalists print it or say it on television, and the amateurs believe it. And the traders snicker.

I think maybe he and Charlie Gasparino have been hanging out and sharing conspiracy theories while bowling or something. They both purport to "know" Wall Street and to "understand" the trading community, but little in what they say or write comports with any experience I've ever had in my 20+ years in the financial markets. I am much more concerned with compensation regimes, risk-taking and risk measurement on Wall Street, the real factors which drive trader behavior. With increased market liquidity, "dark pools" and the rise of offshore exchanges, it is harder than ever to game the system (smacking the close, trying to skew VWAP, stuff like that).

And the thought that each trader has their little hotline to their journalist of choice is sheer fantasy. They are trying to manage their book and not get slammed while taking a piss. Because in today's hyper-volatile, super-flat world, you'd better get your positions straight or you could meet with an unhappy fate. But Ben would have you believe that all these traders are just having a grand old time and laughing at us all the way to the bank. Yeah, right.

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This article has 7 comments:

  •  
    Jan 29 10:54 AM
    With all due respect to your commentary Wall Street and the structures (law and accounting and regulatory) which support it are not rotten to the core. Their core is greed and cowardise and THAT core is alive and well. Nothing rottent there. It is what it is and nothing has really changed much.

    Yes, there was a time when having an honorable reputation meant more than how much money one made or "controlled"... It is a curious thing that honor is not quite defined the way it once was. The only time we speak of honor in business is when we refer to the 19 year old going off to Iraq with a gun. Honor isn't even in the business lexicon.

    Fiduciary duties. That phrase and the notion behind it have been so bastardized in our culture that it would generate digust amongst the men who were responsible for putting creating this country.

    Yes, not all traders are bad people. They are trying to make a living by being clever and what the hell, nothing wrong with that. When cleverness is the goal - the battery from which one is energized - all manner of behavior that would otherwise be ethically repugnant is justified. That is the nature of how the game works.

    The only problem with the nature of the game being as it is - is that there are consequences and the players in the game do not want to bear any responsibility for their behavior.

    If they were black and uneducated society would lock them away. They aren't and so they are allowed to keep going and reincarnate themselves down the street.

    It is a curious thing really. In the Middle East all of the major players offer Shari'a compliant products and services. Embedded in these offerings is a higher fiduciary standard of care that what is offered her in the US. Isn't that interesting. Wall street offers a higher fiduciary standard to its Arab customers than it does to its American customers.

    There is a reason for that. The Arabs demand it and we don't. It is that simple. Here the bull---- created by Wall Steeet is tolerated and promoted. Regulators go along because that is what they do. The Federal Reseve is nothing more than an advocate for the banking system. Think Teamsters and trucking and you will have the right analogy.

    So, under the premise that you get what you deserve in life. We, as a culture have what we deserve. The seeds we plant and the condition of the soil in which they are planted NATURALLY produce what we have. That is the marketplace.

    Defend it and you defend all of its consequences.

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  •  
    Jan 29 12:48 PM
    Roger, you raise very important points. But I don't think "lying with statistics" is what Ben Stein is doing. After all, 10 financial analysts can review the same statisical data and come up with very different recommendations, so to avert the same trap that Ben Stein falls into, we should avoid too much inference regarding his intentions.

    Once can explain Ben Stein's "data" in many ways, including simple modeling of the stock market (in the context of stocks and flows using MIT systems model paradigms, which is what we use). Certainly Ben Stein's "intelligent design" world outlook spills over to how he looks at the stock market, but like nearly everyone who has been financially hurt, he is reacting emotionally in his own voice.

    However, in reacting to Ben Stein's personal and faulty logic, one can easily create the exact opposite, which is another personal and faulty logic. In order to avoid "The Moral Hazard" the market system needs more self-correcting mechanisms (or self-regulating feedback loops) that kick in before the large financial excursions happen.

    mnrtrading.blogspot.co.../
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  •  
    Jan 29 02:49 PM
    Maybe Ben Stein is wrong; maybe he's right. All I know are the few situations that cause me to look at any point of view as prejudiced in some way. Jim Cramer made some comments about the market and suddenly most everybody concerned threw a F....g nutty! I know the realities in my little pissant job and I know that they are "somewhat contrary" (Hahahaha) to the reality that I will present to you otherwise. I know that when my friends get drunk enough they will echo my moral relativism when talking about what "really" goes on. I LOVE waiting for people to get fired or retired or finally so spiritually disgusted with themselves that they see some sort of atonement in finally telling their reality of things. Of course, they get marginalized quickly. Hey, who knows? Maybe they are only disgruntled young/middle-aged/old white/black/asian men/women with a substance of their/your choice abuse problem whom we've tried to help but their condition has not improved and so they are going to persue personal interests anywhere but here so that we can distance them/us as far as possible so that NOTHING CHANGES! Wayne has a good point about the Sharia-compliant thing but I believe it doesn't lay in the "acceptance" so much as in the "consequences&quo... Take a look at what happens in China if you screw up. Don't remember the particulars, but the DUDE is DEAD. Can't see that happening here. Let's go to Europe. Remember the Vatican Bank thing that never happened. Made a couple of movies about that. That's SMART! Marginalize the event! And so it goes and will ...
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  •  
    Jan 29 03:38 PM
    What struck me about the B. Stein piece wasn't what he said but what he left unsaid: in his attempt to claim that the current economic is healthier, whatever share prices do, Ben Stein is apparently claiming that markets aren't very efficient.

    That is an amazing admission, especially coming from an ostensible conservative.

    The upshot is, that if it were really true that the share price of a giant like IBM was subject to the whim of a few traders in London, there is no way that I'd invest my money in the public markets.
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  •  
    Jan 29 09:25 PM
    This is an obvious case of a relative unknown trying to distinguish himself by attacking Ben Stein and Gasparino. And such hubris, I had to do a retake of the date of the article, "now maybe its me but I've come to believe that the subprime issue has moved beyond has moved well beyond portfolios themselves, no?", he said with his wrist firmly at ninety degree angle. ( a rhetorical question doesn't use a question mark) And, he would have you think that we think its some lone Gordon Gecko trader -- its banks of traders in tacit collusion in major financial houses across the world, if you don't think that's possible then I suggest you turn the volume down on those bells going off in your head.
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  •  
    Jan 30 02:44 AM
    i am not sure what your article is about and do not agree with it's general tone.
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  •  
    Jan 31 10:14 AM
    It is perfectly obvious by now that Ben Stein is a totally political animal, and he is talking up the markets and bashing the bears to justify his support for Republicans in the upcoming elections. He's saying "the economy isn't so bad, the subprime mess and recession aren't important, it's all those selfish traders" as a cheerleader for a failed administration. We're going to hear this bushwa from a lot of corners in the next 10 months.
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