In Defense of Finance

“The first thing we do, we kill all the lawyers bankers.”

— Shakespeare, Henry VI (Part 2) — if it were written in 2010

It’s not easy being a financier these days. Even the usually clear-thinking James Fallows jumps on the down-with-finance bandwagon by lamenting the increase in the percentage of Rhodes scholars that go into finance instead of other fields. But let’s think this through: We just had a near-collapse of the world’s financial system due to horrible decisions made by financiers. So that means we want fewer intelligent people in finance?

Hardly. The problem is not that we have too few or too many intelligent people in finance (though I suspect there are too many people overall in finance), the problem is that we have the wrong kinds of intelligent people in finance. There’s no shortage of smart people in finance; there’s a painful dearth of thoughtful people in finance.

To think about what kind of people we need in finance, it’s helpful to think through what exactly finance is for. People tend to think of finance as the (often rapid) movement of money. Yet money in and of itself isn’t what’s important; it’s only valuable because it’s a tool we can use to get stuff we want. Ignoring the tool of money, we see an economy is people exchanging their stuff to get other people’s stuff. You make me a sandwich, and I’ll do your laundry. As long as the goods are as simple as laundry and sandwiches, we don’t really need finance. But when we want to build something like, say, a 250-passenger jet airplane that can fly from San Francisco to Beijing, you can’t exactly use the barter system. Money is a tool that facilitates the exchange of stuff, and when we introduce money, we get two things: a common medium to exchange goods with and a way to shift the timing of when we consume things.

All money really is is future consumption. All finance really is is the exchanging of one person’s future consumption for another person’s current consumption. You make me 30 sandwiches now, and I’ll do your laundry for a month one year from now. Obviously, an airplane is a lot more complex, but it’s the same principle at work. You guys provide us with stuff now (steel, carbon, your time), and in five years, we’ll have planes that will fly people around, who in turn will give us some of their stuff. We’ll get you your stuff back and a lot more. This is an economy. This is finance.

If we want complex goods like airplanes, Google, buildings, electricity — i.e., things that take a long time to make — we need finance. An author who takes an advance in order to support herself until people buy her book is finance. Paying scientists a salary while they try to discover a life-saving drug is finance. If a guy wants to buy a new home, he generally has to pay for it upfront to the people who built it — they put a lot of their own money and time to get the house built after all — but he’s going to use (consume) it over 20 years. So there’s a mismatch between when something needs to get paid for and when it’s going to be used, and finance bridges this gap. People may call finance different things (e.g., an advance, payment deferrals), but it’s all the same thing: people exchanging with each other the timing of when they consume things. You can use my stuff now, as long as you give me more of your stuff later on. Without finance, we can’t make complex goods that take a long time to make.

And here’s our problem: Finance is inherently a long-term function of an economy, which requires people who can balance trade-offs today against benefits many years in the future, but the people in finance today are caricatures of frenetic, short-term, sloppy thinkers. Modern financial “innovations” have transformed long-term transactions into bite-sized, short-term packages. Today’s financiers seem to be the ultimate combination of high IQs and low levels of curiosity. And I say that as a financier.

Finance can continue to play its role in our society even if the people doing it don’t quite understand their role, just as cats in heat can create life even though they’re not aware that’s what they’re doing. But I submit that we end up with a better world if we have thoughtful bankers and investors who deeply understand their function and exhibit characteristics like intelligence, patience, a long-term orientation, and independent thinking. Today, we have hordes upon hordes of day-traders with herd mentalities whose behaviors put our economy at risk. Think of it as a massive feral cat problem.

Bad Signaling

Occasionally, we all run into people who have serious cases of Something To Prove. An old classmate who coyly drops how important she is in her new job, “God, it’s been so stressful running one of the most successful engineering groups in the Valley.” A successful entrepreneur with a smug and snarky way about him that all but screams I BELIEVE I AM SMARTER THAN YOU. Or a newly engaged friend passive aggressively signaling her status to her single friends, “Yeah, Rick and I are so happy, but pretty boring these days — mostly wedding planning and couples dinners. Not like you — you know, single and always out at the bars and meeting new guys. So exciting.”

I get annoyed at the most serious offenders (e.g., “Life was so much simpler before I was so successful.”), and my instinct has been to judge them for their insatiable need to signal their status. But the posturing comments of aggressive signalers come from a place that everyone has: we all care in some way or another what other people think about us. Does the blatant bragger care more about how he’s perceived than the outwardly humble? Maybe. But maybe not. It’s possible that both people care equally about how they’re perceived, and one guy is just more more obvious about it than the other.

Some ostensibly modest people may be just as cocky, but are simply better at managing how the desire to be thought of positively is perceived. One could even say they’re actually smarter and more adept at signaling: They know that raw, self-aggrandizing comments make them look bad.

When famous actors, politicians, and CEOs are modest and gracious, I don’t believe it necessarily reflects a lower sense of self-worth than their externally arrogant counterparts, or even caring less about what other people think. Those roles require a high degree of self-confidence and assuredness. It’s likely that they’re just more socially aware at how poorly bragging makes them look.

But the point is that brashness is negative trait not because it reflects high self-esteem, but because it’s a detrimental social trait with negative externalities on other people. We’re put off and made uncomfortable by arrogance. Confidence without arrogance — self-assuredness with geniality — is a social skill that creates positive human interactions. This is the trait we should value, not a false disconnect between one’s true status and one’s self-perception.

Thanks to Ben Casnocha for helping me think through this. As he mentioned, our trip to San Pedro de Atacama led to a lot of bouncing ideas off each other, many of them reflected in my next posts.

Cicero On Old Age

Old age has its own appropriate weapons: namely the study, and the practice, of decent, enlightened living. Do all you can to develop these activities all your life, and as it draws to a close the harvest you reap will be amazing.

As Montaigne says, he certainly “gives one an appetite for growing old.” I’m reading some of Cicero’s essays now and was skeptical I’d find this subject interesting. So far, it’s his best one.

Another great line:

Great deeds are not done by strength or speed or physique: they are the products of thought, and character, and judgment. And far from diminishing, such qualities actually increase with age.

Eight Hours in Dallas

One of the problems with booking flights using miles is that you’ve got to take what you can get. In the case of my flight to Chile, it was an eight-hour layover in Dallas — a fair trade for 40,000 miles.

Quick impressions of a short visit:

  • Google told me a great place to visit was the Dallas Arboretum and Botanical Garden. They were right. It’s a lush, diverse park with lots of manicured lawn to sit and read, but I wondered if there weren’t any good public park alternatives ($10 entrance fee for the Arboretum). I.e., it’s a paid Golden Gate Park / Central Park.
  • Great weather in mid-March.
  • Dallas seemed like a textbook example of urban sprawl: a business-only downtown with large office towers that clears out at 5pm, surrounded by increasingly spaced-out concentric circles of residential areas and ringed by a circular freeway system. There’s a nascent movement to bring residential urbanism downtown, a small oasis of which seemed to be working, but it’s hard to see it taking larger hold as the downtown area seems almost hostile to pedestrians. It’s not a Jane Jacobs city.
  • The architecture was more interesting than I was expecting: some older brick buildings mixed in with the skyscrapers, and some of the new towers and museums/art buildings are aesthetically bold and pleasing. The small Bishop Arts District has a great feel that often comes when an ethnic neighborhood mixes with an artist culture (e.g., Mission in SF, Greenpoint in Brooklyn).
  • Excellent Mexican food, enough to make a Californian jealous.

The Social Intelligence Paradox

GMU economist Robin “Rational” Hanson, in an interview with Colin Marshall, says, “Our large brains are probably that large mainly in order to handle the social complexities of figuring out how to deal with each other in a large tribe” (HT Andy McKenzie), and this appears to be the consensus among the People Who Know These Things.

The idea is that our brains initially evolved just to be able to survive: hunt, eat, raise children, fight, run, etc. But the average human brain is so much more complex than necessary for basic survival and reproductive functions that it’s likely that we evolved to keep track of intricate social situations. “If I trade this coconut for some of Bob’s saber-tooth cat meat, we both get meat and coconut. But I’ve got to make sure to save some coconuts to impress Betsey. She sure looks swell in that woolly mammoth number.” You get the idea. It’s pretty clear to me that we evolved to be social species.

Yet if this is true, why is it that so many people we think of as having off-the-charts IQ are often socially awkward? I’d guess that someone of above-average intelligence also has a higher social IQ, but it appears to me that as Stanford-Binet IQ reaches the 99.9th percentile, there’s a diminishing correlation to social aptitude. There are certainly people like Bill Clinton with eidetic social memory and Rhodes Scholar-caliber academic intelligence, but this is much more of the exception than the rule. Why?

I submit a couple of theories, absolutely and unapologetically speculative:

  • Our brains specialize, so that at a relatively early age, our wiring gets gelled towards certain types of activities. Someone who spends most of his conscious time immersed in abstract and complex ideas is, by definition, not spending his time interacting with other people. If you start with a preternaturally smart person and compound time spent in deep, solitary thought over a lifetime, you end up with someone who can solve IQ puzzles, but is going to be *super* awkward on first dates.
  • It’s tempting to think of academic intelligence as “higher” up the evolutionary food chain, but it isn’t necessarily a “better” trait, at least not in the evolutionary sense. A trait is only useful if it results in a healthier life that allows one to produce more offspring. Looking at things purely through an evolutionary lens,the guy with a ton of Facebook friends and 5 children from 2 different women may be more evolved than an unmarried Nobel Prize-winner with no children.

Language and Thought

An obsession of George Orwell’s was the use of language by a group of people to exert power over others, and he was hyperaware of how powerful ideas are, which in essence are just elaborate combinations of words. His great essay “Politics and the English Language” precisely identifies and picks apart the practice of ameliorative, vague language for terrible actions. “Defenseless villages are bombarded from the air, the inhabitants driven out into the countryside, the cattle machine-gunned, the huts set on fire with incendiary bullets: this is called pacification.” I’m reticent to sound dramatic, but I can’t help noting here that at the end of the Vietnam war, 29 years after Orwell’s essay was published, my uncle who served in the South Vietnamese Army was sent for three years to a “reeducation camp,” a pleasantly bland name for torture and brainwashing.

But I digress. The “Newspeak” of the omnipresent regime in Orwell’s 1984 is intended to eliminate the ideas of freedom and opposition by eliminating the words for freedom and opposition. Orwell likely never took very seriously the notion that the idea of freedom could be repressed by eliminating the word freedom, but argued strongly that language influences thought: “But if thought corrupts language, language can also corrupt thought.”

(It’s impossible to write about language and thought without mentioning David Foster Wallace. He argues in his essay “Tense Present: Democracy, English, and the wars over usage” [PDF | HTML], a modern day version of “Politics and the English Language,” that language is politics, and Orwell’s title for the seminal essay is redundant.)

Today’s alpha dog of linguistic academics is Steven Pinker, and in The Language Instinct, Pinker does a classic “I love you, man, but you’re wrong” takedown of Orwell. He calls the essay a masterpiece, but also says, “The idea that thought is the same thing as language is an example of what can be called a conventional absurdity… Think about it. We have all had the experience of uttering or writing a sentence, then stopping and realizing that it wasn’t exactly what we meant to say… The discussions that assume language determines thought carry on only by collective suspension of disbelief.”

Pretty convincing. But then we hear from the Young Turk on the language scene, Stanford’s Lera Boroditsky. In one of her studies, Boroditsky examines an Aboriginal Australian tribe called the Kuuk Thaayorre, who don’t have words for “left,” “right,” “up,” “down,” and instead say “west,” “east,” “north,” “south.”  “This is done at all scales, which means you have to say things like ‘There’s an ant on your southeast leg’ or ‘Move the cup to the north northwest a little bit.’ One obvious consequence of speaking such a language is that you have to stay oriented at all times, or else you cannot speak properly.”

In experiments where she asks various language speakers to put cards depicting events in chronological order, subjects will place the cards in the order that their native language is written in, e.g., English speakers left-to-right, Hebrew speakers right-to-left. But the Kuuk Thaayorre will put the cards from east to west, no matter which way they are facing.

Instead of arranging time from left to right, they arranged it from east to west. That is, when they were seated facing south, the cards went left to right. When they faced north, the cards went from right to left. When they faced east, the cards came toward the body and so on. This was true even though we never told any of our subjects which direction they faced [emphasis mine].

Yeah, bananas. I know. There’s more.

How does an artist decide whether death, say, or time should be painted as a man or a woman? It turns out that in 85 percent of such personifications, whether a male or female figure is chosen is predicted by the grammatical gender of the word in the artist’s native language. So, for example, German painters are more likely to paint death as a man, whereas Russian painters are more likely to paint death as a woman.

So the structure and vocabulary of a language have some effect on our thoughts, but probably not enough to eliminate our conception of basic human ideas. Bananas.

Berkshire Hathaway Annual Shareholder Letter

Warren Buffett’s annual letters to Berkshire Hathaway shareholders are likely the best resource out there to learn about investing  — more than any of the thousands of idiotic investment books and rote business school investment courses. To be fair, for someone who wants to learn about investing from scratch, the letters are best coupled with a basic understanding of finance from a textbook (I was raised on the Brealey & Myers), but even for the general student of business, these letters are better than any business book I’ve read, which unfortunately is a lot and way more than necessary. The wonderful thing about the letters — and it’s the same reason people overlook them — is that they’re free. My guess is that a lot more people who have bought books about Buffett than people who have read the writings by Buffett.

His 2009 letter came out on Saturday. Some highlights:

  • He loves visual analogies. This year’s: “Big opportunities come infrequently. When it’s raining gold, reach for a bucket, not a thimble.”
  • On why growth in units and revenue doesn’t mean good returns: “In the past, it required no brilliance for people to foresee the fabulous growth that awaited such industries as autos (in 1910), aircraft (in 1930) and television sets (in 1950). But the future then also included competitive dynamics that would decimate almost all of the companies entering those industries. Even the survivors tended to come away bleeding.”
  • Warren getting salty on the bailed out directors and CEOs: “It has not been shareholders who have botched the operations of some of our country’s largest financial institutions. Yet they have borne the burden, with 90% or more of the value of their holdings wiped out in most cases of failure… The CEOs and directors of the failed companies, however, have largely gone unscathed… CEOs and, in many cases, directors have long benefited from oversized financial carrots; some meaningful sticks now need to be part of their employment picture as well.”
  • On how companies who use their own stock to acquire other companies always evaluate the fair value of the target, but never evaluate the fair value of what they’re giving up for it, i.e., the value of their own stock. “I have been in dozens of board meetings in which acquisitions have been deliberated, often with the directors being instructed by high-priced investment bankers (are there any other kind?). Invariably, the bankers give the board a detailed assessment of the value of the company being purchased, with emphasis on why it is worth far more than its market price. In more than fifty years of board memberships, however, never have I heard the investment bankers (or management!) discuss the true value of what is being given… Directors should hire a second advisor to make the case against the proposed acquisition, with its fee contingent on the deal not going through. Absent this drastic remedy, our recommendation in respect to the use of advisors remains: ‘Don’t ask the barber whether you need a haircut.'”