Self Assured Destruction

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Epsilon Theory PDF Download (paid subscription required): Self Assured Destruction


In the 1960s, our Cold War strategy evolved into Mutual Assured Destruction, a dangerous but stable relationship with the Soviet Union.


In 2020, our Covid-19 War strategy devolved into Self Assured Destruction, a dangerous and utterly unstable relationship with the SARS-CoV-2 virus.


As the story goes, a few weeks after JFK was inaugurated in January 1961, his new Secretary of Defense – Robert McNamara – was briefed by the head of Strategic Air Command on US nuclear warfare strategy. Under the “Massive Retaliation” doctrine of the day, there were two options: go and no-go. Any provocation by the Soviet Union sufficient to trigger a go action would result in the immediate launch of all US nuclear warheads – about 1,500 at the time – against 650 targets, mostly in the Soviet Union, but also anywhere in the world where SAC thought the Russians had military assets. As McNamara remembered General Power (yes, that was his real name) telling him, “I sure hope you don’t have any relatives in Albania, Mr. Secretary, because we’re going to have to wipe them off the face of the earth, too.”

At the end of the presentation, the oh-so-pleased-with-themselves generals asked McNamara what he thought. His angry response:

You don’t have a war strategy. You have a war spasm.

Same thing today.

We don’t have a Covid-19 strategy. We have a Covid-19 spasm.

We launched all of our warheads against ourselves in a massive overkill of a lockdown, where our domestic equivalent of a noncombatant Albania was hit just as hard as our domestic equivalent of a Soviet missile base, and now we’re done. Our arsenal is gone. There will never be another coordinated national effort to control the spread of Covid-19. Not with this President, at least.

But that’s the problem with spasmatic policy and the blowhard leaders who administer it. You end up with neither a war-preventing strategy nor a war-fighting strategy. You end up neither containing the enemy nor defeating the enemy.

First, you ignore the initial small provocations and the warning signs of trouble because you’re not prepared with actions you can take short of all-out war. At first you minimize and you excuse.

Sound familiar?

Then, when you finally respond, you act in an incredibly heavy-handed, all-or-nothing fashion that inflicts maximum damage on both the true war-fighting targets AND targets that have nothing to do with the fight at hand.

Sound familiar?

Finally, if your spasmatic attack fails to wipe out the enemy – if the enemy retains an offensive attack capacity after your all-or-nothing effort – then your population is held hostage by the enemy’s threat. You have no choice but to surrender and hope for a merciful/lucky outcome.

Sound familiar?

Our leaders have botched this war, and we are defenseless against a still potent and now endemic enemy, left only with the deus ex machina hope of a truly effective vaccine.

Here, let me say that again.

Covid-19 is now endemic in the United States.

That means it is everywhere. That means it is something to live with rather than something to eliminate. That means Covid-19 is now being “handled” as a chronic disease rather than an acute infectious emergency, a chronic disease where – every day while it remains endemic – 15,000 to 20,000 Americans will get so miserably sick that they will seek treatment and be officially diagnosed, and 500 to 1,000 Americans will die.

15,000 to 20,000 Americans really sick. 500 to 1,000 Americans dead.

Every day.

By the way, these numbers would be a significant improvement over the numbers today. Over the past two weeks, the United States has averaged 22,089 newly diagnosed cases of Covid-19 and 1,118 deaths per day, even as cases and deaths from New York have dropped more than 80% from their peak (New York now adds about 1,200 new cases and 100 deaths per day). Frankly, I think 15,000 to 20,000 Americans officially sick and 500 to 1,000 Americans officially dead every day is a pretty optimistic scenario for an endemic Covid-19 in the months ahead.

Other countries, allies even, countries like South Korea, Taiwan, Japan and Germany, have waged their war against the virus much more effectively than the United States, so that a nationally coordinated policy of testing and contact tracing to manage an endemic virus without suffering ruinous daily casualties is at least possible.

We don’t have that possibility. We have botched this war so miserably that the only solution to an endemic Covid-19 available to the United States is a vaccine. Other systemically crucial countries, like Russia, Brazil and India, are in exactly the same boat. We’ve all followed a strategy of Self Assured Destruction.

And so we wait. We wait to see if we get an effective vaccine by the end of the year. If we do, then maybe we win the war, despite our absurd strategy and incompetent leadership. Maybe. If we don’t, then we lose.

By win, I’m not saying that our markets or our politics go back to “normal”, whatever that means. I’m saying that our markets and our politics can survive if there’s a viable vaccine developed in the next six months. I’m saying that the “bridge loan” narrative driving trillions of dollars in economic support for corporations and some measly fraction of that for unemployed workers can only work if there is a similarly-functioning domestic economy on the other side of this bridge.

But if it’s a bridge to nowhere …

If there’s no vaccine in the near future …

If Covid-19 persists as an endemic disease where 15,000 to 20,000 Americans get really sick and 500 to 1,000 Americans die every freakin’ day for a couple of freakin’ years, and where the situation is worse – MUCH worse – in countries like Brazil and Russia and India and Indonesia and Iran and Egypt and Mexico …

The free world does not easily survive a globally endemic Covid-19.


[first lines]

Newsreader:    Day 1,000 of the Siege of Seattle.

Newsreader:    The Muslim community demands an end to the Army’s occupation of mosques.

Newsreader:    The Homeland Security bill is ratified. After eight years, British borders will remain closed. The deportation of illegal immigrants will continue. Good morning.

— Children of Men (2006)

After the global flu pandemic of 2008, mankind loses its ability to conceive children, and the world begins a long, gradual descent into anarchy and despair. By 2027, Britain is the one civilized nation remaining, although it has transformed itself into a brutal police state to manage not just a fin de siècle, but a fin to … humanity.


That’s the premise of Children of Men, a great book by PD James and an even better movie by Alfonso Cuaron. It’s a premise that’s ringing pretty loud in my ears right now.

And I don’t know how to make the ringing stop.

See, I’ve been writing this note for the better part of a month now, unwilling to take my thoughts to their logical conclusion. And maybe we WILL get lucky. Maybe we WILL develop a truly effective vaccine in the next few months. I really do have faith in our technological prowess. Because I have to.

But here’s the problem with that faith. Whether or not there really is an effective vaccine, we will be TOLD that there is an effective vaccine. Our government policies and our personal behaviors will go forward over the next year AS IF there is an effective vaccine. The overwhelming narrative from both Wall Street and Washington will always be that an effective vaccine is “in advanced tests” or “showing great promise” or “ramping up production” or “available now for emergency personnel”. Maybe this will be true. God, I hope it will be true. But we won’t KNOW if it’s true … we won’t KNOW if there’s an effective vaccine for billions of human beings … until, what, Q3 of 2021?

If it’s NOT true, if there is not in fact a vaccine that can eliminate Covid-19 as a globally endemic illness, then I think we’re in a full-bore Children of Men scenario. All capital markets become political utilities in this future. Only national champion corporations remain, and the line between State and Oligarchy becomes nonexistent. Democracy? LOL.

The form of social organization that “works” with 15,000 to 20,000 Americans getting really sick and 500 to 1,000 Americans dying every freakin’ day for a couple of freakin’ years, combined with massive political instability and violence abroad, is national socialism with American characteristics. It’s a fetishization of the State and its provision of order, such that all economic and political behavior is funneled exclusively through the State and its crony capitalist “Yay, military!” and “Yay, stock market!” narratives. It’s smiley-face fascism. And not-so smiley-face fascism.

But even if it IS true, even if there is in fact a vaccine that can eliminate Covid-19 as a globally endemic illness, what happens during the months-long period between the announcement of this effective vaccine and its broad distribution? There will still be 15,000 – 20,000 Americans getting really sick and 500 – 1,000 Americans dying every day from this now preventable disease! What would your political response be if your mother or your husband or your brother died from Covid-19 because your government administered this vaccine to someone else first? There will be tens of thousands of such deaths in the United States, and hundreds of thousands of such deaths around the world. Will you accept a loved one’s death under these circumstances with equanimity, comforted by your faith that the Trump II or Biden I administration did everything possible to distribute this life-saving treatment with justice and fairness to all?

Or will you rage?

Forget about the United States for a minute. Let’s say you live in India. Do you trust the Modi government to administer whatever vaccine stock they acquire with justice and fairness? Will you shrug your shoulders if your town or state is passed over and your brother dies? How do you think the Modi regime will respond to your righteous anger? Will they say “oops, our bad” and make amends?

Or will they find someone to blame?

Now do Brazil. Now do Egypt. Now do Mexico. Now do Indonesia. Now do Iran. Now do Russia. Now do China. Now do the United States.

Maybe these regimes will blame you for their mistakes and unjust actions. Maybe these regimes will blame the Muslims or the Jews or the Uighurs or the communists or the imperialists or the Republicans or the Democrats or the immigrants or the “thugs”. Maybe these regimes will blame China. Maybe these regimes will blame the United States. One thing’s for sure, they won’t be blaming themselves.

I’m having a hard time seeing how we get from here (globally endemic Covid-19, incompetent and/or pseudo-fascist leaders in the most powerful countries on earth) to there (a non-outright burning, non-outright fascist world) even if we get a truly effective vaccine into production by the end of the year.

I’m having a hard time seeing how we get from here to there because I know how incompetent and/or pseudo-fascist leaders ALWAYS respond to this sort of domestic unrest and threat to the maintenance of their incompetent and/or pseudo-fascist regimes.

They start a war.

Not an allegorical “war” against a virus, but a real war against an Other. Sometimes that Other is a group or region inside their country. Sometimes that Other is another country. But it’s ALWAYS a war.

There are two ways to read the title of this note: Self Assured Destruction.

One way is how I led off the piece, as a play on Mutual Assured Destruction, as the consequence of having a war spasm rather than a war strategy, as an assured destruction brought down on yourself.

The other way to read it is as the self-assured destruction that incompetent and/or pseudo-fascist regimes visit upon their human enemies in real war, as they confidently propagandize and violently blame another country or group for their own failings.

The first interpretation is in the past. We can’t change the abysmal way in which our government and so many other governments have waged this “war” against Covid-19. We can’t do anything about that now.

The second interpretation, though, that’s in the future. And yes, we CAN do something about the tragic way in which our government and so many other governments will try to lead us down the path of real-world war.

Back in 1997, I wrote a book called Getting To War, about how all governments – democracies and dictatorships alike, in the 20th century or any other century – attempt to mobilize public opinion before taking on a risky action like starting a war. The book’s long out of print (although you can read big chunks of it on Amazon for free if you’re so inclined), but it’s time to dust off that 30-year old methodology and use the modern technology of the Narrative Machine to identify getting-to-war propaganda in today’s major powers.

Thirty years ago, I had no ability to do this narrative research in real-time, and no megaphone to communicate my findings to the world. Today I’ve got both.

Next up … Part 2 of this note – not Self Assured Destruction, but Self-Assured Destruction – where I’ll walk you through the getting-to-war process that all governments use to create a war-supporting narrative, how we can use the Narrative Machine technology to track this process, and what we can do to jam or subvert those war-supporting narratives. If you haven’t yet read the Epsilon Theory note Inception, now would be a good time to do that.

Act I of the Covid-19 War is over. The high-functioning sociopaths who have used us as fodder and feed for decades were caught unawares by this new enemy, and they thoroughly bungled the response of State and Oligarchy. Now the pleasant skins of “Yay, Democracy!” and “Yay, Capitalism!” – false narratives, not the real thing – have been ripped off to reveal the naked sinews of power beneath.

Act II will be the story of high-functioning sociopaths trying to re-establish their system of control through narratives of Other-blaming and war … and how we beat them at their own narrative game.

As for Act III … we’re going to change the world, you know. You and me.


Epsilon Theory PDF Download (paid subscription required): Self Assured Destruction


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The PPP Narrative for Asset Managers

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The vast majority of ET Pro subscribers are in the business of managing other people’s money in one form or another, and many of you are key decisionmakers at asset management firms that qualify for forgivable loans from the US government under the SBA Paycheck Protection Program (PPP). So I wanted to use this week’s note to highlight a narrative backlash that I see developing against RIAs and other asset managers that took PPP money.

To be clear, I don’t have a strong view one way or another on the ethics of asset managers taking PPP loans. I get the criticism (legislative intent was to bridge payroll expense for public-facing companies in extreme duress from mandatory lockdowns), but I also believe the language describing program qualification was intentionally broad enough to allow asset managers and law firms and accounting firms and other similarly situated companies to apply for a forgivable PPP loan in good faith. Clearly there is nothing illegal about a qualifying asset manager accepting PPP money. But it IS a bad look if the narrative spotlight focuses on “Wall Street rich guys” taking PPP money, and I think that’s exactly what is starting to happen.

I first noticed this narrative backlash in the social media reaction to a self-congratulatory blog post last week by Josh Brown of Ritholtz Wealth Management, an RIA with about $1.3b AUM and 35 employees, where Josh thanks his JP Morgan bankers profusely for getting them a PPP loan in round 1 after learning that Q1 billings were down by … wait for it … 12%. You can read the post here in all its glory – https://thereformedbroker.com/2020/05/25/under-pressure/ – it’s a masterclass in tone deafness, all the more odd because Josh is usually pretty adept at this stuff (1.1 million Twitter followers and a fixture on CNBC).

Given Josh’s celebrity status on Fintwit and the blogosphere, his post was picked up by various media outlets, like CityWire (https://citywireusa.com/registered-investment-advisor/news/1-3bn-ritholtz-wealth-takes-out-ppp-loan/a1360996). It didn’t help that Josh’s partner, Barry Ritholtz, wrote a decently popular book titled “Bailout Nation”, railing at this type of stuff.

Since then, I’ve seen a social media resurfacing of older articles and opinion pieces, like this WSJ piece from April 20 (PPP Loan Terms Amount to Legalized Fraud: Healthy companies can easily exploit aid meant for those that had to shut down), as well as more recent articles about larger RIAs taking PPP money, such as Carson Group ($12b), Sanctuary Wealth ($9b), Sequoia Financial Group ($4.6b), Crestone ($3b), and IPG Investment Advisors ($2b).

Does this early-stage narrative have legs? Time will tell, but I think it probably does. As you can imagine, these articles are red meat for the always simmering anti-Wall Street sentiment, particularly in an election season and particularly as the stock market goes up even as the real economy suffers. I think there will be a lot more articles like this … no matter how unfair this treatment might be, it’s just too juicy for any political entrepreneur or media voice to pass up.

Like many of you, this is an issue that hits home for Rusty and me. Second Foundation Partners did not accept PPP funds … not because we thought it was unethical (particularly after the program was reloaded with additional capital in round 2), and not because our small business couldn’t use the money to support payroll as it was intended, but because we thought it could compromise our long-term business and brand if the narrative turned in this direction. If your asset management firm has a similar sensitivity to this narrative, it’s worth paying close attention to these developments.

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The Hertz Story Isn’t What You Think

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Carl Icahn, sharing a laugh

Hertz awards over $16 million in retention bonus to key executives (Reuters)

U.S. car rental company Hertz Global Holdings (HTZ.N) said on Tuesday it has paid about $16.2 million in retention bonuses to a range of key executives at the director level and above, days after the company filed for bankruptcy protection.

The company paid President and Chief Executive Officer Paul Stone $700,000, and Executive Vice President and Chief Financial Officer Jamere Jackson $600,000 as retention bonuses, Hertz said in a filing to the U.S. regulators.

Last week, the board of the company, which counts billionaire investor Carl Icahn as its largest shareholder with a nearly 39% stake, allowed it to seek chapter 11 protection in a U.S. bankruptcy court in Delaware.


My Twitter feed this morning was deluged with people calling out Hertz for awarding $16 million in retention bonuses to senior executives right before they declared bankruptcy.

Sure looks like a classic BITFD adventure in financialization, right? Where entrenched, self-dealing executives transfer vast wealth to themselves in the good times, protect themselves in the bad times, and leave 38,000 rank-and-file Hertz employees to twist in the wind.

But this is not that story.

The Hertz bankruptcy is not a story of entrenched, self-dealing management. Nope, if anything management is getting screwed here, and the $16 million in retention bonuses – spread over 340 employees – is on the way, way, way low end for what I’d expect. This feels to me more like an ultimatum for management than a reward, something like, “Take this to keep your mouth shut and rip up your employment contract, or hit the road and we’ll see you in court.”

Consider this. A week ago Kathryn Marinello was the President and CEO of Hertz, a position she’s held since January 2017. She’s out, left holding 408,000 shares of basically worthless stock. BTW, she spent more of her own money buying Hertz shares on the open market ($520,000) than she pocketed from sales ($355,000). Neither CFO Jamere Jackson (189,000 shares) nor new CEO and former EVP Paul Stone (48,000 shares) has ever sold a share of stock.

I mean, I don’t feel sorry for this crew. Marinello’s cash comp in 2019 was $3.6 million. CFO Jackson got $1.6 million in cash comp, and EVP Stone got $1.1 million. Sure, their stock holdings are now worth squat, but with the exception of 40,000 shares Marinello bought with her own money, they paid nothing for these shares.

But this is not a story of financialization by an entrenched, self-dealing management team.

It’s a story of financialization by an entrenched, self-dealing minority ownership team.

On June 30, 2016, Carl Icahn led a restructuring of “Old Hertz”, where the Hertz Equipment Rental Corporation (HERC) was split off from the car rental operations (Hertz Global Holdings). Each became a separate publicly-traded company (Icahn with 39% equity stake in Hertz and a 15% stake in HERC), each installed an Icahn-controlled board (not “controlled” in a legal sense, but controlled sure enough), and each started taking on massive amounts of debt.

How much debt?

Well, HERC has about $2.1 billion in long-term debt, against an equity market cap of only $830 million (and that’s more than twice what it was at the March lows). The equity position is what we might call a stub … a small piece of the enterprise value of the overall corporation (debt + equity – cash). If you want to understand HERC as an equity investment, you better focus your analysis on that debt position and how the company can support that kind of leverage!

As for the debt levels at Hertz … LOL.

Hertz has more than $19 billion in long-term debt, against a market cap that was (at its 2019 peak!) about $2.1 billion. Now there’s a stub for you.

It’s hard for me to adequately convey the playground that an insanely levered rental company – whether it rents cars or construction equipment – provides for a financialization genius like Carl Icahn. Between asset depreciation assumptions, cost of capital assumptions, and the ability to securitize or otherwise move assets off your balance sheet … the accounting cookie jar that a rental company gives Icahn is otherworldly. Keep in mind, too, that in 2017 – more than a year after Icahn took control – Hertz was forced to report that management had “identified material weaknesses in our internal control over financial reporting.”

And then this happened:

  • Per the 2019 10-k, Hertz paid Icahn-controlled companies $57 million in related party transactions last year, including property lease payments.
  • Per the 2019 10-k, Hertz pension plan obligations are now underfunded by $126 million.
  • Per the 2019 10-k, last year Hertz raised $750 million in new equity, $500 million in new debt maturing in 2026, and $900 million in new debt maturing in 2028. With those proceeds, Hertz redeemed $700 million of debt due in 2020, $500 million of debt due in 2021, and $900 million of Senior Second Priority Secured Notes.

So sure, you can get all worked up about the $16 million in retention “bonuses” that the Icahn board approved to 340 employees if you like.

Me, I’m more curious about the related party transactions, what happens to the pension fund, and who owned those second priority notes.


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A New Gilded Age

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Epsilon Theory PDF Download (paid subscription required): A New Gilded Age


Source: Library of Congress

History never repeats itself, but the Kaleidoscopic combinations of the pictured present often seem to be constructed out of the broken fragments of antique legends.

The Gilded Age: A Tale of To-Day, by Mark Twain (1874)

Winston Churchill has probably since eclipsed him in this regard, but for decades Mark Twain was the person to whom you attributed a quotation if you didn’t know who said it.

That whole bit he did about history rhyming but not repeating? It’s probably apocryphal, too, but at least Twain actually did write the thing that spawned the briefer expression. Strangely, it comes from what is probably his worst book, an attempted collaboration with another author that never really works. Yet even the title of this forgettable novel managed to spur the creation of a new term: The Gilded Age.

Now, because it makes for better storytelling, modern conversations about the Gilded Age as a period tend to focus on excess. We imagine – both individually and in our artistic representations of the period – lavish parties, opulence, and absurd displays of wealth and status. And yes, it was a time when neither taxes nor anti-monopoly power had much authority to displace the ambitions of the extremely wealthy. In Manhattan and Newport, old and new money competed openly for social status. If that is what we mean when we use the expression – a time in which the doctrine of Social Darwinism made conspicuous consumption not only acceptable but morally proper – we wouldn’t be very wrong.

But we would also miss the more important half of Twain’s point. The elegant idea of the Gilded Age is not that it was about prosperity. It is that it was about the narrative of prosperity.

That narrative of prosperity was built from the same stuff as any top-down narrative: an underlying political goal, a small-t truth, a big-t truth, a big lie and an abstraction through which the lie might gain purchase.

The political goal underlying American policy narratives from the 1870s through the early 1900s was nearly self-explanatory. After a brutal Civil War, we wanted – we needed – Americans to believe that the post-bellum period in America, a time defined by reconstruction, rapid immigration, reconciliation, resource exploitation, the emancipation of millions of slaves and the historically unique proposition of rapid rail expansion to a geographically far-flung land, could be America’s Golden Age.

The small-t truth was that these forces really did cause the country and its economy to grow remarkably quickly.

The Big-T Truth was that this expansion laid the groundwork for America to become the clear global hegemon of the 20th and 21st centuries.

The big lie was that this prosperity was equally accessible to all.

The abstractions? Well, those would be Twain’s gilding, wouldn’t they?

In a Gilded Age, abstractions are the things we are told represent prosperity. Back then, well, Americans were told that a lot of things represented prosperity. In Twain’s kind of bad story, prosperity was the ability to speculate on land, the freedom to take your shot on building the same kind of fortune as Vanderbilt and Carnegie. Prosperity was walking into the marble and gold edifice of J.P. Morgan’s bank and thinking, in awe, that we Americans could do something like this. Prosperity was the lives that social elites were capable of living, and if you weren’t, then, well, it looks like you might need to brush up on your Social Darwinism to figure out why not.

The excesses empowered by centers of political and social power were not just excesses. They were attempts to apply a layer of gilding to the baser materials underneath – the still vast and unresolved social and economic problems faced by an emerging United States with devastating inequality of both opportunity and circumstance. If it looked and felt like a Golden Age, wasn’t that all that really mattered?

Perhaps this all sounds familiar. Perhaps this sounds like the Long Now.

That’s because it is.

The Long Now IS a New Gilded Age, a top-down imposition of the idea that it is more important for a people to look and feel prosperous than to prosper. Only instead of land speculation and the pretenses of an aristocratic minority, our gilding largely boils down to the current level of the S&P 500 Index.

If we wish to understand the arc that these top-down political narratives follow, especially how they die and how they do not die, we will find no better example than in the least golden yet most gilded retreat of late 19th and early 20th century oligarchs. A place that even Twain himself ended up calling home late in life.

Tuxedo Park.


Mark Twain with a kitten in Tuxedo Park, New York, 1907. From the Mark Twain Papers, Bancroft Library, UC Berkeley.
Mark Twain (center, white suit) and a kitten (brown fur, left of center) at Tuxedo Park

And the last place in the world where we would look for comfort at such a time is in the seeming artificiality of etiquette; yet it is in the moment of deepest sorrow that etiquette performs its most vital and real service.

Etiquette, by Emily Post (1922)

The highest perfection of politeness is only a beautiful edifice, built, from the base to the dome, of ungraceful and gilded forms of charitable and unselfish lying.

On the Decay of the Art of Lying, by Mark Twain (1880)

Tuxedo was never the grandest destination for the ultra-wealthy.

Or the most opulent. Or the most extravagant. Frankly, it wasn’t any of those things, although even in its earliest days most of the mansions that would be so coyly referred to as ‘cottages’ would still dwarf the average residence of a 21st century one-percenter.

As it turns out, this was by design.

More than a hundred years before Tuxedo was a gleam in anyone’s eye, in 1760, an 18-year old French stocking weaver and immigrant to New York named Pierre began milling tobacco into snuff. After early success, he founded a corporation that is today generally regarded as the oldest tobacco company in operation, a company Pierre established using his family name – Lorillard. Over the next hundred years, he and his sons parlayed the company’s early success selling snuff into a remarkable tobacco and real estate empire.

So fabulously wealthy was his great-grandson Pierre Lorillard IV that in 1877 he was able to commission the construction of the most spectacular residence in a community of spectacular residences – Newport, Rhode Island. It was the city which, alongside Manhattan, formed the central hubs of high society in the Victorian-era United States. It was a remarkable Queen Anne-style mansion on Ochre Point in Newport, Rhode Island which he called The Breakers.

The Lorillard family had long been embedded in Gilded Age Newport society, but the extravagant new property put a bit of extra punctuation on the claim. Even the flagship Lorillard family asset had a lasting attachment to the city. After all, it is Lorillard that named their most successful product – America’s favorite menthol cigarettes – after the city, even if that was to occur some years later.

All that is to say that when Pierre sold The Breakers to Cornelius Vanderbilt II in 1885, it was a bold statement. And when Pierre packed up and hopped off a train rolling through the Ramapo Mountains of lower New York state with his architect and partner on a rainy day only weeks later to chart out a new kind of elite community, it was an even bolder statement.


NY Tuxedo Pk Bruce Price Chanler Cottage | Modernist architects ...
A characteristic shingle-style house of the early period at Tuxedo Park, from Creative Commons

Lorillard intended for Tuxedo to be both a social club and residential community; in short, Pierre built a country club. In 1885, however, the idea of a country club was still new. Really new. It wasn’t the perfunctory, pretentious province of the mass affluent like it is today, but instead the unassailable domain of the ultra-wealthy. Still, the underlying aim that nobody dared or dares to say out loud – to permit ‘desirable’ residents and forbid ‘undesirable’ residents – was largely the same. The difference is that the list of undesirable residents at Tuxedo Park was far longer. It included all of us. Except a couple of the bankers and hedge fund guys on our subscriber list. You gents (and yes, just gents, obviously) might have been OK.

The social half of the operation was first established as a shooting and fishing organization, but the club itself was the center of Tuxedo life in ways that went far beyond sporting activities. On weekends during the ‘Tuxedo season’ it would host events, galas, performances and balls – to which only the right kind of person and the right kind of behavior would be welcome.


The Club at Tuxedo Park as sketched by Vernon Howe Bailey

Who were the right kind of people? Well, membership to the Tuxedo Club was both limited and exclusive. More specifically, it was initially limited to 200 men, and exclusively offered to those who had accumulated great sums of wealth in the right way, which is to say by inheriting it. Or at the very worst, by handling such nasty business at a distance and only when strictly necessary.

Lorillard’s literal rejection of Newport through the sale of The Breakers was thus accompanied by a corresponding departure in values. Newport had, unfortunately, developed a nasty reputation for permitting those who had built wealth through acts of ingenuity or even labor, heaven forfend, to participate in the loftiest social circles that ought to have been reserved for long-standing families of quality, taste and discretion. Tuxedo Park would not repeat that if Lorillard had anything to say about it.

Although the possession of inherited wealth was never an absolutely essential criterion for admission, a substantial number of members were blessed with it, and working for a living was viewed with suspicion by many of the original Tuxedoites. Bankers, financiers, and others who dealt with money only in its more intangible and dignified aspects, however, were acceptable.

Frank Kintrea, in Tuxedo Park, from American Heritage (1978)

Furthermore, membership in the club was a de facto requirement for the purchase of property. By 1888, after growing demand that led to some relaxation of limits on membership, about 350 men belonged to the club. Roughly 30 of them had homes there, and little doubt was left in the matter of who could acquire those. Goold Redmond, a prominent member of the club (and of The Four Hundred and sometime resident of Newport) put it plainly:

All the property owners are members of the club, and none of them would sell to a person who would be likely to prove an undesirable resident. Such a person would scarcely want to buy, either, for it would be decidedly unpleasant, I should fancy, to be a resident of the park and not be admitted to the club.

Goold Hoyt Redmond, as quoted in Tuxedo Park, from American Heritage magazine (1978)

The effect of the policy was obvious. The families who were permitted to spend the season or reside in Tuxedo were not simply families of means, but established members of the ruling class of New York.

First and foremost, there were the Astors, who held vast quantities of real estate in the city and were seen as the gatekeepers of its social scene. It is more accurate to say that the Mrs. Astor, always with the definite article, if you please, was the gatekeeper. She and Ward McAllister maintained the list of the “Four Hundred.” It was the first and last word on who was considered part of society in the city, and by popular legend took its number from the capacity of the ballroom at Beechwood, the Astors’ 16,000+ square foot summer home in Newport.

Tuxedo also welcomed the Schermerhorns, who were an old New Amsterdam Dutch family who supplied just about every trade ship that came into New York Harbor with necessary equipment and supplies. This was the right kind of business, and with the right amount of age on the wealth it produced. It didn’t hurt that the Mrs. Astor was nee Schermerhorn.

Other Tuxedo members were part of the old Dutch roots on the island, too. The Kips, for example, defected to the English after that little kerfuffle and managed to get a whole section of midtown named after them for the trouble. If you’ve ever been east of Lex between 23rd and 34th street, you’ve been to the part of Manhattan named after this family.

Speaking of the minor conflagration that so irritated the Grand Pensionary of Holland, it is perhaps worth mentioning the Pells. They were the folks who literally bought the Bronx and most of lower Westchester County from Native Americans in exchange for a few barrels of rum, then got the British to force the Dutch out of New York when the latter had the audacity to complain about the transaction.

There were also the Bowdoins, of course, whose patriarch was JP Morgan’s right-hand man, and who himself was the great-grandson of the original right-hand man of New York City, Alexander Hamilton. Don’t worry, the Schuylers were well-represented, too. In fact, one family – the Crosbys, after whom the street in SoHo is named – could claim near Schuyler ancestry on both sides of the family. I suppose if you’re going to really commit to the imitation of royal lineages, you might as well…you know, nevermind.

In any case, if the de facto limitations on membership and property ownership or the self-explanatory membership rolls were not clear enough a description of whom Lorillard wanted to allow in and whom he wanted to keep out, however, there was also the matter of the literal stone fortifications and 24-hour armed security that greeted anyone approaching by road. If you didn’t fancy that, you might instead try the 8-foot barbed wire fence that greeted anyone traversing the 25-mile border of Tuxedo Park. The sort of pretense at security in modern ‘gated communities’ owes its existence to the more serious kind practiced here as early as the mid-1880s.

It is more charming than it sounds so long as you present it in post card form.


Tuxedo Park — Tuxedo Historical Society

The narrative of late 19th Century American prosperity promoted by Tuxedo Park was therefore first and foremost a narrative of exclusivity. It was a story that told aspirational laborers and entrepreneurs that an entirely separate world existed for people whose very nature was so lofty and inscrutable that there was nothing they could ever do to be deserving or dispossessed of it. How fabulous and remarkable must the stories of what happened behind those walls have been to the ‘villagers’ who lived beyond them – and yes, the residents of Tuxedo referred to them as the villagers. How striking must it have been to imagine that our still-young nation were capable of producing a true aristocracy. Why, in a few short decades we were almost like Europe already. This must truly be our golden age!

And yet there was an unavoidable problem with pretending at an Old-World aristocracy: there was no hiding how very young anything built in America was. Yet this, too, was a problem with a solution that existed not only in vast ballrooms of Carrara marble quarried by increasingly revolutionary Italian laborers, or in columns wrapped in gold leaf, but in the world of stories and narrative. You see, Lorillard’s vision when leaving the gaudy excesses of Newport, a vision shared by the primary architect Bruce Price, was that Tuxedo must be an old place. A place for old families, old Anglican religion, old social values and old money. And so the wealth invested in its construction was invested in creating exactly that illusion.

Nearly all country places in America have developed along similar lines of gradual and natural evolution; most of them have some tradition going back to Colonial or Revolutionary beginnings, and have passed from periods of early crudeness, and come to full and perfect beauty only with the mellowing help of age. Not so Tuxedo. Old-World and tradition-haunted as it looks, it is new. Incredibly new.

Tuxedo Park, An American Rural Community, from The Century Magazine (October 1911)

Fortunately, the nature of many of these techniques to produce exactly those illusions was recorded for posterity by Bruce Price’s daughter. Her name was Emily Price. You, however, probably know her better by her married name: Emily Post. Mrs. Post is most famous for publishing Etiquette, which now in its 19th Edition remains the American authority on the subject nearly 100 years after it was first published. Yet she also wrote in some detail about her childhood, adolescence and early adulthood spent in Tuxedo, which must be understood as the wellspring of many of the ideas promoted in her more famous text. From those pages, it becomes quite clear that the artificial, tradition-haunted oldness of Tuxedo was no accident. It was the conscious, top-down application of a social narrative by Pierre Lorillard IV, Bruce Price and the other aristocratic visionaries of New York society.

In the initial decade and a half of construction, nearly all of the – ahem – cottages were built on homesites which would not rise too high above the surrounding treetops, if at all. The idea was to present the notion that the old forest of the Ramapo hills had grown up around the Park over centuries. In addition, the styles of construction heavily favored materials and paints which permitted the conveyance of a certain oldness to the place. Not just in the sense that more natural materials were favored, but in the sense that the builders were literally instructed to pick stones for the front gatehouse and homes that had more lichen on them.

In beginning Tuxedo, the architect’s idea was to fit in the buildings with the surrounding woods, and the gate-lodge and keep were made of graystone, with as much moss and lichen on it as possible. The shingle cottages were stained the colors of the woods – russets and grays and dull reds…

Tuxedo Park, An American Rural Community, from The Century Magazine (October 1911)

And so the narrative of late 19th Century American prosperity was also a narrative of Old World establishments. We Americans had our grand old houses now too, you see. Look how prosperous we have become. This must be a good thing!

Yet Tuxedo Park as an abstraction of American prosperity still lacked a final, indispensable bit of gilding – a narrative of class. It needed a propagated set of rules and values so arcane that they could only be understood by those who had already been made familiar with the game. It needed an etiquette of language and actions which made it clear that this was a separate class from the businessman with a home in Newport, desperately trying to work his way inward from the outer circles of society.

So it was that the final, and probably most important, gilding of Tuxedo Park was its ritualized informality. It was the practiced leisure of those sophisticated enough to know that nothing was quite so boorish as trying too hard, unless perhaps it was working too hard. If the origin story of the tuxedo was not familiar to you before, then your guess that it might be related to the aristocratic refuge of Tuxedo Park was correct. You might be surprised, however, to discover that the attire was named after the town and not the reverse. Very much on brand, however, the tuxedo was originally a relaxation of common dinner jacket attire for gentlemen. The vision of Tuxedo class was exquisitely and consistently formal about its practiced informality.

There was always a certain effect of the private estate in that the women wore evening-dresses (generally ones left over from the Newport season), and the men, as a concession to informality, adopted the English dinner jacket, which later became generally known by the name “Tuxedo.”

Emily Post, in Tuxedo Park, An American Rural Community, from The Century Magazine (October 1911)

The idea was not inconsistent with how Mrs. Astor defined her Four Hundred – those who would be comfortable in any ballroom or parlor in the city. It is a pleasant enough sounding idea to be unpretentious, but the intent was anything but. The principle was that the ability to act comfortably in such a ritualized environment could only be the result of long exposure over time and complete buy-in to the importance of the rituals themselves. New money couldn’t simulate it and rebellious personalities couldn’t endure it.

The stories of intrigue from the late 19th and early 20th centuries in the Park are uproariously petty. For example, Emily Post herself wrote often about her frustration at being forbidden access to the performance stage at the club at Tuxedo. Apparently her banjo playing (yes, this was a fashionable skill for young debutantes at the time) and acting shone a bit too brightly in a world where her father’s necessary architectural prowess proved a rare exception to early admittance standards. There were scores of affairs and scandals on the most absurd grounds, excommunications for small breaches of etiquette, that sort of thing. Tuxedo Park was the urheimat of the HOA board member who slips a note into your mailbox about putting your trash cans at the road a bit too early – and then makes it a topic of gossip around the cul-de-sac.

Tuxedo Park may not have invented petty and capricious flitting between practiced informality and rigid norm-enforcement, but it perfected it.

Snobbery at Tuxedo came in such concentrated and virulent doses that it produced a stifling air of complacency and stilted formality.

Tuxedo Park, from American Heritage magazine (1978)

Still, the result of the relentless narrative promoted by Lorillard, the Astors and others from the top-down was the emergence of common knowledge. Within Tuxedo’s stone gates and barbed wire fences, everyone knew that everyone knew that it was a refuge for an emerging class of well-seasoned, elite families. Outside the walls, everyone knew that everyone knew that the very existence of a place like this was evidence of America’s great coming prosperity, an early symbol of wealth creation and the promise that it would soon spread across the diligent, industrious masses.

The symbols of an American Golden Age.

If you had asked individuals instead of members of the crowd watching the crowd, however, you would have gotten a very different description. From even the very early days, you would have been told about how obviously artificial the place was. How positively anyone could see it. Its various gildings – with perhaps the exception of some really remarkable architecture, some of which is attributable to Price himself – were widely deplored within and outside the walls. Nevertheless it, uh, persisted.

Although Tuxedoites might, as individuals, deplore the elaborate formality that prevailed in the park, it seemed to be a group affliction for which there was no cure.

Tuxedo Park, from American Heritage magazine (1978)

Irritation with the artificiality of the many forms of Tuxedo’s gilding hit very close to home for Emily Post herself. Her earliest of many conflicts with her husband were related to the absurdity of the place’s pretenses. Edwin Post considered himself a legitimate outdoorsman, traveler and gentleman (and as it turned out, he considered himself quite a catch for all sorts of women, too). The alpine costumery of its groundskeepers, the stocking of game and fish, the ostentatious faux-country estate mentality – its mise-en-scene, as Laura Claridge put it in her Emily Post biography – was immediately absurd to him.

In truth, for Edwin, anything would be better than spending the summer at Tuxedo Park. He found its mise-en-scène absurd: the gamekeepers; grown men as property guards, walking around in Tyrolean costumes; the artificially stocked lake. It was all humiliating to a real sportsman like himself.

Emily Post, by Laura Claridge (2008)

The facts underlying Edwin’s criticisms of the place were not secrets, either. The nature of the artificiality was widely known and understood.

The lake, for example, was originally the home to beautiful, enormous and sporting species of bass. Bass being the apex predator (among the fish, anyway) in most such environs, the dilettante gamekeepers introduced a species of European carp to be a food source to fatten up the bass. Instead, the carp crowded out the usual food sources for the bass and killed them off within a couple years.

Lorillard and his fellow budding aristocrats also found the wild game of lower New York – at the time some of the most plentiful in the world, if wild and not always cooperative to an afternoon’s casual sport – too difficult to access in a manner befitting a gentleman of quality. So, of course, they introduced massive coveys of quail and other gamebirds, which repeatedly died en masse in freak accidents that revealed just how artificial the enterprise was.

Other realities at Tuxedo couldn’t be reconciled with the gilded narratives, either. By the turn of the century, Tuxedo maintained a narrative of exclusive membership and old world construction from the top-down. Meanwhile, its rolls increasingly included more parvenus who knew enough to keep their mouths shut and support their patrons within the club. What’s more, those new money elites did exactly what they did elsewhere: they built spectacular architectural monstrosities. This was the 1899 Tuxedo Park home of Henry William Poor, of Standard and Poor’s fame. One presumes he enjoyed it greatly before turning it over to creditors a decade later as a result of failures in (no really) ice and sugar speculation.

Yet owing to the need to stay within the still-powerful common knowledge of Tuxedo Park, Poor still gave his estate an on-narrative name. Behold “Woodland.” I bet he made lots of s’mores here.



Even Post herself, who for nearly all of her life consistently professed a understandable fondness for Tuxedo, was individually completely aware of the absurdity of the place.

Tuxedo was the most formal place in the world. Nobody ever waved or hello-ed or hi-ed at Tuxedo. You bowed when you shook hands. . . . [F]irst names were considered very bad form. You might be Johnny in private, but you were Mr. Jones in public. There were only five men in Tuxedo who called me Emily, and then never in formal Society.

Emily Post, as quoted in Emily Post by Laura Claridge (2008)

Indeed, despite her fondness, Post’s enduring legacy is precisely of an etiquette which esteems intent above rule-adherence, nearly the polar opposite of the world in which she began her life. So if everyone – even America’s leading voice on the rules of etiquette – realized that the narrative of Tuxedo Park was utter nonsense, what happened? If everyone knew about the incompetent game management, the artificial architectural standards, the petty scandals, the inconsistency of the membership standards, what happened?

I’ll tell you what happened.

Absolutely nothing.


How easy it is to make people believe a lie, and hard it is to undo that work again!

Autobiography of Mark Twain, Vol. 2, by Mark Twain

For a while, anyway.

It’s a funny thing. When we recognize artificiality, we usually expect that the continuous pounding of reality will expose it. We want to believe that markets – social, financial and political alike – are voting machines in the short run, but weighing machines in the long run. We know that a lie can be halfway around the world before the truth gets its pants on, to steal another apocryphal not-really-Twainism, but the hopeful implication is that the truth will eventually get its pants on.

And when the narrative is a small, spontaneously emergent, mutually agreed upon story, it often does. Of course it does! We can probably all think of stories we can’t believe we ever bought into after reality threw some cold water on them.

But when the narrative is promoted from the top-down and built on a foundation of abstractions and models, it can sustain all sorts of contradictory facts. Indeed, that is the whole point of summoning the abstraction in the first place – to make it nearly impossible to find facts that exist on a dimension that could falsify the abstraction or lie.

Think about your experiences over the last decade financial markets. Can you think of any investor you know who has not said to themselves and others, “It seems like fundamentals have really stopped mattering all that much” at some point in the last 12 years? How about, “Surely central bank intervention like this isn’t going to be sustainable forever?” Or “How stupid is it that politicians keep taking credit for what the stock market is doing?” These are not secret beliefs, whispered in corners by conspiracy theorists. These are not fringe ideas. They are said aloud on every trading floor and in every investment office in the world.

And what about political markets? Does any politically active person you know not grouse about the rise in political tribalism? Do you know anyone who doesn’t think that whataboutism is a scourge, who doesn’t bemoan the loss of a political center, who doesn’t regret the utter polarization of American politics? These are not uncommon observations. They aren’t revolutionary. Not even when we write about them, unfortunately. Which we do. A lot.

These are mainstream views. We all know.

Yet it is not enough for all of us to know that equity markets are now a political utility. It is not enough for us all to know that they are too important as a measuring stick of prosperity, as a layer of gilding, for central banks and other centers of modern political power to allow to fail. It is not enough for us all to know how those incentives inherently create long-term social, political and economic value destruction. It is not enough to know that they empower the persistence of zombie companies. It is not enough to know that they create incentives to direct capital toward short-term share price appreciation over the development of productive tangible and intangible assets.

Nor is it enough for all of us to know that our political markets are broken. It is not enough for all of us to know that a polarized body politic is a sign of a diseased nation, a heads-I-win-tails-you-lose method for destroying the institutions conservatives want to protect and preventing the change that progressives wish to promote. It is not enough that we all recognize this existential polarization as the tool for protecting entrenched interests that it is. And it is not enough to simply know that all of our political institutions have failed us.

Likewise, the narrative gilding of Tuxedo Park didn’t wear away because enough people knew of its artificiality on so many dimensions. It didn’t fade because enough people put two and two together on the excessive formality, the pretense at effortlessness, the Tyrolean costumes or the stone castles named “Woodland.”

It faded because enough people decided to act on their individual knowledge. They packed up and left.

William Waldorf Astor was the first meaningful departure. He was not the last. Yes, even Emily Post, “eventually found Tuxedo manners too artificial for her taste and [she] too defected,” as Frank Kintrea wrote. By the end, the conclusion of the last remaining Lorillard in the Park was dire.

“Nobody lives here anymore who amounts to a row of beans,” growls Pierre Lorillard Barbey, 78, the last Lorillard in Tuxedo Park.

Tuxedo Park : Everyday Look Is In at Ex-Exclusive Community, Los Angeles Times

The only thing that breaks a top-down narrative is action.

That isn’t to say that knowing doesn’t matter. Knowing matters to you. Knowing matters to how you live your life, how you perceive and process information and how you make decisions in arenas where you do possess some modicum of control. But knowing won’t bring about change in what you know. And we all know, y’all.

We have allowed ourselves to become an army of whimpering John Mayers, a few hundred million people waiting on the world to change. People waiting for the truth to come out and break the hold of the governing political narratives that we all know are stupid. That don’t make sense. That don’t serve our interests.

Here’s an idea: Stop waiting and leave.

It is possible in markets. So who will be the CIO or Board Chair at a major public pension plan who will take the career risk that goes along with talking about the need for funding problems to be resolved with fiscal policy instead of blithely dialing up private equity and rotating hedge funds to long only equity exposure, among the most serious implications of an S&P 500-as-prosperity narrative? Who will recommend a complete elimination of the peer group comparison models that drive allocations to equity-centric consensus? Who will be the major asset manager that takes meaningful active risk betting the farm and the management fee franchise on fundamental value again? Who will be the board chair or chief executive at a major US corporation that gets rid of short-term equity incentives and grants as the faux-aligned, short-term results-incentivizing boondoggle that they are?

It is possible in politics, too. So who will lay themselves and their political career on the altar of the next iteration of the “most important election of our lifetimes” to chart out a path that breaks the weak stag hunt equilibrium of our two-party system? Who will forge the hard path that will make it possible for write-ins and third parties and underserved demographics to have a real voice in our collective governance?

Whoever among us works to puts an end to this New Gilded Age, who unlocks the power of real capitalism and real democracy to create multi-generational prosperity, will have performed an act of both clear eyes and full hearts.

Loyalty to petrified opinions never yet broke a chain or freed a human soul in this world — and never will.

From Consistency, an 1887 essay and speech by Mark Twain
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Children of Men

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[first lines]

Newsreader:    Day 1,000 of the Siege of Seattle.

Newsreader:    The Muslim community demands an end to the Army’s occupation of mosques.

Newsreader:    The Homeland Security bill is ratified. After eight years, British borders will remain closed. The deportation of illegal immigrants will continue. Good morning.

— Children of Men (2006)


After the global flu pandemic of 2008, mankind loses its ability to conceive children, and the world begins a long, gradual descent into anarchy and despair. By 2027, Britain is the one civilized nation remaining, although it has transformed itself into a brutal police state to manage not just a fin de siècle, but a fin to … humanity.

That’s the premise of Children of Men, a great book by PD James and an even better movie by Alfonso Cuaron. It’s a premise that’s ringing pretty loud in my ears right now.


Here’s the problem. We are in an incredibly path-dependent world right now.

What does that mean? It means that our world can go in two totally different directions depending on a roll of the dice. It’s like the Democratic primary … if Elizabeth Warren drops out of the race before Super Tuesday and Amy Klobuchar stays in, then Bernie Sanders is on the ballot against Donald Trump this fall, not Joe Biden. But that’s not what happened.

Do we get a vaccine in 6 months or 16 months? Or never?

If we get a vaccine in 6 months, then I think that all of the “stimulus”, all of the extraordinary monetary and fiscal policy, can be – not reversed – but survived. The narrative that the trillions provided to support financial asset prices amount to a “bridge loan” works in this scenario, as actual economic activity starts chugging back to “normal”.

But if the answer is never, or even if the answer is 16 months from now … then the “bridge loan” narrative fails. Then the truly hard choices begin. How does a government support financial asset prices through direct fiscal expenditures permanently? Under these circumstances, I think our political and economic systems alike fall into national socialism. Into fascism. It’s the Children of Men scenario.

The vaccine question is a derivative of a more fundamental question, one that I’ve been wrestling with for a couple of months now.

Can a free world survive an endemic COVID-19, a disease that is a chronic affliction, killing 500 to 1,000 Americans every day (many more in countries like Brazil or India) but never collapsing a major metro hospital system?

I used to think yes. Now I think no.

I think no because I don’t believe we have legitimate governments in the four countries that matter for global security: the United States, China, Russia and India. I don’t believe we have governments in these countries based on the consent of the governed and committed to the interests of its citizenry over institutional self-interest. This isn’t a Trump thing (although he makes it much worse), any more than it’s a Modi thing or a Xi thing or a Putin thing. This isn’t something that gets fixed with an election or a putsch. This is a structural thing. It’s a regime thing. And it’s not that the governing regimes in Berlin or London or Paris are paragons of virtue, it’s that they just don’t matter for what I’m about to say.

In the same way that highly efficient economic supply chains are wrecked under the stress of COVID-19, so are highly efficient political supply chains.

And that’s what modern governing regimes are: highly efficient political supply chains. This is the machinery of what I call The Long Now, where the threat of the economic future is removed by fiat and narrative, replaced by constructed political threats like who can use what bathroom, such that citizens “spend” their votes to purchase a political experience that tastes delicious (mmm, dopamine), but has zero lasting or fundamental economic consequence. It’s pure political theater, finely-tuned to serve the institutional self-interest of every faction in the Nudging State.

But when there’s an actual real-world threat to that real-world economic future, a threat that really doesn’t care about your narratives but just marches ahead according to its biology … well, that’s what breaks the Long Now equilibrium. Like all well-managed supply chains, the Long Now is perfectly robust on its own terms. It IS an equilibrium in its own system. But COVID-19 comes from outside that system, and it’s a wrecking ball. Sure, every faction will try to politicize COVID-19, to turn it into more of the same political theater (A Truth That’s Told With Bad Intent), and that can work if there’s a vaccine in six months take the threat away for real. But it doesn’t work if COVID-19 becomes a permanent part of our public health landscape.

Without a vaccine against COVID-19, I don’t believe the governments of the Big 4 Global Security powers – the US, China, Russia and India – can survive without participating in a major power war to mobilize domestic public support against a foreign Other.

So they will.

This is the next systemic shoe to drop – major power war – and I think it’s entirely path-dependent on whether or not we get a truly effective vaccine into initial deployment by the end of the year. Otherwise it’s not just our economic supply chains that will breakdown irretrievably, but our political supply chains, too.


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The End of the Beginning

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“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.” 

Winston Churchill

I have not written much since the coronavirus outbreak blew up. Not because I’m not thinking about things. But I simply haven’t had much to say. I have no unique perspective to add regarding epidemiology or public health policy. Sometimes the best thing to do is simply hang back and reflect. This post contains some thoughts on where we’ve been, and where we might be headed.

One indisputable consequence of this pandemic is that we have quickly transitioned from a disinflationary or even (I would argue) mildly stagflationary regime to a deflationary economic regime. The duration of this new regime is an open question. Policymakers, particularly on the monetary side, have reacted as expected. They did MOAR. And they will continue to do MOAR to backstop financial markets, so long as they deem it necessary. Unsurprisingly, this has done wonders for financial assets. Particularly duration sensitive assets such as long bonds and growth equities.

Some dominant themes/narratives I think we will grapple with as this evolves:

The transformation of financial markets into political utilities is complete. It has always been a mistake to assume markets are a perfect reflection of the real economy. Now, markets are probably less a reflection of the real economy than ever before. A consequence of MOAR is that markets (or at least pockets of them) have seemingly become completely untethered from the real economy. There are sensible reasons for this, of course: ultra-low discount rates; the fact that solvent businesses with liquidity to draw on should not see long-term impairment of value as a result of the virus, etc. But as with the financial crisis, policy geared toward owners of financial assets has been implemented quickly and decisively. Much more decisively than policy geared toward vulnerable small businesses and their employees. This will have social and political consequences.

We are all MMTers now. Government deficits will never matter again. Well, at least not unless/until an inflationary bill is acknowledged as having coming due. Central Banks are explicitly engaged in debt monetization. This is mainstream. It is accepted. Yes, there are a different flavors of it. There is the progressive flavor, with its Green New Deals and job guarantees. Then there is the “fiscally conservative” flavor, with its tax cuts and its endless promises of shrinking government (of course, government is never actually shrunk in a material way). I’m not interested in arguing over whether this dynamic is right or wrong at this point. All I care about is acknowledging is that it IS. Because it matters. It matters a lot.

Politics is going to get nastier. The United States government is now explicitly in the business of choosing winners and losers in the economy. As usual, owners of financial assets have been selected as winners. As usual, those who do not own financial assets are losers. I expect the long-simmering political conflict between Capital and Labor to further intensify as a result. Political rhetoric will become more extreme. Politicians will become more ridiculous. Congress will become even less effective (difficult to imagine such a thing is possible, I know). Fun times.

Investment-wise, it’s going to be MOAR of the same. Beyond the obligatory post-recession bounce, there will not be significant mean reversion in value versus growth factor performance. Long duration growth bets will continue to perform well, because there is no opportunity cost to making them. I suspect long duration bonds will also continue to perform well in the short-term, against all odds. Because despite what Jerome Powell says in his pressers, I believe we will test negative interest rates here in the US before we test higher interest rates. And convexity is a thing people seem determined to refuse to understand.

Now, this idea of long duration growth bets merits some additional comment. It’s something that doesn’t get enough pixels, in my opinion. Certainly not relative to its importance. 

Most investors are familiar with the concept of a fixed income security’s duration. It’s a (linear) approximation of a bond’s price sensitivity to interest rates. The longer a bond’s duration, the more sensitive it will be to changes in interest rates. But at the end of the day, a bond is just a bunch of cash flows. From a discounted cash flow perspective, all cash flows are sensitive to changes in the cost of capital.

The archetypical example of a long duration equity is probably development stage biotech. These companies have no free cash flow in the present. They burn cash on R&D and regulatory approval processes. Their free cash flows lie far out in the future. But, if a biotech succeeds in developing and commercializing a therapy with a large addressable market, the future cash flows can be enormous. In the meantime, these equities are kind of like the world’s craziest zero coupon bonds.

In this sense, any breakeven or cash burning growth equity can be seen as a duration play. Much of the small cap enterprise SaaS space fits this profile, for example.

Ultimately, interest rates are financial gravity. When rates are high, and gravity is strong, valuation multiples collapse. When rates are low, and gravity is weak, everything floats. And the longest duration stuff either falls or floats the most.

But how does it all end? I see a few very different endings to this story. The first, of course, is some kind of inflationary or stagflationary regime triggered, in part, by relentless monetary easing. But people like me have been worried about this for a long time. And it’s never shown up. Another possibility is that some kind of transformational technological innovation, similar to the internet, allows us to return to much higher trend growth rates. This would be ideal. Perhaps the darkest scenario is that the political conflict described above spirals completely out of control, and we get to live through a reprise of the 1930s and 1940s.

This is not a very hopeful post. It is not hopeful because I do not have a very positive outlook on the macroeconomic and political trends of the day.

That said, this is also not an argument for bearish positioning in a portfolio. If you follow me on the Twitter, you may recall my exhortation to “dare to be smart enough to be dumb.” Flexibility is key here. I can forgive people (myself included) for not grasping how monetary policy would impact financial market behavior post-2008. That mistake is less forgivable today. In my opinion, it is nigh on impossible to invest today without accounting for the gravity of monetary and fiscal policy.

To be perfectly explicit, as things stand today:

Quantitative deep value (“owning really cheap things because they are really cheap”) is at best a tactical trade.

Economic policy will hamper mean reversion.

As investors, trends are our friends for the foreseeable future.


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No Free Lunches

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Alesso, Heroes (We Could Be), 2014

The Heroes Act. Is it a bill or lyrics from a song by Alesso?

[Ed. note: I always knew Pete was hipper than me, but embarrassed to say I had never heard of a non-Bowie musical reference to heroes. So you can imagine my relief when I read that this Alesso guy added David Bowie and Brian Eno to the songwriting credits for Heroes (We Could Be) in 2015, telling the Daily Star, “I just didn’t want to get sued. They aren’t similar, but we needed protection in case we pissed off Bowie.”]

The Heroes Act appears to contain classic pork barrel-like provisions in a Congressional election year. Even by its name, it seems to exalt the federal government (Congress) – forget about party – as a savior in a ‘bold response to the coronavirus pandemic and economic collapse.’ Yes, the states and local governments need support, and the bill provides for $500 billion and $375 billion, respectively. This makes sense, but throwing in the kitchen sink does not. Does the Fish and Wildlife Service need to be included alongside the USGS for a cool $90 million? The connection to the coronavirus is tenuous.

Setting aside arguments for or against specific provisions in the bill, we bring this up because the almost $3 trillion bill cuts to the heart of (at least) one thing that equity market participants are missing.

All of this stimulus will come at a staggering cost to growth and potentially at a cost that threatens the functioning of markets and our capitalist democracy.

While risk-asset markets and the economy are sometimes disconnected, they often suddenly and dramatically reconnect when emotion exits and reality enters. We maintain that the recent rally is a bear market bounce and that the correction over the past couple of days is the start of a more sustained selloff. We believe market participants will eventually catch on to the fact that THERE ARE NO FREE LUNCHES OVER THE LONG-TERM.

The consequences of such aggressive fiscal policy may have initially been perceived as unequivocally positive by risk-asset markets. Over time, however, unintended consequences now hidden and unknowable, will likely manifest. Aside from the unknowable, there are unintended consequences that market participants might come to appreciate in the near future. First, massive fiscal deficits kneecap monetary authorities and make them simply knaves of fiscal policy actors. Monetary policy loses its efficacy as a stimulative tool and becomes only a palliative one. This is why deficits DO matter. Deficits may not matter when myopically considering they can be monetized, but monetization does not happen in a vacuum. Monetization occurs at a cost to the monetary authority in the form of opportunity cost. Next, in recent history, fiscal policy has been notoriously slow and inefficient at stimulating GDP growth.[1] Lastly, monetization of deficits without taxation as a source of funds for spending presents potentially existential problems for a capitalist democracy.

Recent experience demonstrates that, in the absence of Fed action, U.S. rates may rise radically in the face of massive T-bill or coupon issuance. Recently, long-thought-dead bond vigilantes jumped out of their graves in the face of Treasury issuance need to fund deficits. Figure 1 shows the dislocations in March 2020 when the Treasury market began to absorb the fact that long-dated coupon issues would explode to fund the deficits needed to combat the pandemic. [Ed. note: the overnight gaps are interesting to me, too.] In September 2019, repo rates went to about 7% intraday when bill issuance exploded in the face of insufficient system reserves. This occurred well in advance of the pandemic. In the latter case, it was not until the Fed acted by expanding its balance sheet quickly by almost $1 trillion through term repo operations that the repo market stabilized. In the former, it was not until the Fed announced unlimited quantitative easing (QE) that coupons stabilized after several days of incredibly sloppy and illiquid trading. These periods were the catalysts for a shift in the role of Fed policy from a stimulative to palliative one.[2]

Said differently, it’s not a question of whether the Fed has tools, it’s a question of efficacy of the tools employed. Do the tools available actually work as intended? Both traditional monetary policy (through open market operations that manage to Fed fund target rates) and extraordinary policies like quantitative easing (that suppress the term premium of interest rates) work through a rates mechanism. By first order effect, buying USTs (either long or short dated) lowers targeted interest rates. By second order effect, those lower rates may help suppress risk premium (credit spreads). They may also suppress spreads by first order effect if a central bank is buying risk assets directly. When rates are near or below zero, these policies maintain the status quo – at best. They lose marginal benefit. In fact, they may even do more harm than good because they encourage ‘malinvestment’ and create overcapacity (as in U.S. E&P). This oversupply leads to price disinflation and even deflation. This lack of efficacy (at best) or harmful side-effects (at worst) are what ultimately pushes the Fed to focus on ‘wealth effect’ or ‘confidence’ channels. This is what led it to buy corporate bonds. It had nothing left. It can’t afford defaults to shake confidence in equities or destroy the wealth that it has helped create for corporations and individuals through low rates.

Even if one rejects the notion that monetary policy has lost its efficacy or believes that fiscal policy has immediate and multiplicative benefit to an economy, then there’s an entirely different question that ought not be ignored. Importantly, if debt monetization is a panacea, then what of taxation as the source of funds for government spending? If one argues no taxation is needed, the entire system of taxation and spending comes into question. Why even bother to tax? Taxation, authorization and appropriation are some of Congress’ most important roles. If there’s no need to tax to fund spending, then what does that mean for a legislative system based upon that basic equality? Are we as Americans once again (as during the reign of the English monarchy) ceding authority to undemocratic institutions (i.e. – the Fed)? What incentives does such a system create to spend without limitation on any pet project that a Congressman or Congresswoman deems suitable for their district – as long as the Fed chooses to monetize it? It seems clear that it creates a world rife with economic inefficiency, corruption and moral hazard.

What about the rest of the world’s take on such a U.S. system? Do other nations simply sit by and watch the U.S. and Japan monetize their debts without trying to do the same?[3]

Of course not. They will certainly try and have already started. There is now talk of emerging market central banks ‘joining the QE party,’ as this Economist article points out. This will likely not end well as it risks destroying the creditworthiness of already challenged EM economies. Their growth is essential to the world. We are the leader in global monetary policy and one size simply does not fit all. Yet, that lesson seems already lost on those central bankers outside the U.S. that do not appreciate the benefits of our reserve currency (and the worlds’ continued structural need for the U.S. dollar).

This discussion goes well beyond esoteric considerations of monetary policy and Modern Monetary theory (MMT). It ultimately cuts to the heart of sustaining our democracy and the checks and balances that make it work. U.S. democracy works because of these checks and balances, which exist in a fragile equilibrium that the Fed’s willingness to monetize deficits will now upset – unless it is checked by a newly created system of checks and balances. Our powerful democracy has far less cronyism and corruption than many others. The flow of funds from taxpayers to a government for the people and by the people is the foundation of it all. Wholesale debt monetization without appropriate taxation threatens this balance and concentrates power with the monetary authority. Perhaps most scary, is it allows legislators to act without worry about where their self-interested spending eventually goes. As in many countries, a good deal of that could end up in their own pockets. That’s the end game if we are not vigilant.


[1] https://econweb.ucsd.edu/~vramey/research/RZUS.pdf. Using Jordà’s (2005) local projection method we find no evidence that government spending multipliers are high during high unemployment states. Most estimates of the multiplier are between 0.3 and 0.8.

[2] We’d been concerned that the Fed would be backed into this corner, and it was at the heart of our 2020 Outlook, in which we argued that limited policy space would be a challenge to U.S. equity markets.

[3] By the way, Japan’s equity purchases – an attempt to juice equity valuations – have not been particularly successful, as Figure 2 shows. P/Es are actually lower there than in the U.S.

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A Truth That’s Told With Bad Intent

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Epsilon Theory PDF Download (paid subscription required): A Truth That’s Told With Bad Intent


A truth that’s told with bad intent
Beats all the lies you can invent.

William Blake (1757 – 1827)


That’s Isaac Newton in William Blake’s painting, one of the major villains in Blake’s philosophy. Why? Because Newton was a modeler, a proponent of Science with a capital S, the most repressive force in the modern age.

I think Blake was absolutely right.


Our narratives of COVID-19 are all lies.

They are lies of a particular sort, political narratives that have a nugget of truth within them, but are told with bad intent. They are told this way because it works. Because the nugget of truth hides a deeper, unpleasant truth. And a Big Lie.

Some are narratives of the political left. Some are narratives of the political right.

They are all narratives of betrayal, meaning that they seek to excuse or promote policies designed for institutional advantage rather than the common good.

Clockwise from Donald Trump, that’s Fox’s Sean Hannity, the CDC’s Robert Redfield, Surgeon General Jerome Adams, Speaker of the House Nancy Pelosi, Harvard President Larry Bacow, the White House’s Larry Kudlow, and Vox co-founder Ezra Klein. They all get their moment of shame in our magnum opus on the ubiquitous institutional betrayals here in the early days of the pandemic age – First the People.

How do you recognize a political narrative of betrayal?

It’s always based on a model.

A political narrative of betrayal is always a top-down application of social abstraction, where a behavioral model is treated as the thing unto itself, falsely elevated as the subject and object of policy, rather than relegated to the analytical toolbox where it belongs. A political narrative of betrayal will always use “model” as a noun rather than “model” as a verb. A political narrative of betrayal always BEGINS with a prescriptive model of mass behavior – a model that by the most amazing coincidence serves the institutional advantage of the narrative creator – and ENDS with a forced fit to the individual citizen.

All political narratives of betrayal start like this, with a disembodied, modeled abstraction like “the American way of life” or “the economy” or “the market” or “public health” or “national security”. An abstraction that is then defined for you in such a way as to logically require the willing abdication of your individual rights, first as an American and ultimately as a human being.

A political lie always starts by establishing a disembodied, modeled abstraction like “the economy”. From there, the political lie will then start talking about the “sacrifices” that we citizens need to make for this disembodied, modeled abstraction.

Nothing makes me angrier.

Nothing makes me angrier than a politician like Chris Christie, a man whose idea of personal sacrifice is a regular order of fries, shaking his finger at us and telling us how reopening the local Arby’s is just like fighting Nazi Germany, how OUR deaths then and now are a “necessary sacrifice” in order to  “stand up for the American way of life.”

The American Way of Life™ does not exist. It’s not a thing.

What exists is the way of life of Americans.

Start with the individual American. Start with their political rights. Start with the citizens themselves. This is how a legitimate government acts in both words and deeds.

The government’s job – its ONE JOB – is to protect our individual rights in ways that we cannot do ourselves. That’s not an easy job. At all. There are trade-offs and gray areas, and clear-eyed/full-hearted people can disagree on how to accomplish that job. But it is the job.

Its job is NOT to create “alternative” facts like modeled seasonal flu deaths or modeled herd immunity or modeled COVID-19 deaths in nudging service to institutional goals. Its job is NOT to champion the rights of the politically-connected few and ignore the rights of the politically-unconnected many. Its job is NOT to deny the rights of any citizen in service to a politically convenient abstraction like “the American way of life” or “the economy” or “public health”.

When individual rights conflict in unavoidable ways or we are faced with an immediate and overwhelming threat to our system of individual rights, a legitimate government based on the consent of the governed may be forced to decide which citizens’ rights must be temporarily suspended. This is a legitimate government’s last resort.

Today it is our government’s first resort.

Today it is the first choice of our political leaders – White House and statehouse, Democrat and Republican – to decide which rights to prioritize and which rights to deny in service to THEIR conception of what society should look like. All wrapped up in a nugget of truth told with bad intent.

This is how an illegitimate government acts.

Like this:


Model-driven Narrative #1

Whatabout the Flu?

Dr. Sanjay “minor compared to the flu” Gupta 
Rush “it’s just the common cold, folks” Limbaugh
  • Political goal: COVID-19 threat minimization.
  • Truth nugget: The seasonal flu is a nasty (and mitigatable) disease.
  • Deep Truth nugget: We are shockingly blasé about all sorts of largely preventable deaths, and we warehouse our elderly parents in horrible places.
  • Big Lie:  This isn’t a big deal.
  • Policy prescription: Wash your hands, boys and girls!
  • Embedded model:   Laughably inaccurate models of seasonal flu deaths, designed to nudge popular adoption of annual vaccinations.

As the US death toll mounts, this narrative fades farther and farther into the background of our collective memory, but “Whatabout the Flu?” dominated the early weeks of American policy debates. And while it’s easy to find examples of this narrative from the political right, let’s not forget that CNN and Vox were beating this drum as hard as they could when Trump was shutting down some flights from China.

People don’t believe me when I tell them that we don’t actually count flu deaths, that the numbers thrown around by the Dr. Guptas and the Rush Limbaughs are taken from CDC models of pneumonia deaths. But it’s true. Basically we count pediatric flu deaths and hospitalized adult flu deaths, multiply by six, and intentionally generate an inflated flu death total. Why intentional? Because you need to be nudged into taking your annual flu vaccine.

If we compare, for instance, the number of people who died in the United States from COVID-19 in the second full week of April to the number of people who died from influenza during the worst week of the past seven flu seasons (as reported to the CDC), we find that the novel coronavirus killed between 9.5 and 44 times more people than seasonal flu. In other words, the coronavirus is not anything like the flu: It is much, much worse. – Scientific American (April 28, 2020)

On an apples-to-apples, counted deaths versus counted deaths basis, there is no comparison between COVID-19 and the flu. It’s pure narrative. Pure hokum. All based on a laughably inaccurate model. All geared towards the political lie of COVID-19 minimization.


Model-driven Narrative #2

Herd Immunity!

Anders “the death toll surprised us” Tegnell of Sweden 
Dan “more important things than living” Patrick of Texas

  • Political goal: Preservation of economic status quo.
  • Truth nugget: Massive unemployment is devastating.
  • Deep Truth nugget: Massive unemployment is particularly devastating to incumbent politicians.
  • Big Lie:  In the meantime, we can protect the olds and the sicks.
  • Policy prescription: Hey, you’ll probably be fine! I mean … probably.
  • Embedded model:   Laughably inaccurate models of COVID-19 infection spread and severity, designed to nudge fantasies of V-shaped recoveries in the stock market and commercial real estate prices.

Again, it’s easy to find examples of this narrative from the political right, but let’s not forget that the most prominent national example of “Herd Immunity!” policy is driven by the leftwing Social Democrats – Green Party coalition in Sweden. Again, the politicization of these narratives is not a left/right thing, it’s a power thing.

It’s a high-functioning sociopath thing.

What do I mean by sociopathy and division?

I mean the way our political and economic leaders beat the narrative drum about how this virus prefers to kill the old rather than the young, as if that matters for our policy choices, as if older Americans are lesser Americans, as if we should think of them differently – with less empathy – than Americans who are more like “us”.

I mean the way our political and economic leaders beat the narrative drum about how this virus prefers to kill those with “pre-existing conditions”, as if that matters for our policy choices, as if chronically ill Americans are lesser Americans, as if we should think of them differently – with less empathy – than Americans who are more like “us”.

I mean the way our political and economic leaders beat the narrative drum about how this virus hits certain “hotspot” regions, as if that matters for our policy choices, as if hotspot regions are lesser regions, as if we should think of Americans who live there differently – with less empathy – than Americans who are in “our” region.

And once you stop thinking in terms of trade offs, once you stop thinking in terms of probabilities and projected mortality rates and cost/benefit analysis and this expected utility model versus that expected utility model … once you start thinking in terms of empathy and Minimax Regret … everything will change for you. – Once In A Lifetime


Model-driven Narrative #3

Flatten the Curve!

Gov. Andrew “we need 40,000 ventilators” Cuomo  
Dr. Deborah “Trump is so attentive to the data” Birx

  • Political goal: COVID-19 threat maximization.
  • Truth nugget: Lockdowns prevent a surge in cases which can overwhelm the healthcare system.
  • Deep Truth nugget: When we’ve got everyone freaked out about staying alive, there’s no end to the crazy authoritarian stuff we can get away with.
  • Big Lie:  We can get R-0 down to zero.
  • Policy prescription: You’ll find these ankle monitors to be surprisingly light and comfortable to wear!  
  • Embedded model:   Laughably inaccurate models of COVID-19 deaths, malleable enough to serve the political aspirations of both the White House and their opponents.

Of the three politicized narratives, “Flatten the Curve!” has morphed the most from its original form, as its early success in convincing even Donald Trump that lockdowns were necessary to prevent a healthcare system meltdown gave both its White House missionaries and its state house missionaries free rein to use this narrative to fill a wide range of policy vacuums.

The original goals of “Flatten the Curve!” – to prevent a surge in COVID-19 cases with the potential to overwhelm the healthcare system – were achieved. The flood in New York City crested … and fell. Other cities that seemed as if they might follow in NYC’s footsteps … did not. Mission accomplished! But in the grand tradition of other initially successful emergency government interventions (“Quantitative Easing!”, anyone?) “Flatten the Curve!” is well on its way to becoming a permanent government program.

Today, “Flatten the Curve!” has become the narrative rationale for a range of extraordinary executive actions – on both the left AND the right – that would make Lincoln blush. This is the narrative that will propel the Surveillance State into a permanent feature of American life. This is the narrative that will propel the final transformation of capital markets into a political utility. This is the narrative that will propel us into a war with China. If we let it.


If we let it.

Okay, Ben, how do we stop it? How do we turn this misbegotten process of political lying on its head? How do we reject top-down, model-derived policies and their narratives? How do we BEGIN with the biology of this virus and the rights of individual citizens and build a policy framework from THAT?

This virus is 2-6x more contagious/infectious than the seasonal flu (depending on environment), and 10-20x more deadly/debilitating (depending on whether or not your local healthcare system is overwhelmed). It hits men harder than women, and the old harder than the young. Those are the facts. They’ve been the facts since January when we first studied this virus. The facts have not changed.

Knowing these biological facts, what social policies would you design around THAT?

As a 56 year-old man in just ok physical condition, I figure I have a 1% chance of death or disability if I catch COVID-19 when my local healthcare system is in good shape, maybe 4% if my healthcare system is overwhelmed. Both of those odds are completely unacceptable. To me. Other 56 year-old citizens may feel differently. Other 25 year-old citizens may feel the same. Each of us has a right to life, liberty and the pursuit of happiness, and the legitimacy of our government is predicated on preserving those rights for each of us. Liberty and justice for ALL … imagine that.

Knowing these foundational rights, what social policies would you design around THAT?

If you’ve read notes like Inception and The Long Now: Make, Protect, Teach and Things Fall Apart: Politics, you know that I am a full-hearted believer in acting from the bottom-up, in bypassing and ignoring the high-functioning sociopaths who dominate our top-down hierarchies of markets and politics. I still believe that.

But it doesn’t work with COVID-19.

The core problem with any rights-based approach to public policy is dealing with questions of competing rights. Under what circumstances could your right to liberty and the pursuit of happiness come into conflict with my right to life? Under most circumstances, neither of us is forced to compromise our rights, because we have the choice to NOT interact with each other. If my laundromat requires you to wear a mask to enter, but you think wearing a mask is an affront to your liberty, then the solution is easy: go wash your clothes somewhere else. And vice versa if I think your restaurant does a poor job of enforcing social distancing and food safety: I’ll take my business elsewhere.

Let me put this a bit more bluntly. I think that COVID-19 deniers and truthers are idiots. I think that people who minimize or otherwise ignore the clear and present danger that the biology of this virus presents to themselves and their families are fools. And there’s no perfect way to insulate their idiocy and foolishness from the rest of us. But if these idiots and fools want to take stupid risks alongside other idiots and fools, if their vision of liberty and the pursuit of happiness is to revel in some death cult, but in a way that largely allows us non-death cultists to opt out … well, I believe it is wrong for a government to stop them. Yes, there are exceptions. No, this isn’t applicable on all issues, all the time. But I believe with all my heart that if we are to take individual rights seriously, then we must take individual responsibility and agency just as seriously. Even self-destructive agency. Even in the age of COVID-19. Especially in the age of COVID-19.

There are three common and important circumstances, however, where this choice to NOT interact doesn’t exist, where the rights of yes, even idiots, to liberty and the pursuit of happiness as they understand it will inexorably come into conflict with the right to life of those who understand all too well the highly contagious and dangerous biology of this virus.

Only government can provide the necessary resources and the necessary coordination to resolve these conflicts of rights peacefully and without trampling the rights of one set of citizens or another.

You have no idea how much it pains me to say that.

It pains me because I think there’s a snowball’s chance in hell that our government will do that.

Here’s how a legitimate government would deal with the three inevitable and irreconcilable conflicts of rights in the age of COVID-19:

Healthcare workers and first responders have no choice but to risk their right to life in caring for all citizens who are sick, regardless of the agency or lack thereof behind that sickness.

How does a legitimate government resolve this conflict?

By mobilizing on a war-time basis to provide personal protective equipment (PPE) to ALL healthcare workers and social workers and first responders and public safety officers and anyone else who must serve the sick.

Workers who believe that their employer does not provide sufficient protection against this virus have no choice but to risk their right to life in their return to work, as unemployment insurance typically is unavailable for people who “voluntarily” quit their job.

How does a legitimate government resolve this conflict?

By providing a Federal safe harbor to unemployment claims based on COVID-19 safety concerns, AND by maintaining unemployment benefits at the current (higher) CARES Act level throughout the crisis.

All citizens who use public transit or use public facilities have no choice but to trust that their fellow citizens share a common respect for the rights of others, even if they may differ in their risk tolerance and private beliefs regarding the biology of the virus.

How does a legitimate government resolve this conflict?

By mobilizing on a war-time basis to provide ubiquitous rapid testing in and around all public spaces, starting today with symptom testing (temperature checks) and required masking to limit asymptomatic spread, and implementing over time near-instant antigen tests as they are developed.

It’s just not that hard.

But it is impossible. Politically impossible.

So what do we do?

“I have no idea what’s awaiting me, or what will happen when this all ends. For the moment I know this: there are sick people and they need curing.”

— Albert Camus, The Plague (1947)

We do what we can. We howl our discontent. We resist. We help our neighbors. We make. We protect. We teach. We keep the small-l liberal virtues and the small-c conservative virtues alive in our hearts and our minds.

So what do we do?

For the moment I know this: there are sick people and they need curing.


Epsilon Theory PDF Download (paid subscription required): A Truth That’s Told With Bad Intent


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Hateful Memes and Election Season

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As the core COVID-19 narrative shifts from the mixture of human and economic tolls that dominated news over the past few weeks to the coverage of lockdown relaxation across the United States, we are starting to observe other topics and language creeping back into the Zeitgeist for the first time.

Unsurprisingly, most of them have still been tangentially related to the pandemic.

For example, we are observing a lot of shared language in the ether about direct sales and e-commerce (a term I thought had gone out of vogue years ago, to be honest). The framing of these pieces positions them squarely – and consistently – in context of a response to pandemic-driven buying behaviors.

Pepsi Unveils 2 New Websites to Sell Its Products [The Street]

Likewise, there are fascinating micro-clusters of only-sort-of-coronavirusy language popping out in ways we have not observed before, too. For example, this standard wire service blurb is representative of a wide swath of health care companies reporting, affirming guidance and trading up a bit on the news. It is an odd bit of linguistic uniformity.

Mylan’s stock gains 2%, reaffirms guidance for 2020 [DJ Newswires]

And if you can manage to link a holiday like…<checks notes>…Mother’s Day with COVID-19, well, then you’ll probably find your way to a brief top billing on our check for language with high interconnectedness across clusters and topics. Nice one, Mike.

Mike Rowe: Moms are ‘the ultimate’ essential workers [Fox News]

We have also observed that story stocks – the ones which have some kind of non-fundamental appeal that crosses typical demographic and investor style boundaries – frequently make their way to the top of the Zeitgeist. It is an unavoidable result of their connection to all sorts of other pop culture, technology, social and cultural trends. Which, in a nutshell, is what we mean when we call something a story stock.

Elon Musk says he’s willing to be arrested as Tesla reopens Fremont factory [NY Post]


Yet we are observing some emerging consensus topics and language that have little-to-no pandemic relationship, and which we think are likely to be our companions for the next few months. One of the biggest appears to be the role of AI and machine learning in the identification of patterns of online behavior. Or, in the words of researchers at Facebook, ‘hateful memes’.

Facebook says AI has a ways to go to detect nasty memes [ZDNet]

The article itself is largely a summary of a paper published by the Facebook AI team in connection with their prize-sponsored effort to crowdsource solutions to the problem of systematically analyzing combined text and image data (or other multi-modal forms) that typifies most internet memes. In short, it’s pretty hard to spot whether the most common type of internet meme is abusive, mean or hateful, and we’re still not very good at it. It is technologically fascinating exercise. It is also terrifyingly Orwellian.

To their credit, ZDNet asks some good questions.

A second question was what the scale of the problem is of hate speech at Facebook. Given that the premise of the work is to enlist AI to clean up hateful utterances on social media, it’s important to know things such as how much hate speech is removed on a regular basis, or perhaps a tally to date. Facebook declined to comment.

Facebook says AI has a ways to go to detect nasty memes (ZDNet, May 12, 2020)

M’kay.

There ought to be an impulse to ask “why am I reading this now?” in response to this piece, and perhaps even more so to the underlying Facebook research. It’s reasonable to wonder why its language is so deeply connected to other news being published right now. At risk of answering what is usually intended to be a rhetorical question, I’ll offer what I think based on the language I’m observing in other articles it was connected to: election season.

It’s here, and this is ripe territory for the top-down political narratives we will be discussing at much greater length in the coming weeks. If you have not prepared yourself for a news and social media cycle framed in highly polarized terms of misinformation / censorship / manipulation, now is probably your last chance.

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Everything You Always Wanted to Know About CDS … But Were Afraid to Ask

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I know it’s forbidden to say this, but I like Woody Allen movies. If you’ve never seen Everything You Always Wanted to Know About Sex* … But Were Afraid to Ask, it’s worth your time just for the Gene Wilder scenes. And yes, credit default swaps are the sheep in this story.

Here’s the replay for the CDS trading primer we held via conference call and screenshare for ET Pro subscribers:


I’ve also attached the slide deck I used in the presentation here: ET Pro CDS Primer deck.


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American Idol

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An 89 year old man who hasn’t gotten a haircut in months sits at the dais, alone, accompanied by a hotel ballroom all-purpose drinking glass filled with Coca-Cola and a stack of printed slides. The slides are text-only, black font on stark white. No frills.

The speaker is the most legendary investor and business personality in the world. His financial conquests have accrued an almost mythological tincture in their telling and retelling over the decades. He is Daedalus, having built a labyrinth of intersecting interests from insurance to electricity, and then a pair of waxen wings to fly above it all, with just a few dozen employees and contracts written on cocktail napkins. He is Midas, touching afflicted financial corporations in a time of mass insolvency with his rescue money and, more importantly, his imprimatur. One-eyed Odin sitting beneath the eaves of Yggdrasil, having paid a bodily price to have drunk from the Well of Wisdom. He is the Oracle, with tens of thousands braving the journey and the Omaha Embassy Suites to hear his annual pronouncements. …

Anyway, the old man spoke on Saturday. For a long time. The sparsity of text on each slide was in no way a signifier of whether or not he had much to say. Buffett was, as always, loquacious and brimming with interesting statistics – American history, market returns, inflation – turns out the Louisiana Purchase, at just 3 cents an acre, was an absolute steal.

But it wasn’t the same.

Josh Brown, This Version of Warren Buffett

Warren Buffett is the American Idol of investing. He is, as Josh Brown puts it so well here, an impossible combination of Daedalus, Midas, Odin and Oracle. He is a mythic figure, with a public persona and legend that goes far beyond his considerable investment skills.

Warren Buffett is a performer. That’s not a knock on him. Not at all! Public performance is what is required to be a mythic figure. Public performance is what is required to evolve from just a really good singer, someone who can hit all the notes, into someone who transcends mere singing and becomes an American Idol.

Really good investors – like really good singers – are not exactly common, but they’re not exactly rare, either. Transforming yourself from a really good investor into a Great Investor, on the other hand … well, that IS rare. And it only happens through the active creation of a personal mythology. It only happens through public performance.

There is no more powerful venue for public performance than a live audience.

This is how legends are made, whether you are a singer or an investor or a politician. This is how you build a following, not in the sense of casual fandom, but in the sense of zealotry. This is how Warren Buffett used the Berkshire Hathaway annual shareholder meeting to transform himself from a really good investor – probably a great investor – into a Great Investor.



Looks like fun, right? I’ve never made the hajj to Omaha myself, but I know exactly what it feels like. It feels like an SEC football game. It feels like a performance at the Apollo. It feels like a campaign rally. It feels like an inauguration. It feels like a papal sermon in St. Peter’s Square. It feels like a Veterans Day parade.

It feels AMAZING, and that’s true whether you are there in person or watching on TV. It’s better in person, for sure. But it’s not bad on TV.

So what happens when you take the live audience away from a great performer like Warren Buffett?

We, the audience watching from home, don’t think the performance is as good.

Not because the actual physical performance is any different! But because we, the audience watching from home, no longer have the cues to tell us how wonderful the performance is. The crowd can no longer watch the crowd, and that means everything for how the crowd consumes the performance.

This is why sitcoms have laugh tracks. This is why executions used to be held in public. This is why coronations and inaugurations still are. This is why, more than 25 years later, China still prevents any images of the protest crowds in Tiananmen Square from getting on domestic Internet sites. This is how riots start. This is how cathedrals are built. It is the power of the crowd watching the crowd, and for my money it is the most powerful social force in human history.

When the crowd can’t see the crowd, the crowd loses its interest in the performance. We get bored. We tune out.

Like Josh says, it’s just not the same.

Here, I’ll prove it.

In mid-March, the producers of American Idol made a tough decision. Just as they were about to begin their live performance schedule in Los Angeles, where the 20 Idol wannabes would be whittled down week by week, COVID-19 lockdowns made it impossible to maintain that production model. Rather than cancel the season altogether, the producers decided to retool with two weeks of filler material focused on the contestants’ backstories, followed by a resumed competition filmed at the contestants’ and the judges’ homes.

So we went from this in the 2019 American Idol season …



To this in the 2020 season …

Where the contestants literally sing to the camera from their living room or garage, and the entire show takes on the production values of a Zoom conference call.



To be clear, the actual singing is terrific! Seriously, there’s a ton of talent (diverse talent, too!) on this year’s show. The backing musicians are AMAZING, and the acoustics are not as bad as you would fear. No idea what sort of mixing or editing technology is required to make the final product turn out as well as it does, but the producers deserve a lot of credit here.

There’s just one problem. We, the television audience, think it sucks.

I compiled the apples-to-apples ratings data for the first twelve episodes of the 2019 and 2020 American Idol seasons (Sunday night to Sunday night, same network, same time slot), both on absolute numbers of viewers and the 18-49 year-old demographic (which really drives the economics of these shows). The line drawn between after the April 5, 2020 episode is when the production formats for the 2019 and 2020 seasons diverged.

With the elimination of a live audience format, year-over-year ratings have collapsed.

Seriously, with these ratings I’ll be surprised if this season of American Idol isn’t canceled before they crown a winner. Yes, the show still holds up pretty well against its time slot competition, but this just isn’t viable for whatever budget and projections ABC had coming into the season.


American Idol ratings by episode, 2020 vs. 2019

Take away a great performer’s live audience, and you take away their source of narrative power.

That’s true for American Idol. That’s true for Warren Buffett. It’s also true for Donald Trump.

You think Trump is happy to replace his live audience campaign rallies with televised press conferences? You think he doesn’t realize this is killing him politically?

Whatever you think of Donald Trump, if you don’t realize he is a great performer and a master of the Common Knowledge Game, you’re just not paying attention. Without live performances, he loses a major power source for the November election.

I think this is a big reason why Trump is pushing so hard to reopen battleground states.

And one more thing …

If any of the sports leagues are contemplating TV audience-only competition, my advice is to think again.

The power of the crowd watching the crowd is also true for sports leagues. Maybe more true for sports than for any social function other than war. Without a live crowd for the TV crowd to take its cues from, the TV crowd will quickly lose engagement and interest. Regardless of the level of competition, a disembodied audience is a bored audience.

And that’s the only true death for any performer in any field. That’s the only thing you can’t recover from in the modern age. Boredom.

Welcome to the age of bread and circuses, my friends. Same as it ever was. Especially here in the age of COVID-19.


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The Pent-Up Demand Narrative

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In our ET Professional updates over the last few weeks, we have repeated one particular refrain.

The dominant COVID-19 narrative today is a “short and deep” economic impact.

There’s a corollary narrative here that we think is particularly important for investors, and it’s a narrative that we think is closely tied to real-world data that investors can track on their own.

The corollary COVID-19 narrative today is “pent-up demand” that drives the up-slope of a V-shaped recovery.


The “Short and Deep” Narrative

Here’s on overview of what we’re seeing in the Narrative Machine.

The narrative maps below represents all major outlet US equity markets coverage since March 1, with the bold-faced connections and nodes representing articles with language characterizing the economic effects as “temporary” or “short-term” or “V-shaped” in the first map, or language relating to “lasting” or “long-term” or “L-shaped” economic effects in the second map.

The way to read narrative maps is to look at the number and frequency of bold nodes, yes, but much more importantly you should look at the centrality and the connectivity of the bold nodes.

In the first map, focused on the language of short-term COVID-19 impact, you can see how this language is deeply connected to each of the most central clusters (general market commentary, fiscal and monetary policy, corporate earnings, etc.), and extends from those central clusters into nearly every other peripheral cluster on nearly every market sub-topic. The one exception would be any cluster that focuses on the energy sector. No one is talking about the oil & gas industry with short-term or V-shaped recovery language!

In the second map, however, focused on the language of long-term COVID-19 impact, the only topic with concentrated use of and connections driven by this language is unemployment (dark green cluster on right of graph). There is widespread pessimism about just how “short and deep” the labor market and employment effects will be, but that pessimism is isolated to only those topics.

Language about the short-term economic effects of COVID-19 is pervasive in the way we talk about markets today.

Language about the long-term economic effects of COVID-19 is not.


US Equity Market Coverage Referencing “Temporary / Short-Term” Effects

Source: Quid, Epsilon Theory

US Equity Market Coverage Referencing “Lasting / Long-Term” Effects

Source: Quid, Epsilon Theory

“Short and Deep” implies “Pent-up Demand”

When you dig into what’s actually being said in these articles and transcripts about the short-term economic impact of COVID-19, you find a corollary narrative about pent-up demand.

A strong narrative structure, like we have with “Short and Deep”, means that NEW information or missionary statements tend to be accepted if they conform to the existing narrative, and tend to be rejected or marginalized if they oppose the existing narrative. This is what people often refer to as “confirmation bias” if you want to take a cognitive or behavioral economics approach, or you can express it as a rational outcome of Bayesian information theory if that’s your cup of tea.

We’re in the middle of earnings season right now, which means that most of the missionary statements we hear come from CEOs and CFOs on their quarterly earnings call, followed by buy-side and sell-side missionary statements about those calls, followed by media amplification of the missionary statements that fit the “Short and Deep” narrative and cartoonification or downplaying of the statements that don’t.

Since these earnings calls are focused on what just happened in Q1 and what is being experienced in Q2 (almost every company has pulled their long-range guidance) it is nearly impossible for these calls to change our minds about “Short and Deep”.

What happens instead is that the market reaction to many Q1 earnings calls is a positive response to news that was “not as bad as expected.” That’s not a prediction about those companies or their specific earnings situations (we really have no idea), but an observation that the narrative structure provided the language to absorb reports that could be aligned with the “depth” of the expected outcome. In other words, there’s a structural narrative asymmetry to positive earnings “surprises” today, not because these companies are doing surprisingly well in real-world, but because they compare well to what’s dominating the way we talk about these companies in narrative-world. Narrative expectations become a strong market tail-wind.

It’s not that market missionaries are lying about what they are experiencing in real-world. On the contrary, virtually every missionary statement we’ve looked at has been consistent in expressing clearly and earnestly the depth of the problem in Q1 and continuing into Q2. But that directness has in turn granted those parties credibility to express optimism about the briefness of the revenue/earnings problem, so that the narrative of “Yay, Pent-up Demand!” and rapid economic repair in Q3 and Q4 becomes common knowledge – what everyone knows that everyone knows.

And that’s the catalyst we think could reverse the current market-positive narrative structure.

If real-world demand for goods and services remains at these abysmal levels … if language about the long-term economic consequences of COVID-19 begins to spread beyond the unemployment cluster … then the common knowledge of “Pent-up Demand” will diminish and the narrative structure of this market can become profoundly skewed to the downside.


What investors should watch for

What would we be looking for to judge whether this narrative structure is reversing? Here’s our list:

  • 2H 2020 Guidance: The rubber will begin to meet the road in updated guidance on the second half of 2020 that we should begin to see following the relaxation of stay-at-home orders throughout late May and early June. Because of the “Pent-up demand” narrative, we expect a lot of the initial reports (correctly or incorrectly) to be passed through that existing framing. But the guidance from management that will follow that has a different objective – they want to beat, and they want to get grants with optionality priced to permit those beats to benefit them. We believe there will be more information (in terms of influencing investors to change their minds) in the guidance updates in June/July than in any corporate missionary behavior about COVID-19 to date.
  • Real-World Retail Knock-On Narratives: The delay in retail bankruptcies in expectation of liquidation sales that will accompany a relaxation in lockdowns is not a novel observation. There are, however, credit and real estate funds with meaningful exposure here that almost certainly sought and will seek to dampen impacts on Q1 – and yes, Q2 – marks by not accounting for the full coming destruction in value to which they are exposed. The same goes for oil & gas, where hope springs eternal on 1.1-1.3x marks which relax the typical commodity price-driven model approach on the basis of ignoring “short-term volatility.” Real world BKs cause real-world portfolio illiquidity. Be aware.
  • Second Half 2020 Lockdowns: As we discussed in a recent ET Live, we think that the fundamental corollary to housing prices in 2007/2008 is the actual, real-world ability of COVID-19 to cause new hot spots that lead to recurrence of stay-at-home orders in some US regions later in 2020. If these re-lockdowns occur, they will place enormous pressure on the “length of time” narrative about COVID-19’s economic effects.
  • Democratic Political Narratives: Investors should expect the COVID-19 pandemic to be ruthlessly politicized as part of the 2020 election in ways that it has not been politicized to-date. They should furthermore expect the promotion of new narratives – especially by the Democrats – about the economic reality and the length over which the effects of that reality will be felt. There will be “Trump sank us into a depression” narratives. They do not exist today – at all. They will be new, and they should be monitored.
  • GOP Political Policy: Election year politics don’t just show up in campaign slogans and rhetoric about “Trump sinking us into a depression” or “Trump doing everything to rescue Americans.” They show up in policy. The embedded assumption in markets that fiscal policy will keep supporting small businesses and households is part of the narrative structure now, and the White House cannot allow that narrative to falter. This IS their reelection strategy. Yes, the DNC will try to hang a depression narrative around Donald Trump’s neck. The President and the Fed and the GOP-controlled Senate, however, will continue aggressive policy action to ensure a strong S&P 500 and other cartoons of better-than-expected economic outcomes.

The nice thing about this list, I think, is that fundamental investors and allocators are well positioned to evaluate these items. You don’t need AI or a massive team of analysts or even the Narrative Machine to keep up here. Meanwhile, though, we will keep focusing our research on the short-term versus long-term linguistic structure of how we talk about markets. Together, we will get through this!

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Too Connected to Fail

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Epsilon Theory PDF Download (paid subscription required): Too Connected to Fail



If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.

Attributed to J. Paul Getty in The Five Rules for Successful Stock Investing

I don’t know how much life wisdom it is possible to extract from the life of J. Paul Getty.

On the one hand, Getty became fabulously wealthy by taking actual risk and doing things (like, say, learning Arabic) that no one else was willing to do at the time. On the other hand, he famously bartered for the life of his abducted grandson, seeking to whittle down the ransom demands to an amount that would be fully tax-deductible. Gee thanks, Gramps.

The Ridley Scott film chronicling this affair is a pretty fascinating story in its own right. Filmed and nearly ready for distribution right before the revelation of sexual assault allegations against Kevin Spacey, Ridley’s picture leaned on the great Christopher Plummer to step in and reshoot every scene featuring the, um, protagonist. It is an underrated film too overshadowed by the attendant real-life drama, and Plummer positively owned the Getty role.

Whether or not the notoriously miserly bastard – Getty, not Plummer – had much wisdom to commend him in other areas, however, his famous and possibly apocryphal description of the relationship between exposure and co-dependency remains powerful. It is the staple concept of the Too Big To Fail genre of global financial crisis thinkpieces, since it at once describes the nature of interdependence between banks and other banks, between banks and large institutional clients (e.g. hedge funds, some corporate hedgers, some asset owners), and between banks and the financial system at large.

But like Getty’s expression, TBTF is fundamentally an expression of the ability of scale to create systemic co-dependencies. It is accordingly, and appropriately, the rallying cry for those who seek to decentralize how reliant we are on any social or political institution, industry, business or individual by reducing and limiting the scale of our reliance on them. For those more inclined to ignore the extent to which government institutions are not organs of the people but petty powers to themselves, that usually means regulation. For those more inclined toward skepticism about state solutions to concentrated power but naivete toward the Ponzi-like self-dealing that has typified most good-sounding efforts to decentralize power, that usually means buying into the vision of this or that tech oligarch.

Yet there is a similar class of systemic risks which exist independent of scale. That is, they exist because everybody knows that everybody knows that an institution affects too many other issues or areas of society to be left ‘unmanaged’. They are often fulcrums on which some other policy or important issue rests, or otherwise carry external political implications.

In short, they are too connected to fail.


Yes, there is a financial markets observation coming, but a couple examples first.

Like, say, corn.

I grew up three houses down from a cornfield in Illinois. I used to get lost in that cornfield. I saw a tornado rip up that cornfield. I consider wrong opinions about cornbread fighting words under the precedent of Chaplinsky v. New Hampshire. I maintain a bottle of corn oil for the sole purpose of use in my green chile pork stew. Sometimes I think about corn.

You should, too.

Leave aside the decades of silliness of ethanol or the years in which low fat, high sugar diets rich in high fructose corn syrupy goodness were pushed by nutritionists and American food safety and health officials on American families. Instead, think about what you say when you talk about corn with friends and neighbors. What, you don’t talk about corn?

OK, fine, for the sake of argument let’s pretend that you are the normal one here. Still, I’m willing to wager that you, like I, have opinions on “farmers” and the US as the “Breadbasket of the World.” I’ll bet you know at least a little about ethanol’s ability to make us “energy independent” and something-something environment, something-something Chevy commercial mumbled under the breath of a lobbyist stinking of an artificially maple-flavored bourbon with a mash bill that runs awful heavy on the corn. Maybe you even know a bit about how corn was going to be how we built a diplomatic rapport with Brazil?

You and I know those things because there was a concerted missionary effort over decades to make the narrative of this particular agricultural commodity connected to things that do matter to us. Our country. Blue collar families. Health. Safety. In turn, those efforts manifested in rhetorically powerful policies which have become third rails in states with arbitrarily disproportionate influence on national primaries and senate composition.

Corn is not too big to fail. In both real-world and narrative-world, corn is too connected to fail.


Or, say, public education.

I went to public school and it worked out great for me. Still, my wife and I homeschool our boys, and not just in the way all of us are sort of having to do that right now. It is a life and lifestyle we have chosen. I still think about education and public school a lot.

You should, too. And you probably do.

When you discuss educational outcomes with friends, family and neighbors, what is the framing for your discussion? Do you talk about pedagogy? Singapore math vs. common core vs. the point-counting system and carry-the-one stuff we used to do when we grew up? Do you talk about the specific educational outcomes you want for your child, their predispositions and where they might be best-suited to focus efforts? Or do you, like the rest of us, mostly talk about “what we can do to improve our schools?” About how you can best support the teachers and staff at the local school?

Those aren’t necessarily bad things to discuss. The point isn’t that you or I are thinking and talking about the wrong things. It is simply worthwhile to know that we have accepted a dialogue which presupposes both the incumbent institution and the framing of the issue in terms of the producer of something we need.

Why do we do that?

We may certainly do it in part because of earnest conviction by many that compulsory public education is the best, fairest and most socially cohesive way to organize childhood learning. We may also do it in part because of decades of missionary-promoted narratives arguing that “support for public schools”, “opposition to non-public education” and “support for teachers” are rhetorically identical to “belief in education.” As many American families have discovered over the recent months, we may do it because our lives are (and for many of us, must be!) designed completely around subsidized supervision of our kids between the hours of 8AM and 3PM every day. And yes, we may do it because the tax-advantaged credentialing and real estate acquisition business we call the American university system actively penalizes thinking about childhood education in any other context. In the end, it is these entrenched connections that force the framing of our conversations about the topic.

Our current public education system is not too big to fail. In both real-world and narrative-world, it is too connected to fail.


You may well be fine with that. And that’s fine!

After all, calling something ‘too connected to fail’ is not a pejorative expression. It is a descriptive expression. Maybe you even read the above and said to yourself, “Well, what you’re describing sounds kind of like a description of public utilities.” No. What I described isn’t kind of like public utilities. I literally described what we treat as public utilities – entities which everybody knows everybody knows deliver a necessary public good.

But that is the fundamental risk of things that are too connected to fail. They expand the definition of “necessary” from “things we die from or suffer greatly if we don’t get” to “things which would upset the political balance” or “things which would shed light on a structural problem elsewhere in society if they broke” or “things which would be really, really inconvenient for someone in a place of political power if things went wrong.”

In other words, public utilities are not only what we call public utilities. Public utilities are also the industries and institutions whose narratives have connected them inextricably to other social and political objectives and needs. Everybody knows that everybody knows a failure in these things would have ripple effects on a variety of other institutions and issues of one kind or another. Effects we often aren’t willing to contemplate. And in the wake of the COVID-19 pandemic, we can officially add one more to the list:

Capital markets.

Don’t get me wrong. Capital markets have been deeply connected to other American institutions and concerns for just about our entire history. And they very obviously have a scale issue too, if it is even appropriate to think about them as a monolithic institution. It depends on the context.

However, I think the connections today are different in both kind and magnitude. In light of recent policy responses from the Federal Reserve in particular, they are worthy of consideration. To wit:

  • State and municipal pension systems are today both vastly underfunded and utterly reliant on the returns of US equity markets. In some cases that reliance can no longer be qualified by “over the long term”. Short- and medium-term stock market returns are now “necessary” to ensure a functioning pension system for tens of millions of American households.
  • With the exception of legacy systems, corporate defined benefit programs have gone away, replaced with defined contribution systems which eliminate the obligation for any party to fund a retirement benefit, replaced by the “necessity” of positive short- and medium-term stock market returns. This is especially true for the concentrated cohort of oft-referenced Boomers approaching or at retirement age.
  • Memes of “Yay, Alignment!” have shifted executive and board compensation programs toward equity-linked incentives from cash compensation, creating “necessity” on the part of many institutions to ensure share price stability and appreciation over short horizons.
  • Politicians such as Donald Trump have become increasingly explicit about messaging that stock market returns be used as the measuring stick for their presidency.
  • Media outlets have, in turn and where appropriate for their editorial aims, selectively done the same as part of a broader abstraction of the economy into “the stock market.” There is very little economic or business news in 2020. There is only market news.

What’s more, these connections in both real-world and narrative-world have become common knowledge. They are things we all know that we all know, beliefs about the true purpose of capital markets that are now being said out loud. Political strategists openly discuss and social media promotes data on the stock market’s impact on election outcomes. The St. Louis Fed openly celebrates the impact of nominally liquidity-focused intervention policies on short-term equity market returns. White House officials call the personal mobile phones of stock market-covering morning show hosts live and on-the-air.

The common knowledge about what markets are for is no longer “to direct capital to its most productive ends”.

The common knowledge about what markets are for is now “to give us the returns we need.”

Sure, markets have always directed capital and provided some return in exchange. This isn’t new. It’s kind of the point of the whole thing, after all. But capital markets that are for directing capital where it should go even if that doesn’t give us the returns we need right now will tend to do that. And capital markets that are for giving us the returns we need right now even if that doesn’t direct capital to the most productive places will tend to do that. This isn’t complicated.

Any time we change through word and deed what we all agree something “is for”, it is a Big Deal.

It is a Big Deal because once you accept the common knowledge primary purpose of capital markets as a “return-generating machine”, and once you implement policies which are designed to ensure that returns keep being generated at whatever cost (remember, it’s “necessary”), it is extremely difficult to walk those policies back.

It is a Big Deal because it fosters and promotes blind acceptance of policies that are designed to ensure equity prices and credit spreads hold within certain acceptable boundaries under the laughably thin veneer of “maintaining liquidity” by huge swaths of market participants who are among those who “need the returns”.

It is a Big Deal because it will permit and encourage the allocation of capital based on the expectations of policy intervention rather than on the expectations of turning that capital into future cash flow. That will reduce the value of everything we create together as a society over our lifetimes.

It is a Big Deal because it will make our children poorer and the world they inherit less vibrant, less dynamic and less prosperous.

Clear Eyes: In the coming weeks and months, if you hear anyone dismissing concerns about moral hazards of or the impact on long-term returns and cash flow generation of policies intervening in the prices of risky assets, know that you are speaking to someone who at best doesn’t believe in the basic function of markets and more likely doesn’t have a foundational belief in why markets work in the first place. They believe in returns, not markets. That is because they need market returns (e.g. someone with a large, AUM-based management fee business) more than they want long-term prosperity for all of us. Don’t waste time arguing with them. They are too entangled in the too connected to fail problem.

Full Hearts: If trying to build a pack here has taught us anything, it is that there are people in every corner of this industry – asset owners, fund managers, individual investors, strategists – who are interested in creating an environment where it is still possible to continue investing. You know, things like evaluating value, cash flow, growth prospects and the capital stewardship traits of management? Lawful good doesn’t mean lawful stupid, and there is no need to needlessly fight the Fed or the broad treatment of markets as public utilities. But there ARE ways to add value as investors that don’t require becoming entangled with what makes capital markets too connected to fail.

Embracing some of those methods will be hard. Really hard.

Can full-hearted board members overseeing large asset pools grapple with the risk of killing off consensus-driven models based on Wilshire TUCS universes and asset consultants that keep investors entangled with the too connected to fail problems of capital markets?

Can full-hearted corporate executives and boards move on from the Yay, Alignment! memes that permit stock- and option-based compensation models that favor an emphasis on short-time price appreciation?

Can full-hearted asset managers begin to consider moving away from AUM-based compensation models that drive behaviors, methods and positioning toward industry norms to protect the management fee franchise?

If change must come from the top down, the answer is no. But from the bottom up? From a group of people who recognize that the net social good of financial markets is the proper direction of capital to its most productive ends? From people who are committed enough to that idea that they are willing to take career and business risk?

Maybe.

With the COVID-19 pandemic putting a damper on our in-person ET Forum plans for later this year, we are planning something else. We want to use this unique time in history to help build regional networks of asset owners, business leaders and asset managers who think capital markets still matter. Networks that are too connected to fail – but in the right way.

Look for more from us on this effort over the coming weeks.


Epsilon Theory PDF Download (paid subscription required): Too Connected to Fail


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