Wall Street’s Merry Pranks: Things that Matter #4

Lisa Simpson: Get out! Get out!
Bart Simpson: OK! But on my way, I’m going to be doing this. And if you get hit, it’s your own fault!
Lisa: OK, then I’m gonna start kicking air like this. And if any part of you should fill that air, it’s your own fault.
Marge Simpson: Hmm. I better go check that out. Now Homer…don’t. You. Eat. This. Pie!
Homer Simpson: Okaaaay. Alright pie, I’m just going to do this. And if you get eaten, it’s your own fault!
 The Simpsons, Season 6, Episode 8 “Lisa on Ice”

So much of the nudging from our smiley-faced authoritarian overlords on Wall Street sounds like it is coming from a mid-windmill Bart Simpson. I’m going to give you low-cost tools. I’m going to create ways to encourage you to trade them (frequently) at close to no cost (that you can see, anyway). And if you happen to trade so much that you create short-term gains everywhere, if you end up with an underdiversified portfolio that blows up, if you end up selling at the bottom and holding cash through half of the recovery…well… it’s your own fault.

Verbal: Who is Keyzer Söze?

He is supposed to be Turkish. Some say his father was German. Nobody believed he was real. Nobody ever saw him or knew anybody that ever worked directly for him, but to hear Kobayashi tell it, anybody could have worked for Soze. You never knew. That was his power. The greatest trick the Devil ever pulled was convincing the world he didn’t exist. One story the guys told me — the story I believe — was from his days in Turkey. There was a petty gang of Hungarians that wanted their own mob. They realized that to be in power you didn’t need guns or money or even numbers. You just needed the will to do what the other guy wouldn’t. After a while they come to power.

 The Usual Suspects (1995)

I originally intended to include nothing but Spacey quotes that feel much creepier and weirder than they did six months ago. I decided against it but had to keep the classic Söze line.

Why? Because the greatest trick any nudger, any libertarian paternalist ever pulls is always to convince the world they don’t exist. Their new business model, their new sales pitch, is all about the customer. They are just conveying it to you, and it’s really your decision whether you’re going to take advantage of it. But don’t mistake value for virtue — the magic of free markets is that they empower value-seeking behaviors to generate societally virtuous outcomes. The low-cost investing revolution and its sister — the movement to empower individual investors — has been a generational boon for investors. They created immense value. But never forget that this is a business and that these products are created by profit maximizers, not virtue maximizers. When we see branding and advertising that convey psychic or moral value from do-it-yourself and low-cost investing, we must know that we’re being nudged toward other less virtuous, riskier behaviors. 

Well, when all the people arrived in church, Eulenspiegel mounted the pulpit, said something from the Old Testament, tossed in the New as well, with Noah’s Ark and the Golden Bucket, in which the bread of Heaven Lay — and said, moreover, that all this stuff was the greatest holiness. Then at the same time he began to speak of the head of Saint Brendan, who had been a holy man. He had Brendan’s head right there — and it had been commanded of him that he use it to collect for the building of a new church, and to do so with purest goodness, never (on pain of death) accepting any offerings from any woman who might be an adulteress.

“And whoever here may be such women, let them stand back. For if they offer me something — those who are guilty of adultery — I won’t take it, and they will be revealed in shame unto me! So — know yourselves!”

Till Eulenspiegel: His Adventures, No. 31, Paul Oppenheimer (Editor/Translator)

The Söze-style penchant for creating havoc and disappearing into the background — and avoiding responsibility — is hardly new. It’s straight out of the playbook for the Trickster that exists within every major mythology. Till Eulenspiegel, a late middle ages version, is well known to Germans but almost completely unknown in America, which is a shame. This story is the best example I know of a trickster’s need to adapt his schemes to be more palatable when the world gets wise to him. Sound like any industries you know?


Some people always knew they wanted to be investors. They read Barron’s as a teenager and had their parents create an account for them to buy and sell stocks when they were 13.

Not me.

I wanted to be a composer. I would have settled for being an operatic tenor. If I couldn’t do that, I’d be willing to try my hand at being a musician in an orchestra. Short of that, I’d settle for being a drummer in a rock band. I supposed, if I couldn’t do any of those things, finance might be interesting enough. When I started the process of looking at universities, I considered pursuing each of these five things. I ultimately concluded that, if I were good enough at any of the first four, it wouldn’t matter if I had a degree saying that I was. So I studied finance. It’s a good thing, too, because it turns out I wasn’t nearly good enough at any of the others. I auditioned with some regional orchestras and opera companies, and got enough alternate work to pay for food and rent in college. It never would have gone any further than that.

Now, orchestral auditions are especially funny. These days, you’re called into the room and you sit in front of a screen. You are asked to play excerpts from the standard repertoire. I was a hornist. The horn is among the most versatile instruments, and so the point of the audition is to demonstrate your ability to perform all the things the horn is called upon to do. You need to display technical prowess, and so they ask you to play the famous horn call from Richard Wagner’s “Siegfried”. You need to display facility throughout the range of the instrument, so you are called to play the opening from “Ein Heldenleben”, by Richard Strauss. You must have a capacity for lyricism, for which you are asked to play the solo theme from the Poco Allegretto movement of Brahms’ Third Symphony, which has been shamelessly stolen by everyone from Sinatra to a weird and creepy Santana-Dave Matthews duo. Then they ask you to show you can do all of those things at once by playing the corno obbligato solo from Mahler’s Symphony No. 5.

But there’s one piece that shows up every time, even though it doesn’t get played by orchestras too terribly often: “Till Eulenspiegel’s Merry Pranks”. It’s another Strauss tone poem, and it is the Tower of Babel to every richly scored Merrie Melodies and Looney Tunes cartoon. Seriously, listen to the whole piece with your eyes closed, and your mind will fill in just where Bugs Bunny tricks Elmer Fudd into shooting his shotgun into a rabbit hole that sends it back through a funnel into Fudd’s face. The piece itself is a musical imagining of Germany’s version of the classic trickster character. Of course, it’s Germany, so the pranks are pretty dark, and most are scatological. As with many such stories, however, they also effectively highlight some of the absurdities of language and human behavior.

My favorite Till Eulenspiegel tale is the 31st of those that may have been assembled by Hermann Bote in the late 15th century. Paul Oppenheimer at CCNY did a lovely and sadly underbought translation, if you’re looking for an off-the-beaten-path and entirely inappropriate bedtime storybook. In this story, Eulenspiegel has become a bit too well-known to play his usual characters. A sort of Sacha Baron Cohen of the German late middle ages, if you will. He needs to find a new way to make money, and so he decides to pass himself off as a dealer in religious relics. He takes on a priest’s cassock and goes from town to town in Pomerania with a certain scam in mind. After procuring a skull from a graveyard, he inlays it with silver and asks the local priests — who are, naturally, universally corrupt and drunk — to allow him to raise money to build a new church in honor of the saint whose skull he carried. Which is, of course, just the remains of some dead blacksmith, but no matter. There is, however, a catch: our heroic church-building protector of holy relics is sworn never to accept donations from any woman who has ever committed adultery, and he will know if they are lying.

So who comes up to kiss the skull and drop some money in the pan?

Every woman in the church, of course. As soon as the first pious busybody makes her way up to demonstrate her faithfulness and purity (and to wait for the fireworks from her more libidinous sisters), all the other faithful wives don’t really have a choice. If she is going to go up there, then it’s not like they can avoid giving to the cause and proclaiming their virtue. Now, the guilty ones, their decision is a bit more complicated. Their bet is either that Eulenspiegel is a fraud or that he’s not. The alternative, not going up, results in the same outcome for them: being outed as an adulteress. So, for them, too, the best strategy is to kiss the skull and drop a coin or two in the basket. They were doomed to this roll of the dice as soon as the first woman walked to the front.

With every adulteress who comes to this conclusion, it’s easier for all the rest, because it’s more likely they’ve seen someone they know or suspect to be guilty come away blameless. At a certain point, despite Eulenspiegel’s bold words celebrating the holiness of their parish, most people have gotten wise. But who cares? We like the eggs. It’s a useful exercise for everyone. Eulenspiegel and the priest get paid. The pious confirm their piety. The guilty get a bit of public absolution, and even more license to continue their sin.

OK, great, so what does this have to do with finance, markets and politics? Well, “Till Eulenspiegel’s” is a story of those who would deceive us by exploiting our need to appear virtuous and good. It’s a story of the good among us proclaiming virtue and forcing the hands of others to proclaim it as well (whether they are virtuous or not). And when the non-virtuous join in the proclamations, it is a story of how they lean on their newly-found virtue to get themselves into some real trouble. Of course, by that time, Till Eulenspiegel has already gone full Keyzer Söze. He never even existed.

What virtue are we called upon to signal in finance, then? Well, is there any investing behavior more widely pursued, more universally lauded than low-cost, passive investing? Is there any trait more prized than empowerment of the individual investor to use those tools to take his investments into his own hands? When the industry comes to us, silver skull in hand and asking us to pledge ourselves to these virtues, most of us do so willingly. After all, we recognize that stock-picking is usually a waste of time. We recognize that spending a bunch of time fussing about which fund manager to pick is usually a waste of time.  And we don’t like to pay fees that don’t buy us anything.

This pound-the-table religion about active vs. passive management is all well and good for those of us in the business, who mostly live and breathe the Things that Matter. But for a universe of individual investors (and rather distressingly, probably some institutional investors, too), the message of empowerment is anything but. It’s a nudge into terrible portfolios, terrible costs and terrible outcomes. But hey, at least they got religion and implemented those terrible, far-too-actively-traded portfolios with ETFs!

I recognize that this is an odd way to start a note that’s going to be about the importance of costs in investing. And that really is what this note is about. It’s an especially odd way to start a note that’s going to characterize those costs as one of the big Things that Matter in investing. But while we walk through just how indispensable low-cost investment tools must be to any modern portfolio, what I really want to emphasize is that the order of this Code was not an accident. By and large, the decisions you make about risk, diversification and behavior are all going to impact your portfolio more than the expenses you are paying on funds or to your financial advisor.

Perhaps more controversially, I also want to observe that even among costs, those direct expenses will often fall short of other costs that get short shrift in most solutions offered: especially taxes, transaction and market impact costs, and the indirect costs imposed by buy/sell behaviors.

More to the point, I fear the empowerment of low-cost investing tools is making adulteresses of many of us.  Given license by a perception that buying a bunch of index funds makes us passive (it doesn’t), we actively trade those positions in ways that impose far more costs than we ever would have borne directly. We build portfolios that are excessively risky (or too defensive), underdiversified or dependent on single factors that produce long-term risk and return impacts that dwarf the costs of advice on portfolio construction. We trade portfolios for no cost without recognizing the terrible execution we are getting. We fire the only people holding us accountable for our behavior as investors — our financial advisors — to chart out our own course.

And the Pranksters and Priests of Wall Street love every minute of it.

The Most Important Development in Finance Since 1952

So now that I’m done negging on low-cost investing, let me give you a slightly more positive take: the availability of low-cost indexed vehicles to access the world’s financial markets is the single most important development in finance since at least the development of the 401(k) in 1978, and probably since Markowitz in 1952. It’s difficult to really measure the impact that indexing has had, because it has taken a variety of forms. Most people think of the direct impact of funds flowing from expensive actively managed mutual funds to indexed mutual funds and ETFs with a lower cost. This alone has had a multi-hundred-billion-dollar impact, retaining wealth in the hands of individuals that would otherwise have gone to fill the coffers of fund management companies. There has also been a direct shift from ownership of individual securities to index funds, which has had the effect of reducing commissions paid to brokers by an amount that is probably somewhat less. I haven’t seen a detailed study on the matter, but my back-of-the-envelope math says investors have accumulated something on the lower end of hundreds of billions here as well.

Indirect benefits have been significant, too. Because of prevalence of low-cost index fund options, active funds and other strategies have been under pressure to lower their costs in response. This kind of thing is hard to quantify, but as the guy running a fund management business, trust me… it’s a lot. And while all this was going on in retail land, we’ve observed financial futures contracts becoming more common, more liquid and among the most cost-effective means of accessing global financial markets for institutions. We have also seen hedge fund fees drop steadily, incentive fees shift toward a recognition of underlying market betas, and private equity managers begin to move away from fees on uncalled commitments. In a 2016 article, Bloomberg estimated the cumulative impact for asset owners at a cool trillion, give or take. I think this number is probably a bit light once the indirect impact is considered fully.

I argued in “You Still Have Made a Choice” that investors should think constantly about opportunity costs and the implicit bets they make in their portfolios. There, my focus was on the implicit bets we make on one asset class or investment to outperform another when we under diversify. One could just as easily apply that kind of thinking to the explicit expenses we pay. And they set a very high bar. If you think that you have a good chance of selecting a manager in a major asset class that is likely to consistently outperform the 70-80bps per year you typically save these days by selecting a comparable passive option, you are suffering from hubris, delusion or both.

The “Other” Direct Costs of Investing

OK, so the amount of ink spilled on saving the 70-80bps previously paid to financial advisors and fund managers is justifiably voluminous. But here’s where Eulenspiegel takes us for a ride — and where those of us jumping up to kiss the skull act as their accomplices: In celebrating this victory, we seem to assume that everyone else is using their newfound freedom from a financial advisor and an infinite array of index funds the same way that we are. We assume that they are long-term, diversified, generally buy-and-hold investors in command of their behaviors that are reveling in the synergy of that approach with an arsenal of low-cost solutions.

It is a pleasant fiction, isn’t it?

In a prior piece about the Things that Don’t Matter — “And They Did Live by Watchfires” — I referenced some of the data showing just how fictional that is, at least as it pertains to ETFs. Most of the data on average holding periods you can find pretty easily, something I encourage everyone to do. The data and reports you’ll find split the world into two pieces. On the one hand, you’ll find a lot of studies showing that average holding periods for ETFs are somewhat less than for other vehicles — usually around 1 ½ to 2 years — but still on the longish side. On the other hand, mean holding periods of the instruments themselves end up being shorter. Much shorter. In some cases, these periods can be measured in weeks. So what gives?

What gives is that you’ve got a very bipolar universe of users. Most of the world — especially people with financial advisors — see low-cost index strategies, whether they come in mutual funds, ETFs or futures contracts, as tools to develop an efficient portfolio. All hail us, the faithful wives. But you’ve also got a smaller universe of (mostly individual) investors who have rallied around the message of low-cost investing to execute strategies that are anything but. Witness the march of the adulteress army to the altar. How do I know these people exist, other than the fact that the data show that they exist?

Because I meet them every day. Because financial advisors tell me about them and ask me what to do about them every day. The amount of bitcoin day-trading, TVIX-flipping, SPY-to-QQQ-to-IWD swapping that goes on in some individual investor accounts is shocking. And to a one, these investors are painfully cost-conscious. They wouldn’t dream of paying a management fee to a fund manager. And paying a financial advisor? Forget about it!

And yet.

The Petajisto paper referenced in “Watchfires” covers trading costs reasonably well, although increases in size and volume of the market have almost certainly narrowed some of the spreads since it was originally published. Still, trading costs of any actively traded strategy have the potential to be as large as the average difference between a passive and active fund. All investors should be thinking about trading costs as a Thing that Matters every bit as much as direct advisory costs, and based on my conversations with advisors and individual investors, I don’t think most investors give it much of a thought at all.

Separately, and potentially far more importantly, the kind of activity implied by the increased turnover of this special class of investors in low-cost vehicles can have a massive impact on taxes. In the chart below, I show the equivalent advisory fee you would pay in order to equal the impact of different levels of annual short-term taxable turnover.

Source: Salient 2017. For illustrative purposes only.

Let’s unpack that. Assume, for example, that you had a 20-year horizon. Now assume that every year you turned over 40% of your portfolio, and that you did so with positions that produced short-term gains. This is fairly typical of the activity I see even from goody two-shoes virtue-signaling investors and advisors like me, whose average holding periods are in the 18-to-24-month range. Even in this case, the impact from taxes is the same as paying a 75bp advisory fee to a fund manager or financial advisor. Now imagine (or just look above to see) what a more actively traded approach is going to look like. It’s not pretty.

Now, I’ve made a lot of fuss about how some misguided investors are misusing index funds and ETFs, but this isn’t really about that. Frankly, this is a point that needs to be heard by investors in any commingled vehicle, mutual funds and hedge funds perhaps more than any, so I want to say this as clearly as I can: if you are a taxable investor, taxes matter more than fees, and you’re not paying enough attention to them.

No, Virginia, You’re Not a Passive Investor

The “vehicle-centric” view of investing guides investors toward do-it-yourself solutions where the only important consideration is whether you’re paying an explicit fee. The resultant behaviors for a portion of those investors lead to disproportionate tax impacts, and they lead to transaction costs. There’s a reason why I’ve written that Investor Behavior Matters. But those behaviors matter most when they impact the two biggest decisions that investors must make: how much risk to take and where to take it (diversification).  So, unsurprisingly, I do want to take another opportunity to remind everyone that they aren’t passive investors just because they bought a bunch of index funds. In “I am Spartacus”, I put this in context of a global portfolio of financial assets. Here, I want to take a different tack.

Let’s assume that the world of index funds (here, I use ETFs, but could just as easily be mutual funds) consisted of the 100 largest such vehicles as they exist today. Now consider an exercise in which we decided we wanted to buy 10 of those funds at random, assigning them 10 different portfolio weights (also at random). If we did this random selection, say, 100,000 times, how often would we have gotten different risk and return outcomes[1]? How much would they really differ from one another? Basically, what I’m trying to answer is, “If I had absolutely no insight into asset allocation, but was being told I needed to keep costs down and do the investing myself, what is the range and likelihood of different portfolios I could end up with using those instruments.” The table below shows the answer.

Source: Salient 2017. For illustrative purposes only.

First, how do we interpret this? In short, the difference between good and bad asset allocation decisions is big. It’s bigger than taxes. It’s bigger than transaction costs. It’s bigger than advisory fees. And if you are assuming that you don’t really have a lot of ex ante insights, that’s kind of a big deal.

A nice portion of the portfolios cluster around a 6-8% return with 12-14% volatility, but they’re only about 17% of the total. More than 43% of the portfolios have returns that differ materially (by 2-4%). And if you’re comparing the best 20% to the worst 20% of portfolios we could have selected, you’re talking as much as a 6% annualized difference in returns, with correspondingly large differences in the amount of risk you were taking to achieve it. And this is just including the Top 100 ETFs, which are largely confined to large, liquid, broad market instruments, and not the more esoteric options that begin to fill up the portfolios of many practitioners.

To many readers this is certainly intuitive, and so I don’t pretend I’m making a novel point here by saying that asset allocation matters. Other readers might criticize this by saying, “Surely we should expect more from folks than just a random allocation to funds.” This is the point in the conversation where I would stare at you intently, but quietly, until you amended your statement to something less stupid so that we could continue our erstwhile cordial discussion.

More novel, however, is the observation that — in rough numbers — a better than random approach to asset allocation can matter to the tune of 2-6x the impact of a typical active fund’s fees.

In Defense of the Financial Advisor

So yes, Costs Matter. And if you asked me how much each of these direct and indirect costs matter, my very generalized, not-at-all-personalized for you list would look something like this:

  1. Indirect Behavioral Costs on Asset Allocation Decisions
  2. Taxes
  3. Advisory Fees (Tie) / Transaction Costs (Tie)

One of the responses Ben and I invariably get from readers is, “Include more actionable ideas!”, so I’m ready for the chorus of, “OK, I get it. What do I do?” Here’s what you do:

Hire and pay a financial advisor.

Before anyone jumps in, I’m not telling you to pay a bunch of high fees for actively managed strategies in markets where they don’t have a prayer of producing sustained outperformance after those fees. God knows homo marketus can find just as many perfectly good ways to create taxable gains and transaction costs in actively managed solutions as well.

What I AM telling you is that you should find someone who you trust. Find someone who is looking out for you on taxes. Find someone who is looking out for you on transaction costs. Find someone who tells you the truth about how much you’re paying them. Find someone who is going to save you from your fear when you want to sell low, and who will protect you from your greed when you want to buy high. Find someone who will keep you diversified when you want to take stupid risks in markets and securities where you don’t have an edge (which is all of them — sorry). Find someone who isn’t trying to get you to trade in and out of new ideas all the time. Find someone who doesn’t sell to you with Eulenspiegel-style virtue signals. Find someone who doesn’t disappear like Keyzer Söze when things go wrong.

Find someone who will treat you like a partner, and pay them.

But not too much.

[1] Here, we present this as a historical analysis. No resampling, etc.

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Pecking Order

Out of all the animals we keep on our “farm”, chickens are the only ones that bring me no joy. Chickens are, by nature, brutal and cruel. They will torture the weak to death with their pecks, not because they have to, but because they can. It’s the way their brains are hard-wired, and it works for them, as a species. So I pretend that chickens aren’t evil and I’m not complicit. Because I really like the eggs.

We are trained and told that the pecking order is not a real and brutal thing in the human species. This is a lie. It is an intentional lie, one that we pretend isn’t evil and where we are not complicit.

Because we really like the eggs.

And that’s the news from Lake Wobegon, where all the women are strong, all the men are good-looking, and all the children are above average.

― Garrison Keillor

We can’t all be rich.

We can’t all be famous.

We can’t all be Someone Who Matters to the World.

[Team Elite Narrator: OR CAN WE?]

Blake: Put. That coffee. Down. Coffee’s for closers only. You think I’m f**king with you? I am not f**king with you. I’m here from downtown. I’m here from Mitch and Murray. And I’m here on a mission of mercy. Your name’s Levine? You call yourself a salesman, you son of a bitch?
Moss: I don’t gotta sit here and listen to this s**t.
Blake: You certainly don’t, pal, ’cause the good news is — you’re fired. The bad news is — you’ve got, all of you’ve got just one week to regain your jobs starting with tonight. Starting with tonight’s sit. Oh? Have I got your attention now? Good. ‘Cause we’re adding a little something to this month’s sales contest. As you all know, first prize is a Cadillac Eldorado. Anyone wanna see second prize? Second prize is a set of steak knives. Third prize is you’re fired. Get the picture? You laughing now? You got leads. Mitch and Murray paid good money for their names. You can’t close the leads you’re given, you can’t close s**t. You ARE s**t! Hit the bricks, pal, and beat it ’cause you are going OUT!
Glengarry Glen Ross (1992)

The truth is that unless you are really rich, you work for Mitch & Murray. Yes, that includes you, Vox writer changing the world one smarter-than-thou opinion at a time. Yes, that includes you, tech start-up developer kicking back in your flair-bedecked WeWork cubicle.

We don’t feel the crushing power of the Mitch & Murray pecking order as palpably as the salesmen berated by Alec Baldwin feel it, because the language of David Mamet has been replaced by the language of Dick Thaler and Cass Sunstein. The modern Mitch & Murrays don’t browbeat us. They nudge us. They convince us that a set of steak knives is a darn good outcome, that it’s a promise kept rather than a threat delivered. Coffee’s not just for closers. No, no … coffee is for EVERYONE. In fact, let’s put some caffeine into everything you drink. Something nice and caffeinated to wash down that big slice of office birthday cake.

Most importantly, today’s Mitch & Murray writ large — the system of Mitch & Murrays — provides credit to the non-rich, essentially limitless credit for anything that’s intangible or depreciates quickly, anything that lets the non-rich FEEL rich. How about a nice dinner out? New smartphone? You deserve it! How about a couple of years of graduate school? More than a couple of years, shooting for a tenure track position? [Heh, heh] I mean … why certainly, even better!

Go on, try the eggs. They’re delicious.

And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

― Ben Bernanke (2010)

Step One in the Pecking Order Lie is to promote a narrative of trickle-down economics — that making the rich even richer is a good thing for the non-rich.

This is exactly what Ben Bernanke is saying here, that the Fed’s extraordinary efforts to prop up the stock market aren’t just good for the rich, but will be good for everyone once the “wealth effect” kicks in and the rich start spending their money.

Whenever someone uses the phrase “wealth effect”, they are promoting a trickle-down narrative.  

How does trickle-down monetary policy work? By spending TRILLIONS of dollars to buy financial assets, the world’s central banks have inflated the prices of ALL financial assets, EVERYWHERE in the world.

This is not a secret plan. This is not a hidden agenda. This is the avowed purpose of what central bankers call Large Scale Asset Purchases (LSAPs). The goal is to force us to “reach for yield”. The goal is to force us to buy more and more risky assets (stocks) at higher and higher prices. The Fed is trying to make the stock market go up. And they’re succeeding.

Here’s a great chart from TCW showing how this works. The orange line is the growth rate of the US economy. The blue line is the growth rate of how rich we are. By tripling the stock market, the Fed has made us much richer than our economy has grown … SOOO much richer than our economy has grown.

But the goodies of a trebled stock market aren’t evenly distributed. Who owns stocks? If we’re talking about households, leaving aside pension funds and endowments and other institutional investors, it’s the rich, mostly. And that household share of the Central Bankers’ Bubble doesn’t increase linearly with wealth, but exponentially, meaning that the really rich own a lot more stocks than the merely rich, so the really rich have gotten a lot richer than the merely rich.

Here’s a chart from Deutsche Bank showing the impact (it’s a year old, so the effect is even more pronounced today with the stock market 20% higher). Thirty years ago, the non-rich (the bottom 90% of American households by income) owned 35% of American household wealth. Today they own about 22%. Forty years ago, the really rich (the top 1/10th of 1% of American households by income) owned about 7% of American household wealth. Today they, too, own about 22%. Moreover, the gains of the really rich have mirrored the losses of the non-rich, which means that the well-off and merely rich (the remaining 9.9% of American households) haven’t seen much of a change one way or another.

Now this shift in relative wealth of the non-rich and the really rich didn’t start with the Central Bankers’ Bubble and its narrative of trickle-down wealth effects from monetary policy. It started roughly in 1980 with the Reagan narrative of trickle-down wealth effects from fiscal policy. And before we make overly facile comparisons with the 1920s and 1930s, this chart isn’t taking into account pensions and social security and other safety net features of the modern semi-sorta-welfare state. So I don’t know how historically abnormal today’s level of significant wealth inequality might be, whether it’s Louis XVI level inequality or simply robber baron level inequality.

But I know that it IS.

I know that inequality is growing. I know that the pecking order has been getting stronger for a couple of decades now, and that it’s been driven by the Central Bankers’ Bubble over the past decade. I suspect that this is probably a good thing for global egg production. I also suspect that this is a bad thing if you care about liberty and justice for all.

The narrative around trickle-down fiscal policy has become highly politicized, as the good Democrat soldiers at the usual Team Elite bastions never tire of telling us how those Republican tax policies will increase wealth inequality. And they’re right.

But these same tireless foes of trickle-down fiscal policy trip over themselves praising and promoting the narrative of trickle-down monetary policy under Bernanke and Yellen, which has been FAR more effective at delivering windfall gains to the really rich than Ronald Reagan or Paul Ryan could ever dream of achieving through tax “reform”.

Lenin called communist sympathizers in the West “useful idiots”. The Nudging State and the Nudging Oligarchy have their own willing crew of stooges, drawn primarily from children of privilege (well off or merely rich, not really rich) who want to “make a difference”, who want to be Someone Who Matters to the World.

[Team Elite Narrator: But you DESERVE to be Someone Who Matters to the World, my young friend. You’re good enough, you’re smart enough, and doggone it, people like you. Why, here as a WaPo staffer you’ll be making the world a more succulent host for Jeff Bezos better place for all!]

The picture on the left is Jeff Bezos, age 40, worth a billion dollars or so. The picture on the right is Jeff Bezos, age 52, worth 100 billion dollars or so. HGH looks good on you, Jeff.

I think that at some point in the next decade, it’s inevitable that oligarchs like Bezos will gain access to life extension technologies unavailable to ordinary mortals. At that point, the pecking order will take on an entirely new dimension. At that point, we have a war. Which the non-rich will lose.

You’ll be pleased to know that Janet Yellen, with a reported net worth of about $15 million, is “greatly concerned” about growing inequality, but regrets that the Fed has no purview on this terrible problem. Perhaps Congress should do something, she suggests, like “making college more affordable” — by which she means extending even more debt financing — or “supporting early childhood education” — by which she means publicly funded daycare so that both parents can work in support of the Nudging State and the Nudging Oligarchy.

This is Step Two of the Pecking Order Lie — the provision of massive debt financing to the non-rich, preferably for non-appreciating experiences like going to college or quickly depreciating things like cars and smartphones.

Why? So that the non-rich will FEEL RICH even as they BECOME POORER.

Student debt (and every other form of consumer debt) is the functional equivalent of an office birthday cake. Debt provision and a pleasant narrative to go with it is a highly cost-effective behavioral tool for maintaining worker morale in the face of objectively deteriorating labor conditions.


Milton:   The ratio of people to cake is too big!
 Office Space (1999)

Unless, like Milton, you don’t get your slice of cake. Then you burn the office down. Or vote for Trump. Same thing.


It is a sin to believe evil of others, but it is seldom a mistake.

― Garrison Keillor

The pecking order is real. It is beautifully masked in modern human society, but no less brutal and no less cruel than in the chicken coop.

How do you escape the pecking order? How do you quit Mitch & Murray? Well, you can make a lot of money. That’s the tried and true method. Enough money to build a walled garden around you and yours, expanding it as you can to take in others. F-you money. Somewhere between merely rich and really rich should do the trick, depending on how many generations you want to protect within those walls. Unfortunately, that’s a big gulf these days, that distance between merely rich and really rich, and it’s getting wider every day.

But there’s another way.

No matter how much money we have or don’t have, we can reject the idea that we can be Someone Who Matters to the World and instead embrace the idea that we must be Someone Who Matters to the Pack. Now maybe your pack IS the world. Probably not, but maybe. If it is, then be bold and matter to the world. But more likely it’s your family. More likely it’s your friends. More likely it’s your partners and employees. More likely it’s your church. More likely it’s your school. More likely it’s your country. It’s damn sure not your political party. It’s damn sure not an oligarch.

Why should we reject this notion of being Someone Who Matters to the World? Because that’s the shiny lure that the Nudging State and the Nudging Oligarchy dangle in front of bright young things. And bright not-so-young people, too. The shiny lure of mattering is how they set the hook — which is debt — and that’s how they reel you in. Because once you’ve got that hook in your mouth … once you’re up to your eyeballs in debt … it’s soooo hard to ever get free. I know of which I speak. So do a lot of people reading this note, I bet.

The simple truth is that we can’t escape the pecking order. We can’t escape economic inequality and the hard-wired impulses to brutality and cruelty used to support inequality. Not for long, anyway. Walled gardens never last.

But we can do better. We can reject the lies used to justify inequality even as we accept the reality of inequality. We can be IN the pecking order world without being OF the pecking order world.

There is an autonomy inherent in rejecting the lure of the Nudging State and the Nudging Oligarchy, an autonomy that can power a life well lived. It doesn’t mean rejecting the world as it is. It doesn’t mean leaving the grid for Alaska homesteading. No, that’s a prison of quite another sort. It doesn’t mean mattering to nothing. It means mattering to other humans who see YOU as an autonomous end-in-itself and not as a means to an end. THAT’S your pack. Make a difference for THEM.

In January 1941, eleven months before Pearl Harbor brought the United States into World War II, Franklin Roosevelt gave his Four Freedoms speech — Freedom of Speech, Freedom of Worship, Freedom from Want, Freedom from Fear — memorialized over the next few years by Norman Rockwell in these famous paintings.

What is autonomy? It’s freedom.

What freedoms? These.

If you get nothing else from Epsilon Theory, get this: these freedoms are not granted to us by the State or the Oligarchs. They are not theirs to give. They are not rewards for good behavior or allocations from a central pot. They are ours. They have always been ours. They cannot be taken away.

But we can give them away. We can sell our birthright for a mess of pottage in the form of student debt and a tasty slice of office birthday cake. We can allow ourselves to be beguiled by the glamour of mattering for a Mighty Cause, giving away our allegiance to those who would use us as fodder or feed. We can embrace the pecking order lie and exchange our True Freedoms for Hollow Freedoms, for a freedom of socially acceptable speech and a freedom of socially acceptable worship and a freedom from socially manufactured wants and a freedom from socially manufactured fears.

We can’t escape from a world dominated by the Hollow Freedoms any more than we can escape from a market dominated by Hollow Liquidity and Hollow Volatility. But in markets and in politics we can call things by their proper names. We can maintain our autonomy of mind. We can find our pack and matter to them. We can recognize that a politics without shame is a politics without honor, just as a market without risk is a market without reward. We can take a loss in the short term, knowing that we’re playing the long game. We can do this handshake by handshake, investment by investment, candidate by candidate, good deed by good deed.

And watch how our world starts to change. Watch how we Make America Good Again.

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Clever Hans

This is Bali, a three-year old mustang mare we adopted in 2016 from the Bureau of Land Management, trained by daughter #3, Haven.

Vast herds of wild horses still roam out West on federal land. Officially categorized as an invasive species, many of these herds suffer terrible depradation from overpopulation and limited resources. In response, the BLM has captured more than 40,000 mustangs and moved them to long-term holding pens back East. Check out the inspiring 2011 film “Wild Horse, Wild Ride” to learn more about the controversial BLM program and efforts to encourage adoption of these magnificent creatures.

Mustangs have to be “broken” to accept a human’s touch and control, a word that conjures up images of bucking broncos and the forcible crushing of an animal’s spirit. But that’s not how it works.

The most effective way to break a horse is “negging”, a word familiar to high schoolers but not to me. Negging is negative attention. In the YA social scene, it’s small insults to supposedly pique your target’s attention and interest, like “You’d be pretty if you cut your hair.” In the horse training scene, it’s sitting in the paddock and turning your back on the mustang, ignoring her entirely. The horse gets curious and comes to check out this strange creature sitting on her turf, albeit keeping a healthy distance. The trainer continues to studiously ignore the horse. This goes on for quite a while, maybe a couple of days, but each time the mustang approaches she gets a little closer, until ultimately she makes the first physical contact and allows the human to start controlling her.

It’s really pretty amazing. This highly intelligent animal is so desperate to have a social interaction, so frustrated at being ignored, that it willingly surrenders its autonomy. Sound familiar?

This is Dick Thaler, who won the Nobel Prize in Economics a few weeks ago. He’s best known for the ideas presented with Cass Sunstein in the book Nudge, where they describe a system of “libertarian paternalism” in which a State-directed “choice architecture” improves public policy outcomes by influencing our behavior through clever framing techniques.

So if you want more organ donors, you require an opt-out choice rather than an opt-in choice on your driver’s registration. If you want more diversified 401k allocations, you make a predetermined mutual fund the default choice for your employees. If you want to preserve a law forcing citizens to buy health insurance from a government-approved list, you characterize any restoration of the freedom to say no as a “heartless cut” in the number of insured, by counting as cuts your estimate of the people you will no longer be able to force into buying insurance.

By treating citizens as manipulable objects, the Nudging State can get them to give more, save more, and insure more, all on their own volition. What possible objection could anyone have to that?

This is Adrian Veidt, aka Ozymandias, aka The World’s Smartest Man, from the classic Alan Moore comic series Watchmen. The central plot of Watchmen is that the world’s smartest man saves humanity from itelf by tricking us into choosing a peaceful set of behaviors. This is the pure expression of Nudge. This is the pure expression of smiley-face authoritarianism. By the way, Adrian Veidt is also the world’s richest man.

In the end the Party would announce that two and two made five, and you would have to believe it. … The heresy of heresies was common sense. And what was terrifying was not that they would kill you for thinking otherwise, but that they might be right.

– George Orwell, 1984 (1949)

Jackbooted thugs are so passé. Unless you live in Barcelona, I suppose. Or Berkeley. It’s just so messy to stomp on someone’s face when you can cleanly accomplish the same ends with “choice architecture” and “libertarian paternalism”. If Orwell were writing today, a Ministry of Liberty would figure prominently, right alongside the Ministries of Peace, Love and Truth.

If you don’t like what’s being said, change the conversation.
― Don Draper

Ad men understand “choice architecture”.

It’s not called the Wheel.
It’s called the Carousel.

I’ll make him an offer he can’t refuse.
― Vito Corleone

Mob bosses understand “choice architecture”.

An offer you can’t refuse is what game theorists call a Hobson’s Choice, part of a more general class of games that includes ultimatums and dilemmas. 

Any customer can have a car painted any color that he wants so long as it is black.
― Henry Ford

Oligarchs understand “choice architecture”.

The secret to smiley-face authoritarianism is a choice architecture that presents a Hobson’s Choice as the most natural thing in the world.

Chief Bromden:  My pop was real big. He did like he pleased. That’s why everybody worked on him. The last time I seen my father, he was blind and diseased from drinking. And every time he put the bottle to his mouth, he didn’t suck out of it, it sucked out of him until he shrunk so wrinkled and yellow even the dogs didn’t know him.

McMurphy:  Killed him, huh?

Chief Bromden:  I’m not saying they killed him. They just worked on him. The way they’re working on you.

One Flew Over the Cuckoo’s Nest (1975)

We are being worked on, and our bottle is social media.

Nurse Ratched has two employers — the Nudging State and the Nudging Oligarchy. Tough enough to resist separately, and they’re merging today. We’re all in line for McMurphy’s final treatment.

John Keating:  We don’t read and write poetry because it’s cute. We read and write poetry because we are members of the human race. And the human race is filled with passion. And medicine, law, business, engineering, these are noble pursuits and necessary to sustain life. But poetry, beauty, romance, love, these are what we stay alive for. To quote from Whitman, “O me! O life! … of the questions of these recurring; of the endless trains of the faithless … of cities filled with the foolish; what good amid these, O me, O life?” Answer. That you are here — that life exists, and identity; that the powerful play goes on and you may contribute a verse. That the powerful play *goes on* and you may contribute a verse. What will your verse be? 
 Dead Poets Society (1989)

Oh captain, my captain! Writing your own verse — as a parent, as an investor, as a citizen — is the Resistance to smiley-face authoritarianism.

This is Clever Hans, a celebrity animal at the turn of the 20th century, a horse who could perform complex arithmetic calculations. For years, no one could figure out the trick, because there was no trick, at least not in the sense of intentional fraud.

Now of course Clever Hans had no idea how to do math. But his trainer did. And Clever Hans could absolutely recognize the subtle tells in his trainer’s expression as he approached the right answer. Clever Hans would have been a good sheep. Or a good investor here in the Hollow Market.


We homeschool our children.

I don’t talk about this very much in public, because most people assume that homeschoolers are either religious zealots or antisocial freaks, and we’re definitely not the former. Maybe a bit antisocial, but I wouldn’t call it “freakish” per se. We just don’t like seeing neighbors’ houses. Or neighbors. People, really … okay, maybe a little freakish after all. But that’s not why we homeschool.

We homeschool because we want to be more active participants in our children’s education. That’s not a knock on our local public schools, which are as good as they come. That’s not a knock on private schools in the area, many of which are world-renowned. We homeschool because most of the practices and structures of the modern school, public or private, exist for the benefit of the institution, not the child. There’s nothing evil or bad about this, it’s just inherent in the logistics and organization required for any effective institution responsible for hundreds or thousands of people. But it’s not just logistics. It’s not just the bus schedule. It’s also the curriculum. It’s also the homework and the testing. It’s also the social structures and social behaviors that are embedded in the modern school.

Modern education is a perfect example of the Industrially Necessary Egg — spotlessly clean and cool to the touch, not because that makes for a better tasting egg, but because the protein factories that supply mass society with mass quantities of eggs require chemical washes and refrigeration to turn a profit. That’s fine. I get it. We live in a big world where lots of people want eggs, and the protein factories satisfy that desire pretty effectively.

But what’s not fine is that we have all been nudged into believing that the Industrially Necessary Egg is the Best Egg, that a fresh egg, which isn’t scrubbed clean and never sees a refrigerator, is an Inferior Egg. We have all been nudged into believing that of course 13-year olds should be grouped with other 13-year olds during most waking hours, that of course there should be a clear delineation between home life and school life, that of course the school day should mirror the adult work day, that of course classroom lectures are the most effective pedagogy, that of course children can only be socialized by letting them roam free in a big flock from one semi-shepherded environment to another.

I don’t begrudge the practices and structures of modern schools. Necessary is as Necessary does.

I don’t begrudge the taxes that I pay to support these schools. Don’t tell anyone, but I’d pay even more to support public education and public safety.

What I begrudge is the question that I always get when I tell someone that we homeschool our kids: “Don’t you worry about their socialization?”

My response: “Don’t you?”

My god, hospital admissions for suicidal teenagers have doubled over the past 10 years. Tell me you don’t know a family touched by this tragedy. Tell me you don’t see how our children are sexualized and objectified at a younger and younger age, not by predators lurking outside some gender-neutral bathroom, but by themselves, adrift in the vast oceans of social media. Tell me you don’t see how drug and alcohol use by our children is changing in form, where instead of getting high to party they get wasted to obliterate themselves.

None of this is the fault of the Industrially Necessary School. But it’s not unconnected, either.

So yeah, we want to be active participants in our childrens’ lives, and that’s why we homeschool. Not to shield them or isolate them from reality, but to be there for them as counselors and teachers as they confront reality. And not just to be there for them when mass society allows us, when it’s our turn during the work week to take responsibility for our own kids, but to embrace that responsibility all of the time. Because it IS our responsibility all of the time, no matter how much mass society facilitates and nudges us into partially abdicating that responsibility so that we can work longer and longer hours in service to the Nudging State and the Nudging Oligarchy.

I know that homeschooling isn’t for everyone. I know that homeschooling is impossible for most. I know that when I say “we homeschool” it is entirely a royal we, where my wife shoulders 99% of the burden. But I also know that you don’t have to homeschool outright to be a truly active and engaged participant in your child’s education. Everyone can do that.

Engaging actively in our children’s education has given us two great gifts.

First, the stress level in our family evaporated the day we got off the industrially necessary schedule of the school and onto the organically beneficial schedule of the child. Imagine if you suddenly found three or four hours of new time every day. Imagine how that would reduce the stress in your life, and now think about giving that gift to your child. Even if you can’t escape entirely the scheduling clutches of the Industrially Necessary School, simply recognizing how much of your child’s schedule is institutionally nudged on you and them rather than educationally required of you and them will change everything.

Second, we were able to inject a program of critical thinking and critical speaking into our children’s curriculum, what a classical education would have called Rhetoric and modern education calls Debate. I dunno … I never did Debate in high school, and my prior was that this was impossibly nerdy and more than a little silly. I could not have been more wrong. Our girls can think on their feet. Our girls can stand their ground. Our girls can make a persuasive argument, and they can recognize how others try to persuade them. My favorite part of a critical thinking/writing/speaking education? Our girls have demolished hundreds of smarter-than-thou mansplaining-in-training boys in debate competitions around the country. What does a curriculum of critical thinking/writing/speaking look like? It looks like girls and boys of different ages and backgrounds, all practicing and competing on an equal footing in a battle of research and wits — now there’s a socialization we can all support!

And here’s the kicker. Our girls are now teaching these critical thinking and critical speaking skills to those who have a hard time raising their voice effectively in a Team Elite world, from middle schoolers in Bridgeport, Connecticut to high schoolers in Malelane, South Africa to prison inmates in California. What do I mean when I say we need a Movement to change the world? This.

What I’m describing is the difference between education and training.

Education — whether we’re talking about the education of a child, the education of an investor, or the education of a citizen ­— is always additive to the free-thinking autonomy of the child/investor/citizen. But that’s not what the Nudging State and the Nudging Oligarchy have in mind. They don’t want education. They want training. The Nudging State and and the Nudging Oligarchy want to train you like Haven trained her mustang. They want to turn you into Clever Hans, an intensely other-regarding animal who welcomes the saddle. Because once you’re trained to welcome the saddle, you’re going to take the bit.

The playbook of the Nudging State and the Nudging Oligarchy is always the same — put a compelling Narrative around some Industrially Necessary System and train humans who use that system into some version of Clever Hans.

It’s clearly the playbook for our modern markets, where we are trained by the Nudging Fed and the Nudging Street. We are Clever Hans, dutifully hanging on every word and signal from Janet or Mario or Goldman or Merrill as we stomp out our investment behavior.

It’s also the playbook for our modern politics, where we are trained by the Nudging Parties and the Nudging Media Oligarchs. We are Clever Hans, dutifully hanging on every word and signal from Donald or Bernie or Fox or WaPo as we stomp out our voting behavior.

In all of these Industrially Necessary Systems — schools, markets, and politics — recognition and critical thinking is the antidote to Clever Hans Syndrome, and active engagement is how you administer the medicine. What do we DO about our Hollow Markets and our Broken Politics?

  • Actively engage with yourself to recognize how many of your behavioral choices in the world of investing and politics aren’t a free choice at all, but are instead derived from a clever “choice architecture” imposed by others. You probably won’t change your behavior. That’s kinda the point of these pleasantly skinned Hobson’s Choices — they’re offers you can’t refuse. But the day you recognize the choice architectures that enmesh us is the day you start making true choices. It’s the day you start thinking and reading differently. It’s the day that everything starts to change for yourself, your family, and your clients.
  • Actively engage with yourself to create a critical thinking curriculum that adds to your reservoir of free-thinking autonomy. Read more history. Read more biography. Read more science fiction. Every day. Watch a lot less CNBC and CNN and Fox and all the rest. I know we can’t wean ourselves from Facebook and Twitter. It’s our bottle and we’re addicted. I am, too. But take the time to listen to someone whose political or market views you emotionally dislike and force yourself to see the world through those views, not as an adversary but as another thinking, feeling human being. Every day. Educate yourself, don’t train yourself.
  • Actively engage with others to spread the word. To educate, not to train. We treat others as free-thinking autonomous human beings, not as manipulable objects. Never as objects, even if it means losing the client or losing the election. This is how we fix things. Bird by bird. Voice by voice. From below, not from above. As wise as serpents and as harmless as doves.

What will your verse be?

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