The recent scandal has brought a spotlight on the long-term issues of unfair college admissions,. Once you get past the outright criminality of this incident, there remains the backdoor of unfair practices that are just a step or two less flagrant and unjust. Here are five steps that can reduce the clear biases and gaming that are at the disposal of the wealthy.

None of these are new or surprising. I am writing about them here for two reasons.  First, you might find that I give a different spin to some. Second, adding my voice to this issue is like voting in an election.  It is one more hand raised saying that what is done now for college admissions is unfair and must be fixed.

The first two can be enacted immediately, it is only a matter of the colleges having some moral backbone. I venture these two alone will reduce the bias for the wealthy and connected by three quarters or more:

Eliminate donor advantages. A general precept of charitable donations is that there is not a monetary quid pro quo. Indeed, if there is, the contribution is not tax deductible. In college admissions there is a monetary benefit, because a degree from a prestigious university increases earning power and status. And this monetary value extends beyond the student being ushered in through the back door. It remains for generations due to legacy admissions. Let charitable contributions stop at the same place they do for other institutions, with the prestige of having your name on the building or the endowed chair.

Eliminate legacy admissions.  Legacy admissions are the feedstock for the donor advantage. They are intended to feed these donations. Alumni are the primary source of donations to the university, and are cultivated by the understanding that if you are an alum your children will have a higher chance of being admitted. A higher chance that of course is increased by making donations to the school. The legacy advantage is the same as the donor advantage heightened by having attended the school yourself.

The next three are directly related to the admission process. They already are part of some university admissions policies, although they make the work of the admissions office more difficult.

Eliminate gaming of extracurriculars. No more credit for building houses in Kenya, or for handing out food at homeless shelters. If a high school students wants to do these actives, more power to them. Just don't tell the admissions office, because they won't care.

These activities are the province of the wealthy because they often have a price of admission, either monetary or through connections. They also are not available to those who actually have to work during the summer. The summer before my junior year in high school was spent as a bus boy at the local Sizzler, before my senior at a steel working company making playground equipment. Trips to less developed countries or internships at non-profits were simply not part of the vocabulary.

Get rid of standardized tests. If having a $250 an hour test prep tutor or spending money on test prep summer programs were simply a matter of help in putting in extra time studying, that would be one thing. But these programs, while not going to the point of giving the student the test ahead of time, are one step removed from that because they are run by people who are familiar with the tests, the types of questions, and can give templates for the problems the student will face. The numbers might be different come test day, but the problem will be the same.

You don't get this peek at a Princeton Review course or with a How to Take the SAT book. You get it for $250 an hour with a private tutor.

Some schools already do not require the standardized tests, but don't expect much action on it anytime soon. Life will be harder for an admissions officer if this quick and easy yardstick is gone.

Make admissions ethnicity-blind. A hispanic from a middle class family should not have an advantage over a white kid from a middle class family. An African-American from a poor family should not have an advantage over a white kid from a poor family. An Asian kid should not be at a disadvantage because they are as a group more successful at jumping through the  current college entrance hoops.

Note: This idea became championed by Elon Musk. I wrote this before his work became public. 

Here is a solution for getting the Thai soccer team out of the underwater cave:

Fashion a watertight, flexible cylinder that a boy can lie in prone. It needs to be flexible so that it can be worked around tight curves in the cave. Have an oxygen supply either internally, or fed through an air tube from an external tank. The cylinder can be hooked onto the existing line that leads to the cave, and is carried along by the divers. The boy will be cocooned inside the cylinder, and will not need to do anything. He will be brought out the same way supplies are currently brought in.

It is World Cup time, a good time to reintroduce two posts I did one of the last times we had the World Cup capture the imagination.  One of them suggests changes to the game that will make soccer less boring. Another expands on this to create a more dynamic version of the game.

What is wrong with passive investing and index hugging?  One problem is that these strategies often use ETFs. I wrote about the potential for ETF meltdown last October, with a follow-up shortly thereafter, so I won't belabor that here.  Another problem is that most passive portfolios follow a cap-weighted index. Recently I also wrote about the risk from this. So I won't repeat that here, either. What I will do is add another risk that comes from the passive and index-hugging approach to portfolio management, the resulting lack of diversity in investment strategies and outlook.

The need for diversity is fresh on my mind because last week I was fortunate to share the stage with two academic luminaries, Andrew Lo, a finance professor at MIT , and Simon Levin, a professor of ecology and evolutionary biology at Princeton, at an event jointly sponsored by the BCG Henderson Institute and the Institute for New Economic Thinking. It took place at BCG's new office at Hudson Yards on New York's West Side, a place where shiny office buildings are popping up like sunflowers.

Andrew and Simon co-authored a paper arguing that financial regulation can learn from the regulation of biological systems. Andrew also has a recent book Adaptive Markets with arguments closely related to the same topic, that financial systems can be viewed as adapting to the changing, dynamic work in ways analogous to biological entities.

The essence of a biological system is that it is dynamic and complex, with the agents of that system facing unexpected changes in their environment. One way they meet the challenges of their dynamic world is to adapt through evolutionary changes. But in the biological realm evolution takes time, whereas the changes to their environment can be sudden. The more immediate survival mechanism in the biological realm is diversity, both across species and within any given species.

Diversity is the immediate result of sexual reproduction. There is a mixing of genetic traits, so each offspring is a little different. Which means many offspring are less than ideal for the current environment. In contrast, with asexual reproduction you get carbon copies of the parent, absent the occasional mutation. If the world keeps on going the same way and if the survivor in the assexual world is among the fittest for that world, then its offspring will be equally fit. The diversity in outcome from the sexual species will just add noise and inefficiencies in terms of survival.

The reason the world has largely moved to sexual reproduction is that things do not stay the same. Because the asexual species are all genetically identical, if things move the wrong way they all die off. But because there is diversity within any sexual species, there is a chance that some will have the characteristics to survive in the new system. Maybe those will not be the ones that are the best in the current system, and maybe they won't be the best in the new one, but they will be good enough in both.

Passive investing is the financial equivalent of an asexual ecology. That is, being asexual means it is not diverse. (And being asexual also means that passive investing, as many portfolio managers can attest, is not a lot of fun.)

The risk, then, is that with us all crowding into the same passive investments we will not have the diversity to adapt if something bad comes along.  But it is actually worse than that.  Being all the same might actually create the bad thing that comes along.  Because we don't just live in the ecology, we create it, and we create many of its shocks.  If things start going in the wrong direction, the effect of all of the passive investors moving in the same way, and the lack of deep-pocketed investors ready to take alternative tacks, will itself create the dynamic cascade.

By the way, this is a problem that is not restricted to passive investing, or even to finance.  I have written about the asexual capitalist, and how the same problem of a lack of diversity inflicts the capitalist system broadly.

Matterhorn Disaster by Doré

You are in a buy-and-hold, passive investment. So, you will make market returns.

Not quite: With the markets, doing nothing doesn't mean you're not doing something. Because while you are sitting on your hands, things are happening around you, and your investment portfolio is changing. The reason is that you are in an index that is market capitalization weighted. The bigger the company, the more of it you are holding. This means you are going to hold more in industries and sectors that by nature have big companies. So more in big banks and insurance companies than in specialty retailers and restaurant chains. And, more important for the point I am focused on in this post, increasingly more in companies that are doing well, that is, companies that have rising market capitalization. And on the flip side, you are effectively selling off stocks that are not doing so well.

If Apple is worth five times as much as XYZ, then you hold five times as much in Apple as in XYZ. And if Apple moves up to be worth ten times as much, you hold ten times as much.  This is what will happen with what appears to be a buy-and-hold, passive, do nothing portfolio.

This is a big concern now because of the run-up in the FAANG (Facebook, Apple, Amazon, Netflix, Google) and related stocks. They have taken a large share of market capitalization as they have risen in value, and there is a momentum dynamic to be unleashed if they start to drop. This has happened time and again when cap weighting has led to extremes in the share of total market capitalization claimed by a popular sector. Consumer discretionary grew to 22% of the index in 1972; Oil 30% in 1980; TMT 34% in 2000; Banking 23% in 2007. In each case it finally got out of hand and dropped back to its earlier level and dropped the market as well. The odds are it will happen with FAANG.

Of course, the market cap does not rise by magic.  Each time investors find a reason for the sector to be gobbling up the market.  With TMT it was that the old methods like P/E were no longer relevant.  So I don't get much comfort in the justifications for the domination this time around of the FAANG and related stock.

This is bad, for both you and for the market generally. First off, you get more and more concentrated. Which means less and less diversified. Secondly, it is bad for the markets because you might be doing nothing, but the effect is to pile on.  If someone comes into the market, they are really stocking up on Apple, so, guess what. Apple really goes up.

What is particularly problematic is that when you are in cap weighted passive, you have a factor bet without realizing it. Because you are following a cap-weighted index, because you are measuring yourself against that index, the factor bet looks like "no harm done." It looks like you are simply moving with the market, the end objective of a passive position.

An alternative that has taken hold is to hold stocks based on some other factor than market cap. The problem is that any rule that is based on some factor is going to have the problem that you are still making a bet. What you want to hold is a portfolio where you can pick any factor -- P/E, capitalization, momentum, any "smart beta" factor of your choosing -- and fail to find any relationship between that and your portfolio return.

I wrote about Facebook in a blog in January, pointing to ominous clouds on the horizon. (And, one looking at the future of Facebook and the world in 2011.)

For an update. Those clouds now are overhead. With the ever-growing realization that Facebook has been a channel for manipulating our life-as-we-know-it (literally so), there is the drumbeat of #deletefacebook (which I joined last week). And with this are articles showing how difficult it actually can be, which bring to the fore just how deeply Facebook has plunged itself into our being.

There are how-to guides to find alternative to Facebook. There is the recounting of the times Zuckerberg has skirted over the line on privacy, each followed by the ritualistic apology. And there is Colbert's acerbic humor on "Suckerberg", which includes screen shots showing the mind-blowing amount of information Facebook holds on various staff members of his show -- including call's made from one staffer's cellphone, the family tree of another,  and the data for the face-recognition of a third.

Many people will leave Facebook and use alternatives. Some will discover they can leave without using social network alternatives at all. People who stay with Facebook will opt out of everything they can think of, especially related to sharing their personal information with advertisers and apps. (As part of the mea culpa this time around, Facebook is centralizing the privacy settings so you don't have to navigate through twenty different places to do the job.) People will log into apps using their email addresses rather than Facebook, thwarting the insidious tunneling by Facebook beyond its own borders.

Whether people leave or decide to stay with tighter privacy controls, the targeted advertising and third-party sharing that is the life blood of Facebook will be eroded.

Beyond these short-term, but possibly devastating reactions that are focused on Facebook, it is becoming all the more likely that we are at the beginning of a broad sea change in how we view social networking and in our willingness to give up privacy for a song. Jaron Lanier pointed out the faustian bargain we have made with Facebook, Google (which at least gives us something of value in the search engine) and the like, and proposed a path for us to be enfranchised for the personal data we toss into the world.

There is an alternative to the business model of mining personal data, which is having Facebook and others move to a subscription model. But this will not sustain the valuations Facebook currently enjoys. People are not likely to pay out of pocket anywhere near the value that is implied by giving the world all of their personal data. Which suggests just how much we all are giving away.

The following is a brief, contemporary account of our world, which we call, for obvious reasons, the Amazon Dystopia. I leave it undated -- Nadir.


The dystopia is most evident in the control of the working class. During work and commuting time all workers are mandated to wear a “health watch”, a wristband that monitors their movement. The wristbands also tell the time and weather. Workers also wear “world view” collars and glasses equipped with biometrics and a 360 degree video display to determine the level of their exertion, and where they are fixing their gaze. The collars can generate electric impulses to encourage workers. If they fail to perform, there is summary dismissal. The government has recently added a worker-terminating explosive charge if workers are found engaging in treasonous behavior – which includes “robust criticism or a marked lack of enthusiasm.”

Cocking and the Rise of the Plutocrats

The elections are determined by majority vote, but the people’s choice becomes the tool of the wealthy once ascending to office. This transformation is known as “cocking”. This is an unfortunate play on the Koch name, but one that is not classified as robust criticism.

Cocking was first revealed in the Washington Post, which reported that the Koch brothers, a center of corporate political power, presented various incumbents with a check made out to their opponent for $25 million, with the threat that the check would be handed over to the opposition if the incumbent did not act in what the Koch brothers considered to be the best interests of the country. The threat only had to be made good one time, and the story planted for the Washington Post team to uncover, (with a Pulitzer for their efforts), before compliance to the threat became absolute.

The Consolidation of Power: From the One Percent to the One
The cocking grew, and political power became increasingly consolidated with those with the deepest pockets, until it finally has become a plutocracy of one. And having power over the press has helped to correctly frame the new order for the masses. At least the small subset of the masses that is not placated by free, unlimited streaming of videos and music.

From Each According to His Need

A value-added tax is now a primary source of revenue. Essentials such as food, clothing, and school supplies pass through a taxation station, the “fulfillment center”. Its operation is based on extensive records of every citizen, both their biometrics, gazing patterns, queries, social interactions, and of course consumption history, to infer their preferences, to the end of taxing them more highly on their purchases based on the algorithmic determination of how much they need them. This principle is promoted with the slogan, “from each according to his need.” All purchases are made with the certification of the buyer that they will not resell or redistribute, with the delivery chain iron clad from the fulfillment center to the consumer's doorstep to reduce the risk of missteps.

Luxury goods by definition are not needed, and therefore generally are exempt from taxation.

To Each According to His Abilities

The tax is paid to the agency that is responsible for the building and maintaining of this distribution system. This payment is tax exempt, because it already is a tax. The agency is in private hands because the government has determined to leave to business those things that it can do best, as measured by the profit they can extract. Thus the slogan, “to each according to his abilities.” As has been noted in various recent Washington Post articles, this is the most sure way of adding to the economy, and thus to the wealth of all individuals.

The Revolt of the Masses

Note by the conveyor of this account: As with any dystopia there is a plucky, fearless group that is fighting back. Led by Kadir and his former-rival-but-now-lover Sabella, a beautiful woman who is good with knives, this group is bringing in others to fight against the tyranny of the plutocracy.

Note by the second conveyor of this account: They are discovered and killed. The end.

The recent tumble in the market is being attributed to the wage report, a rise in interest rates, and concern about inflation. A reassessment of economic conditions does not lead to such a violent reaction. It might give a push, but then gravity does the rest. For the markets, gravity is the technicals -- how leveraged or overextended investors are, how concentrated, and how much liquidity there is in the face of a flood of selling.

This is just a quick recap of a couple of posts I have done over the past months that relate to technicals behind the current market downturn. In early November I wrote a post about how the low volatility regime we have enjoyed (if that is the right term) could blow up. We have seen the first leg of that with the decimation of the inverse volatility ETFs and ETNs. They have actually printed negative prices. What was worth $2 billion a day ago was worth $20 million in after-hours trading, and depending on how they terminate, could become zero.

The VIX went from the lowest level in history to near the highest. The next shoe that might drop will be the actual market volatility. If actual volatility rises, there will be a rash of funds that target a specified volatility that will have to sell positions -- mostly equities. If a fund is targeting, say, 12% volatility and market volatility goes from 12% to 24%, the fund will need to go from fully invested to 50% invested.

Looking at an extreme tail risk, the total failure of the inverse volatility ETF might cause ripples across ETFs more broadly. Some investors, I would think mostly retail investors, might simply hear that an ETF went to zero in one day, and think that is a concern for other ETFs. If they start to liquidate on that basis, it could lead to widespread contagion. I posit this in a post from October, though with high yield ETFs as the spark.

The cascade due to volatility and the contagion from ETFs might occur, or might not. If they do, it will be a slower process than what we have observed over the past few days. And things do not follow a straight line. There will be "bargain hunting" along the way. But depending on how that plays out, it might be piling more investors onto the thinning ice.

Investors tend to focus on the most likely outcome. As a risk manager, I spend time focusing on the unlikely, on the bad things that might possibly happen. Where T.S. Eliot writes, "This is the way the world ends, Not with a bang but a whimper" I would write, "This is one possible way the world might end...."

So, with that as the starting point, how might the world end for Facebook? And, by extension, for Apple and Google, because Google faces similar, but not so dire, business risk, and because much of Apple's raison d'être is to provide the hardware for Facebook and related applications.

Regulatory Backlash

As a start, there is a crescendo of regulatory backlash to the power that Facebook and Google wield. It is most manifest in recent action in Europe, and has been given some headline coverage from a speech a few days ago by George Soros at the World Economic Forum. If you want a sense of where he is coming from, the Washington Post headlined it as "Facebook and Google are doomed, George Soros says."

The current controversy on net neutrality applies to Google and Facebook. One concern is that without net neutrality there will be a stifling of the small start-ups, and increased power for the larger players. Point the rifle three clicks to the left from the net neutrality debate, and you have them in the line of fire.

A Self-destructive Business Model

Facebook and Google have a business model that is at war with itself. On the one hand they link like-minded people together, so they can share their views, interests, and product suggestions. On the other hand, they depend on advertisers for their revenue. But if their business model is perfected in the first case, there is no need for the second. People will know what they want without the advertisers that are outside their social circle chiming in.

Social Norms

Obviously a social network like Facebook or Instagram only works if people want to share on the social network. And the bulk of those who do so are acutely sensitive to the cool thing to do. If it becomes uncool, that is the end of that. Put another way, the fever pitch of social media is of the same flavor as any fad. It has no purpose other than being the thing of the moment. For social media, that moment might last another two years or another ten. But at some point there is the risk people will find it so last year, or so "what my parents used to do."

As a measure of it being a fad, what other $500 billion company could disappear from the face of the earth tomorrow and have no real impact -- except on advertisers?

And there are signs of change. When Cook states that he wouldn't want his nephew on social media, that is not a good sign. Closer to home, a month ago my fourteen year old daughter decided to get off of social media.

A recent meme is social media as cigarettes. Think of cigarettes in the Mad Men era. People were addicted, but also it was part of being social, and it was the way you kept yourself busy. If you weren't holding a cigarette, what were you going to do with your hands? Social media is addictive, social, and keeps you feeling like you are doing something with your hands.

How Does Apple Fit into the Mix?

The iPhone is the hardware that runs the fad. Take away the need for social media functionality, and there is no reason to move beyond the power of, say, the iPhone 6. Maybe you disagree with that, but by the time you get to the iPhone X I think you are at a bridge beyond. Once you deal with the battery issues and avoid dropping it, (or drop it and pay $100 to get the screen repaired), a smart phone lasts forever, and has the power you need if you are not lighting up social media. Put another way, think about how frequently you upgrade your iMac.

The Darkening of Silicon Valley

One thing that can help push social norms away from Facebook is a reframing of the Silicon Valley sphere away from the cool end of the dial and toward the menacing. The sea change that is putting Silicon Valley companies in the sights of regulators is also washing away the veneer. Soros wasn't the only one bashing the fruits of Silicon Valley. There was a litany of others along with Soros from the World Economic Forum. Undeniably, Silicon Valley is exciting, filled with great minds, and is the go-to destination for college kids. I know the feeling; that was the investment banks of the 1980's. And look where that ended up.

Case in point, there is the growing realization that Facebook is not simply a fun app, and the work of those brilliant Silicon Valley engineers is not just creating a global sand box where we can play. In the wrong hands it in can subvert a political system with more efficiency than a rioting mob. It already has. That has got to move the dial a bit in terms of perceptions.

Note: I did a post on Facebook back in 2011 that has similar sentiments, but with a more philosophical flair.

Whenever I write about the UFC, I should add a standard apology to those who are reading my blog with an eye toward the area of my expertise: finance, and in particular financial risk management. But I have enjoyed mixed martial arts (MMA) since its inception in the mid-1990's, (I also love Brazilian Jiu Jitsu, which I have been active in over the same time period), and find the current missteps in UFC fascinating. Watching the UFC, by far the largest MMA organization, in its tail spin from the incredible height of its purchase by WME-IMGfor $4 billion is becoming more interesting than watching its fights.

The UFC was a failing enterprise in the 1990's, and was salvaged in 2000 by the Las Vegas Fertitta brothers for $2 million. They each cleared over half a billion from the sale. The president of the UFC, a former personal trainer, Dana White, pulled in a similar amount, plus or minus (actually, minus) a few hundred million.

Even at the time of the acquisition in 2016 the purchase price was met with skepticism. But they did have some marquise talent, most notably Ronda Rousey. Her run is over. Not a surprise, because MMA demands many fighting skills, and there are thus many ways an up-and-coming athlete can find to break through an opponent's style, which in the case of Rousey was superb grappling without a base in stand-up fighting.

So, anyway, how is it going? Ronda is gone with no other women in a position to take on anything approaching her role. Dana and crew have latched onto Connor McGregor, a brash fighter who is both flamboyant and good in the octagon as the next big draw. They went all-in with McGregor by setting up a fight with Floyd Mayweather, the undefeated boxing champion. The fight pulled in $600 million, netting a hundred million plus for each fighter. This is the point that the UFC went full-stop into entertainment business, and as I wrote in a recent post, it is the point where it jumped the shark.

Now it is not clear that McGregor will fight again in the UFC. But with the hope he will come back and defend his title, and because now entertainment trumps sports, he continues to hold the title even though he has not defended it for over a year.

The number of viewers is languishing. FOX's recent title match was the second most-watched UFC event this year, but also was the fourth-lowest on FOX to date, with two million views (though it peaked above three million during the title bout). A UFC Christmas event drew 350,000 viewers, a tenth of the draw of last year's.

Meanwhile, it looks like the entertainment complex is doubling down after the McGregor-Mayweather spectacle by suggesting Mayweather will meet McGregor in a MMA fight. If their boxing match was a joke -- Mayweather carried him for ten rounds to give the fans their money's worth before leveling him -- this would be a farce. It would be like arguing that a 41 year-old version of Lionel Messi should spend a few games as a linebacker in NFL football because in American football, among other things, they kick the ball. Mayweather is not stupid; we will never see him in the UFC, but that it would be put out there even for a second to tantalize the UFC fans is a measure of how entertainment value is dominating substance.

And, to top it all off, I hate to say that MMA is getting boring. Maybe the push toward entertainment at all costs is reducing the focus on athletic elegance. Or maybe the nature of MMA, which requires skills in a wide set of fighting styles, kickboxing while standing, jiu jitsu when on the ground, and wrestling and judo for the takedowns, leads to a jack-of-all-trades and master of none, and for those who are familiar with the best of each of these disciplines, a sport that is less than the best is inevitably going to come to seem crude.

I'm not going to write anything here about the huge drop in bitcoin over the last few days, so what I am writing cannot be ignored should bitcoin get back up to the 20,000 range. And I'm not going to write about the stupid articles that espouse bitcoin. Though to get a sense of the level of thoughtfulness for the arguments for bitcoin, just to pull one recent one at random, check out this from Forbes.

I'm going to point out only one simple but devastating barrier to bitcoin becoming the standard, becoming even a second-tier means of payment:

If bitcoin doesn't find its way back into the shadows of the drug trade and underground economy on its own, it will be banished by the stroke of a pen, actually, of many pens. No sovereign will give up the power of issuing and controlling its currency. The central bank and monetary authority is one the most powerful economic tools of any government. If bitcoin or other extra-governmental currencies start to take hold, they can and will be made illegal to use for payment in one country after the other.

The cryptocurrencies will still find a market in the underground economy, where people want to avoid taxes or need to remain anonymous and untracable because their activity is illegal or subversive (It is true the ledger is public so all transactions can be seen. But the identity of the user behind the address can be kept anonymous.) But it will not be useable for the bulk of transactions, like your mortgage, credit card bill, tax payments. Or purchases on Amazon. It will be good for your recreational drugs, and your under-the-radar part-time t-shirt printing business.

A few other thoughts while I'm at it:

I can't take seriously a currency, crypto or otherwise, keeping in mind that currencies are supposed to be a store of value, when its exchange rate is determined by speculative activity, untethered to anything in the real world. Where the volatility is greater than for any asset in the real world. And where the assessment by bitcoin.org is that "it is truly difficult (and exciting) to imagine how it will play out."

To those who think there is credibility for bitcoin and other cryptocurrencies because Goldman now is considering a cryptocurrency trading operation, just remember this from Matt Taibbi:

The world's most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."

And right now, bitcoin smells like money.

Note: A fiat currency is the currency issued by a government that is declared its legal tender, accepted for payment of all debts, public and private. The word "fiat" means it is not backed by anything. No gold or silver; the government declares it as currency by fiat.

Twitter was not available to the pod people in The Invasion of the Body Snatchers. They had to confront the humans directly, pointing and screeching to muster the mob to attack. But now that we have Twitter, a pod person in our day and age can efficiently and remotely signal a human to the pod-people mob with hashtag HumanToo.(This hashtag is already used in other contexts, but always by humans, so no problem.)

We don't have body snatchers right now, and, for what it is worth, we have put in legal protections should the event ever occur. Barring a dystopian state, (probably inevitable should the instance arise), no one can take someone's body without due process. No one can point and screech and have the mob take over from there.

At least that is true if body snatching is considered an assault on civil liberties that are protected by law. I suspect that is the case. Just as there are other actions that require due process. No one can be incarcerated without due process. No one's property can be seized without due process. However, there are harmful actions that can occur outside the constraints of due process, like accusations that do not rise to a threat of harm or to libel. While immune from the requirement of due process, they can destroy one's character and reputation. (Thus the term character assassination.) It can leave the victim unemployable, and set them apart from society.

The pod people had bad intentions from the start, at least from the human's perspective. But sometimes there are things going on that justify some pointing and screeching. Unfortunately, what starts off with noble motives can move into body snatcher mode. And when pointing and screeching is given free rein, that is where things inevitably arrive. With the excesses, the social winds finally turn, and any value, any noble cause, is lost in the process, even met with a backlash.

In a recent post I discussed McCarthyism. This is a good example of how a legitimate concern -- there really were spies tied to the Soviet Union infiltrating the government, intent on subverting our government -- can turn into body snatching. Accusations could be made without support. People could be targeted mistakenly or even for ulterior motives. (And, getting back to the pod people, what if a timid pod person is not body snatching, but is only body touching. Do we pile him in with the full-throttle snatchers?) All with the result that, in so charge an environment, and based on the accusation alone, they were destroyed.

As I mentioned in an earlier post, working in a pension fund makes me think toward the long term. In that post I spoke about broader long-term risks; here I will give my view about long-term risks at the more specific level -- namely, industries to short if you are looking out a generation or more. That is, how various industries will decline over the next thirty or forty years. That is a long time, like the time since Whip Inflation Now of the mid-1970's, or the LBO craze of the late 1980s, but if you are under fifty there is a good chance you will live to see it, and your grandchildren will be in the thick of it.

General propositions
The key drivers of what to short are developments in the following areas:

• Increased reliability of products. Already, many of the things we consume are more reliable and last longer than any time in the past. Take computers and LED screens. And soon, it will be electric cars.
• Less consumption of goods. In the sense that most of our time is spent on fewer things – like those highly reliable computer items.
• More commodity items. Which means less demand for advertising. Compare advertisements today with those of a generation or two ago. Almost everything was driven by brands. Now we are not as focused on brands, and as far as brands go, there are so many brands that are hard to differentiate that they may as well be commodities. Meanwhile luxury goods are moving toward items that are inherently scarce, like art and real estate -- items that do not require production.
• More efficient production. And part of that efficiency is that what we produce requires less labor.
• Increased demand for personal space and privacy. We will circle the wagons around our personal space and privacy. We are going to draw the line when we find that companies know more about us than we know about ourselves.

Let's start with the easy ones, where there is a clear consensus, and work our way down from there:

Energy
Oil. We all know that fossil fuel is a goner. And the more obvious it becomes that oil remaining in the ground will be a stranded asset, the more oil will be pumped out in the shorter term. So between growing renewables, flowing oil, and more efficient technologies, energy will be abundant.

Will the oil jobs be replaced by renewables. Is it only a matter of retraining of those working in this sector to work with renewables? No, because even ignoring the higher economies in production, the capital plant of renewables lasts a lot longer and requires less maintenance per kilowatt-hour produced.

Saudi Arabia and the rest of the Middle East. There is a clear regional implication to this, of course. This is not good for the Middle East. And what is also bad for the Middle East is climate change. Some predictions are that the Arabian Peninsula will become so hot as to be uninhabitable. So much for the Saudi's Vision 2030. And, I really can’t understand what the thinking is with Aramco. It is a long-term bet under the clouds of oil demand dropping with increasing speed and the political vulnerability of Saudi Arabia.

Transportation
Trucking. Trucking will also clearly be altered from an employment standpoint by self-driving vehicles. We got a taste of this a few weeks ago when Tesla unveiled its semi truck. Whether you like Tesla's odds or not, self-driving trucks are coming, especially for runs along the interstate.

Things will also change at the local level, for example for package delivery. A new household appliance, already in the works, will be a lockbox that can be opened for securely delivering packages, as ubiquitous as mailboxes. In the limit there will be one run per day of an autonomous vehicle to each residence and business. (How the packages get from the vehicle to the lockbox is the weak link in taking humans out of the loop in this scenario.)

Autos. Another no-brainer is that the automobile-related industries will be far smaller. Gas stations will disappear. And most mechanics. Cars will last far longer and require less maintenance, garages, which are already on the downswing, will largely disappear as well. (New tires from Costco.) Once production is scaled up with a few rounds of efficiency gains, electric cars are not complex, and are cheap to build. The cost of cars will be a fraction of what they are today. With low maintenance, low fuels costs, low purchase price, and autonomous driving, transportation will be far safer and less expensive.

People will be traveling less; fewer trips to the mall. People will have less need for a dedicated car because they will summon an autonomous car that can be running people one place or another nearly 24/7. And most people won't care as much about style because they will be treating them as what they are, transportation services -- which gets to my point about more commodity-like products.

There will still be the vestigial car, just like there are still mechanical watches. Gas-powered cars will be admired and collected for their workmanship and intricacy, and not for their performance or function. Driving a car will be a hobby, like horseback riding. And maybe not in forty years, but at some point, people-driven cars will be seen on the street about as often as horses are. They will be enjoyed on closed tracks, just as horses are today.

Casualty Insurance
It is a mixed bag; some lines will dwindle, others will grow.
Auto. Autonomous vehicles are safer than people-driven vehicles, especially when all cars are autonomous. Fewer accidents means less need for casualty insurance.
Liability. Less high-risk labor.
Property. Things will be looking up here, due to the effects of climate change.

Real Estate
Commercial. Stores will become less prominent as the efficiencies of delivery improve. And as many items last longer. This leads to issues for commercial real estate. There will be construction for warehouses and "fulfillment centers." These are cheaper to build and maintain than commercial retail space. So less construction and maintenance. With the move toward renewables, there is a drop in construction of large-scale fossil fuel plants, and the plant for renewables will not require as much construction and maintenance demand.

Residential. Demographics and lifestyle will change the demand for housing. There will be less demand for large houses with living rooms and dining rooms that are not used, and for four and five bedrooms. This means a glut for some zip codes. And it also means fewer construction jobs. Houses will have solar cells and batteries to be increasingly self-sufficient, so less energy use.

So chalk up the construction industry -- one that is more immune to technology -- as another casualty.

Basic Materials and Mining
With less demand for new cars, less construction, and key goods that are replaced less often, there will be a drop in demand for many raw materials. Though others, like those that are needed for batteries and computers, will increase in demand. Or maybe not. Who knows what raw materials will be in demand, and how great that demand will be with the changes in technology that we might see over the course of the next generations. And because these products last longer, and finally meet the needs for various functions, they will not be the same engine of production.

Advertising (and Facebook and Google)
There is a feedback loop between advertising and the information and social network companies that depends on advertising. This feedback leads to a self-destructing business model, with the information companies and advertising going down together. The information companies depend on advertising, and yet they are information engines that reduce the need for advertising.

And advertising for non-luxury and non-status goods (luxury and status goods are not the fodder of Google or Facebook) will drop for the reasons I mentioned above: less advertising because we will demand fewer goods, and many of the goods will be commodity-like. Few of us care about which chargers we buy for our phones.

There are other pressures that might build for social networks such as Facebook. We will still need search engines, but Facebook is already tiresome to some of us, and we are getting the first whiffs of the toxicity at its root. With the world veering toward an impersonal dystopia, we will guard our privacy, we will circle around our real relationships. Here are recent articles from Wired that give a flavor of where things might be going, one a truly harrowing saga of overcoming malicious cyber attack, and another one of any number you can find, appearing with increasing frequency, on privatizing Facebook. From the perspective of forty years out, Facebook and social networking in general will have been a flash in the pan.

I enjoy studying American history of the post-World War II period, and just remembered that earlier this week we passed the anniversary of a milestone for that period: On December 2, 1954, the United States Senate voted 65 to 22 to condemn McCarthy for "conduct that tends to bring the Senate into dishonor and disrepute", signaling the erosion of the crushing anti-communist excesses of the previous years. McCarthyism has been applied indiscriminately and almost invariably incorrectly to any number of perceived political and social excesses, but it is worth recalling it for what it was.

First, to criticize McCarthyism is not to diminish the real threats. We must understand that at the time there was a real, broadly recognized threat to the U.S. Through documents from Soviet archives and Soviet messages, we know that the Soviet Union engaged in substantial espionage activities in the United States during the 1940's, that the Communist Party in the U.S. was being funded by the Soviet Union, and that it was used as a base for recruiting spies. We should not have McCarthyism diminish the reality of the subversive elements of the time.

The threat was real, but the reaction to that threat was a frenzy, often described as a witch hunt, that was particularly focused on those in the entertainment industry and government. A simple accusation was sufficient for people to be attacked, lose their job and even their career, with no further prospects for employment at more than a menial level. President Truman remarked that, "A man is ruined everywhere and forever. No responsible employer would be likely to take a chance in giving him a job." Those who were accused had no recourse because the process took place through extra-judicial channels; no response could hold sway. Pleading the Fifth Amendment during the proceedings was taken as an indication of guilt.

What is more, although there were instances of serious attempts at subversion, there also were many who were attacked for activities from decades earlier that, though perhaps outside the social and political norm, had been benign. These were pulled up and judged with the now more stringent standard. It was as if a law had been enacted, and those who did not follow that law in the past were found guilty.

Yet at the time, these excessive and unlawful efforts which cast aside any notion of due process were supported by many thoughtful people. For example, William F. Buckley Jr., a prominent conservative intellectual, wrote that McCarthyism “is a movement around which men of good will and stern morality can close ranks." Certainly there were those who were opposed, but popular opinion – and no doubt the concern that those who opposed the juggernaut would be painted with the same brush – keptthem silenced.

The political climate of McCarthyism declined through the 1950’s as public opinion shifted, and a number of court rulings pushed back against the processes that supported it. Most notable is one in 1956 that pushed back on using the invocation of the Fifth Amendment to infer guilt. The Court wrote that “we must condemn the practice of imputing a sinister meaning to the exercise of a person's constitutional right under the Fifth Amendment”, and in 1957, when the Court condemned cases where “Guilt or innocence may turn on what Marx or Engels or someone else wrote or advocated as much as a hundred years or more ago.”

The baby boomers have changed our society as their demographic wave has washed over one institution and norm after another. Split sessions for public schools, a new level of competition for elite colleges, the free love generation and the rise of student protest, the housing bubble, the creation of the Millennials, (a.k.a. the echo boomers). They have the numbers and the political will to do things, and they have time and again pushed against the norm. To use the phrase of one baby boomer, they think different.

The final change will occur with the crashing of that wave: The availability of assisted dying for all. Assisted dying is already becoming the norm for those with terminal illnesses. Australia is the most recent to join the ranks of Sweden, the Netherlands, Belgium, Canada, Columbia, and Luxembourg, as well as California, Colorado, Washington, D.C., and Oregon in the U.S. (I use the term assisted dying broadly, to also involve giving the subject a lethal drug, and not literally being on hand as they take it and pass away. That is what is allowed in California.)

Currently there are restrictions, like having a terminal illness, especially one that is either painful or imminent. But once the mechanics are in place and the threshold has been passed, it is only a matter of degree to have assisted dying for those who decide that their debilitating state makes them no better off than one who is terminally ill. Once we have clear diagnosis tools for Alzheimers, for example, I can imagine voluntary assisted dying protocols along the lines of a more successful and less surreptitious Alice Howland in the film Still Alice.

The way is being paved to make this more acceptable. For example, consider the context provided by a recent full section in the New York Times devoted to the bleak world of old age and dying in Japan. We will see more articles depicting the emptiness of old age, the drain on society and our children, arguments that we should take charge of our death just as we do our lives -- this is the sort of thing that resonates with the baby boomers, also called the "me generation" -- and even arguing, as I have, that keeping someone alive can be akin to torture. I also have argued in a past post that we could help matters along by giving payments (obviously to a designated beneficiary) if someone elects to forgo expensive treatments that would only delay death by a short period.

In three years Tesla will be rolling out the fastest production car in the world. And not a "production car" as in, we made ten or so of these so it can be called one. No, a production car that rolls off of an assembly line — though I hope the rate of production is controlled with DeBeers-like style — and that still outperforms any car you can buy at any price.

The Tesla Roadster that was unveiled this weekend and is slated for delivery in 2020 is not only better, it is in a different league in terms of its performance specs when compared to any car at any price. Including, for example, the 1500 hp Bugatti Chiron, which starts at $2,998,000. The Roadster does zero to sixty in under two seconds (no other car is even built with the idea it can beat two seconds), a quarter mile in under nine seconds (no other car is even close to nine seconds). Top speed of over 250 mph. (It might be ten or twenty mph shy of the record here, we will have to see. Musk has said once it gets into production, the performance might exceed what we are seeing with the prototype. For now we just know it is "over 250 mph".) Plus, it seems to be user-friendly. Obviously it is quiet. And it seats four, at least if two of the four are small.

And, its best-in-the-world performance in terms of speed and acceleration will not even be the headline item when it gets its test-drive reviews. I predict that the Tesla Roadster will take corners unlike any car built today. First of all, it has a lower center of gravity because of its batteries. Second, it can have the distribution of that weight precisely tuned because the batteries can be placed most anywhere on the underbelly. And third, with a separate motor for each of the rear tires, the Tesla can have a computer assist that keeps the car from skidding out as you take a corner. Anyone who has tried to make a Tesla S skid on wet or icy roads already knows this. Imagine what happens when you are speeding around a turn and the computer can differentially send more torque to one tire versus the other.

And, this is only the beginning. As Musk has pointed out, by the time the car is in production there will doubtlessly be further improvements. And even then, it is only Version 1.0. The bigger point is that an electric car is a better technology than the gas-powered car. Over time the gas-powered car will have to yield.

Already, two days after the announcement, I have been reading the reaction from the aficionado of high-end sports cars, supercars, and, as the Bugatti and its kin are called, hypercars. The basic argument is: "There is more to a sports car than how fast it goes. It is the workmanship. The feel of the car shifting gears. The sound of the engine growling. The melding of man and machine." It is the laudable appreciation of these finer points that is behind the market for mechanical timepieces. They cannot be as accurate, but they embody the workmanship of great craftsmen; the feel of winding the spring; the sound of the mechanism ticking; the melding of man and machine (I guess).

So it will be for the exquisitely crafted cars of today, from the Ferrari to the Bugatti. If we take performance as the objective, the best car in the world will no longer be one that is one or two or three million dollars. It will, at least for a time, be the two hundred thousand dollar Tesla. And after that, it will be another electric car. Like fine timepieces, the supercars of today will be admired and owned not for superlative performance, but for an appreciation of their workmanship and their mechanical intricacy.

...An Actuary is someone who wanted to be an accountant but didn't have the personality for it....An introverted actuary stares at his own feet, and extroverted one stares at the other person's feet....What is the difference between God and an actuary? God doesn't think he is an actuary...."Look at the white horses over there." Actuary: "They're white on this side, anyway."

Unfortunately, when it comes to the mess our pensions are in, actuaries are no joke. Pension funds labor under actuarial assumption for expected returns that are mainly pulled out of thin air without any regard for financial economics. Does anyone really think pensions will be able to grow at seven percent or more per annum? When they are constrained by their various constituents to hold 50% to 60% in bonds and cash? (See Figure 3 of this OECD publication.)

Those unrealistic assumptions lead to unsupportable levels of contributions, and thus pensions are underfunded as a matter of course. You know the assumption are wrong when virtually every pension is on the negative side of the ledger. But the actuaries do not seem to have been trained in the concept of making course corrections. Nor do they educate themselves in financial economics to better evaluate the mess they are creating.

Why am I going into this? Over the weekend I attended an event honoring a former colleague of mine from my days at Morgan Stanley, Jeremy Gold. He is an actuary who has spent his career trying to move the pension actuaries toward a firmer foundation in financial economics -- to have them at least avail themselves of what financial economists can provide. In the mid-1980's, Jeremy and I worked together in the Fixed Income Research Group at Morgan Stanley. He and I went on various trips to push fixed income products, and to market the fledging new strategy of portfolio insurance (flying out once to have dinner with the head of the Port Authority of Los Angeles, who we discovered, part way through the first course, had -- surprise -- thought we were selling port insurance). We co-authored a paper in 1988, In Search of the Liability Asset, that is still on various reading lists, maybe not for actuaries, but at least for those in finance.

Jeremy left Morgan Stanley in the late 1980's to get a Ph.D. from Wharton, and spent the next twenty years as a thorn in the side of the actuarial profession, pushing them to add financial and economic structure to their methods. One of the best and most widely read of his works for this is the paper Reinventing Pension Actuarial Science.

At the base of it, finance is not actuarial science. It is not predicated on repeatable, or even known, probabilities. There is no appeal to the law of large numbers for the systematic risks of the financial system.The future does not look like the past. There are no mortality tables for asset returns.

...What do actuaries and Packer fans have in common? They both think that history will repeat itself...

So if you want to be the arbiter for over 20 trillion of U.S. pension assets, a good start is to do it based upon a foundation in finance.

I wrote a post a month or so ago on the risks from ETFs, in particular how ETFs on less liquid markets - with high yield bonds being my poster child - could cause problems for the market generally. Basically that there is a fundamental flaw when people think an instrument based on a illiquid market is capable of intraday liquidity. And that if the ETFs in such a market have a severe problem, ETFs generally might be considered tainted by a range of retail investors, leading to an outflow from even the more liquid ETFs.

Here is an article that points toward the potential for problems with high yield bond ETFs:

Investors Playing ETF Rout Pushed Junk Bonds to Brink of Chaos.

Excerpt:

Trading in exchange-traded funds got a little crazy last week when it became clear that junk bonds were in for more pain. But the market was fortunate the consequences weren’t more severe, strategists warn. Though spared the worst, investors came close to creating a scenario where ETF activity drove prices....a snowball effect where a dislocation develops between the fund price and the value of its underlying assets.

In case you haven't noticed -- and I haven't -- we apparently are in a world of exceptionally low risk. To see this you need look no further than the volatility of the major markets. The volatility of the U.S. equity market, for one, is at its lowest level in a generation. So, no worries here, right?

I wrote a blog post in 2011 titled The Volatility Paradox which explained that when volatility is low, risk is actually rising because people are more emboldened to take on higher leverage and to move to riskier assets. If volatility is half of what it used to be, why not lever twice as much? Thus the immediate question is what happens if there is a sudden surge in volatility from our current, low level. What is the dynamic through which a volatility shock might propagate across the financial system?

A conventional stress test will assess positions that have explicit volatility exposure, such as positions in options, in the VIX and other volatility-based instruments. There is plenty of dry powder here; over the course of 2017, as the U.S. equity market volatility as measured by the VIX index dropped to one of its lowest points in history, we have seen a growing concentration in short volatility exposure by leveraged ETFs, mutual funds, and hedge funds.

But a stress test that does the simple mathematical calculation of direct portfolio exposure to volatility will underestimate the effect of a rise in volatility, because there are dynamics triggered by other strategies that do not have explicit volatility exposure but that have a link to the volatility of assets and to the assets themselves. A rise in volatility will trigger actions for these strategies, leading to selling of the underlying assets, and this in turn will lead volatility to rise even more, creating a positive feedback between the volatility of the market and the assets in the market.

What are these strategies? Well, a good place to start are volatility targeting, risk parity, and other strategies that will rebalance their portfolios when volatility rises. Volatility targeting is a strategy that targets a level of volatility to manage risk that is typically set based on the manager’s mandate. For example, the manager might follow a strategy that will seek to keep the portfolio’s volatility near 12%. If the volatility of the market is 12%, the fund can be fully invested. However, if the volatility of the market rises to 24%, the fund will sell half of its holdings in order to stay in line with its 12% target. Risk parity allocates portfolio weights to have the same total dollar volatility in each asset class. These multi-asset class strategies often use leverage to adjust holdings of underlying assets, buying more of the lower volatility assets relative to the higher volatility ones. If the volatility of one of the asset classes rises, the fund will need to sell some of that asset class in order to maintain equal dollar volatility. In both of these cases, there is a clear mechanism going from the rise in volatility to a drop in the underlying asset.

Things won't all happen at once. The agents for these strategies differ significantly in their time horizon. Those who are directly linked to volatility, those that are in short-volatility ETFs and the like, will have an immediate P L effect from a surge in volatility, and will need to reduce their positions immediately. The volatility targeters will only reduce positions as the rise in volatility is seen as having a non-transient component, and their adjustments will be in a weekly to monthly time scale. And the risk parity agents will have an even longer time horizon, because they generally make asset adjustment with a monthly or quarterly time frame, and do readjustments based on a longer-term estimate of volatility.

Oh, a little more on the relationship between low volatility and risk: If you want to see really low volatility, look back at the swaps markets in the summer of 1998. But you might recall that in August of 1998 there was a rash of defaults in Russia, which was then followed by the blow up of LTCM, the (before that) famously successful quant fund whose principals a few months earlier had graced the cover of Business Week (never a good sign). In that case, low volatility didn't spell low perceptions of risk, it was an indication that no one wanted to go into those markets because things were so uncertain. I go through my first-hand experiences with this in one of the chapters of my 2007 book, A Demon of Our Own Design.

I had a video interview in the U.K. on my recent book, The End of Theory, with Rachel Straus, (Big Money Questions), that just came out with the Daily Mail. You can get to it here.