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Symposium : Tribute to Benoit Mandelbrot at the Ecole Polytechnique

Posted by Harry Seldon on February 28, 2011

Tribute to Mandelbrot

A symposium specific to a tribute to Benoit Mandelbrot will take place at the Ecole Polytechnique on the 17th and 18th of March 2011. Entrance is free but upon registration :

http://events.polytechnique.fr/accueil/hommage-a-benoit-mandelbrot/

Title of the event is “Universalities and fractals”. You can find the absolutely fascinating program at the previous address.
Here are just a few presentations :

  • Heinz-Otto Peitgen. University of Bremen and Florida Atlantic University « The Mandelbrot Set: Revitalizing Iteration Theory and Popularizing Mathematics »
  • Luciano Pietronero, Universita La Sapienza, Rome « Fractal Cosmology »
  • Laurent Calvet, HEC Paris et National Bureau of Economic Research (USA) « Risque extrême et régularité fractale en finance » (Extreme risk and fractal regularity in finance)
  • Jens Feder, Physics of Geological Process, Université d’Oslo, “Fractals flow and Fracture”
  • Peter Jones, Yale University « Product Formulas for Measures and Applications to Analysis »

By the way of this blog, I much thank the organizing committee as it seems to me that Mandelbrot was one of the greatest genius of the XXth century. I have been much awaiting this kind of tribute in France. That’s why I will deeply regret for a long time the fact that there is no way I can come on the Friday.

Here is a reminder of the few articles I wrote about Mandelbrot:

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7 lifechanging books about fractals, chaos, nature, philosophy and even finance for the holidays

Posted by Harry Seldon on December 14, 2009

Mandelbulb
Mandelbulb by Daniel White

As we are still at the beginning of the holiday season, maybe you haven’t bought all your gifts yet. In that case, here are a few lifechanging books you can offer to your loved ones.
By lifechanging, I mean you will never look at the world in the same way after reading one of these books. There is even a good chance you will find the world a lot more simple after your reading because these books give you keys to the behaviour of nature and mankind.

If you don’t like too much specialized books, you will like these ones because each one of them will speak about several topics among geology, economy, biology, social sciences, and climate.

Moreover, you will find some element of answers for several popular questions of our days like:

fractals_nature_model

So, let’s go to the point, here are these absolutely marvellous books. Notice, they are somehow sorted by order of importance.

So, in case it was not clear, now you see why my Twitter name is @Fractalharry ;-)

You can propose other books in the comments.

Enjoy your reading.

PS I have linked to Amazon for your convenience but I don’t touch any commission!

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Simplexity: Things are a lot simpler than they seem and vice versa

Posted by Harry Seldon on October 20, 2009

Have you ever heard of simplexity ?

Some systems are a lot simpler than they look like. For instance, let’s consider the shape of a tree. It looks complex, especially if you compare it with a straight line. However, if you have read Mandelbrot or heard of fractals, you know that all you need to draw a tree is a 2 lines pattern, which you repeat a big number of times introducing at each step some light randomness. You can model pretty easily this tree shape. At least you can generate at your will tree shapes. That is typically the way used in computer graphics to generate natural virtual 3D scenes. However, this does not mean you can predict the accurate shape of a tree from its seed.

So, is the tree shape complex or simple? Thanks to Mandelbrot we know now that the shape is a lot simpler than it seems. Associating the notions of predictability and simplicity, the converse is also true: it is more complicated than you could think even if you have heard of fractals. Hence this notion of simplexity, contraction of simplicity and complexity.

Here are a few good books on the subject:

If you know about fractals and chaos, you must be already familiar with that fact that simplicity can bring complexity quickly and easily. But you might not know this term of simplexity.
More generally, each time you think “this thing is a lot simpler than I had imagined at first”, you experience simplexity: in fact, you changed your first impression of overall complexity by discovering the underlying simple principles.

While we are at it. There is a field where simplexity shows all its magnificence: it is in finance. International finance looks complex but there are a limited number of principles behind it. You can even fairly easily model a stock chart. (Even if this model has nothing to do with the actual models used by financial analysts). But even with a good model you cannot predict easily the stock chart of a determined company.
For more info, you can have a look at the Facebook group “Finance & Mandelbrot”.

And at last, because I cannot prevent from saying it again, If you want to keep things simple, then regulate them. Contrary to what you could think, you do not need very accurate models to control a system.

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Petroleum industry is too profitable, so what?

Posted by Harry Seldon on September 07, 2009

Petroleum is even more profitable than finance. Do you need a proof ? This post is extracted from the longer (too long?) post revenues per employee sum up world’s troubles. First, I give you again the chart of revenues and profits per employee of a few top companies

Revenues_per_employee

But, maybe you do not believe me when I say that oil is more profitable than finance. Indeed if you look closely at the chart, the profits per employee of Goldman Sachs are 380k$/E while it is only “379.18k$/E” for Exxon. That it is about the same, but still, finance wins.
So, to support my point, let me add other data: (from Fortune 2008 and 2009 - though notice that the results do not change much between both years)

  • List of the industries generating most revenues per employee
  • List of the 10 highest paid CEOs Ok the first one is from a finance company (Blackstone), the second one is from a software company (Oracle) but, be seated, “The next seven highest paid CEOs all helm energy companies: Ray Irani of Occidental Petroleum (OXY, Fortune 500), John Hess of Hess Corp (HES, Fortune 500), Michael Watford of Ultra Petroleum (UPL), Aubrey McClendon of Chesapeake Energy (CHK, Fortune 500), Bob Simpson of XTO Energy (XTO, Fortune 500), Mark Papa of EOG Resources (EOG, Fortune 500) and Eugene Isenberg of Nabors Industries (NBR).” (CNNMoney) Shouldn’t we feel sorry for traders who are not working in the oil industry?
  • 25 top-paying companies First one is a law firm (Bingham McCutchen), second one is a Medical Doctor firm (Lehigh Valley Hospital & Health Network), interestingly, the 3rd, 4th, and 5th company are also law firms (Orrick Herrington & Sutcliffe, Alston & Bird, and Perkins Coie). And the 6th one at last is an oil company: Devon Energy “The largest independent oil and natural gas producer in the U.S., Devon pumps half a million barrels of oil a day” (CNNMoney). One word about lawyers and MD: I am really not shocked to see them first because a lawyer or a MD has much more responsibility than an engineer. So even if their job may be in some cases less complex (does not mean easy obviously) than engineering, it is definitely worth more money per person. Back to our subject, Goldman Sachs is only 11th, behind, another oil firm (EOG Resources) and behind sofware companies (among other Adobe Systems).
  • Best big companies to work for The first one is… an oil company: Valero Energy the Largest oil refiner in North America! And the second one is nothing else than Goldman Sachs! However, notice that the ranking puts a high weight on the size of the company because else in the ranking of the best companies to work for Goldman Sachs is before Valero and that the first company is Google (2007).

Petroleum industry is way too profitable, so what?
Petroleum industry is the most profitable because oil is the most useful thing around. Oil is energy and the world needs energy. There is a high demand for energy so energy should be expensive. OK but this does not explain why oil companies revenues per employee (and wages) and profits are so high.
In fact, wages and profits should be greatly lowered by the expected high cost for unextracted crude oil. Cost of crude oil should appear in the balance sheet of an oil drilling company, and then in all the supply chain. Well, crude oil costs do appear in terms of concessions. But they are way undervalued. As an approximation you can neglect these costs. You can think that current cost of unextracted crude oil is ZERO$. That exactly means that nobody owns it and that reserves are unlimited. In my opinion everybody owns it, just like every natural resource, and it is limited. The market of natural resources (oil among others) should take into account in its pricing process all the natural reserves and not only the extracted reserves.
And to pronounce a taboo word : taxes. Profits from petroleum companies should be more taxed because these profits are not merited. They are not justified by an extraordinary complexity or by an extraordinary innovation. The useful innovation would be to find substitutes to petroleum.
Maybe if, like many, you really hate taxes, one other solution would be to force petroleum companies to highly invest in fundamental research for new energies.

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Revenues per employee sum up world's troubles

Posted by Harry Seldon on August 22, 2009

Revenues_per_employee

Let’s have a look at the 2007 revenues per employee and profits per employee of a few top firms. Notice 2007 is the year before the global crisis. The aim is to see whether this tells us something about the current state of the world and namely whether this tells us something about energy and finance troubles. The companies are all chosen in the Fortune 50, except Google (150th) that I wanted to include because it is a very interesting case and because it is self-proclamed world white knight (cf ‘Do not be evil’ motto). Here are the companies with their industry:

When I say top firms, it is because most of them are highly successful companies, worldwide recognized as the best in their field. However, some of them are also well known top loosers.

Why am I looking revenues per employee and not only profits per employee? Let me ask you another question: how do you measure a company profitability? From an investor point of view you look at the profits (and return on equity). However, if we speak about absolute profitability for the company as a whole, that is including profitability for the employees themselves, there is a problem. Indeed the more a company is wealthy the more they pay their employees (engineers wages in finance are at least 30% higher than in other fields) but the more they pay their employees the less profits they make as profits are revenues minus costs (P=R-C).
Let’s imagine a company where the owner is also an employee. This company pays very high wages (500 k$/employee/year). It turns out that this company equilibrates its budget and does not make “profits”. Would you call this company “not profitable”? I guess not. Profits do not express employees’ wealth. So, I am looking for a way to measure profitability for both employees and shareholders as a whole. The interest of dividing by the number of employee is that it gives you a hint on what is left that can be given to employees for wages and bonuses. This division is somehow a wage estimator.
Moreover, as I want to compare an indicator between several companies of several sizes from several industries, the division allows to normalize the results and allows for the comparison. It is a standard method used by Fortune to compare results between industries. As another example, it is used by Pingdom to compare Tech companies.
To be accurate, I would have liked to know the value of wages plus profits divided by the number of employee. This is not easily available for many companies at once unlike revenues or profits. I am not even sure this study could be done using the companies’ annual report.

I want to make this comparison to know if there are fields, industries, that are more easily profitable than others, to know if profits are linked to the complexity of what they are making or not, to know if our economy is working properly and, more exactly, I ‘d like to know what is wrong with the world’s economy.

Let’s look at the chart of the revenues per employee of these companies. Revenues per employee are the total revenues of the company divided by its number of employees. It is not the mean wage but there is indeed a strong correlation between high revenues per employee and high wages (See Fortune article about best paying companies below). This means than high revenues per employees does not mean high cost (excluding wages) per employee.
Notice the y-axis is in k$. Profits per employee (Profits divided by its number of employees) are also indicated for reference and verification of basic profitability. They are not directly the bonus per employee but it is somehow linked to it.
Source of data is CNNMoney / Fortune. I made use of their nice compare tool which I advise to you if you want to go further into the analyis. Unfortunately, they do not offer ways to quickly graph the results. It is a pity as it is so easy, nowadays, to make nice stacked bar charts on the web.

Does anything surprise you? You are welcome to comment about this chart.

So, it comes as no big surprise that oil and finance industries come first. However, there are some surprises (at least for me). I will cite them below and explain them just after. And I tell you right now that you are welcome to comment on the chart and on these surprises.

1 Oil is first, not finance. This is because oil is free. Didn’t you know?

2 Finance is only second contrary to my initial guess.

3 Oil and Finance are the 2 biggest problems of the day although they are the most profitable fields. Coincidence?

4 Oil is slightly higher in revenues than finance.

5 Finance is itself much higher than the rest.

6 The Google case

7 The Wal Mart specificity

8 What about Mc Kesson?

1 Petroleum industry is first, not finance.
It was not that obvious that oil would come first. By the way, when I speak about oil industry, I mean it at large, that-is-to-say including refining or drilling. You would find all these industries in the first places of the ranking of industries by Revenues per employee published by Fortune. I will come back on this chart below or in a next post.
So, it is not obvious because petroleum engineering is not the most complex of engineerings. One way of measuring this complexity is to see how many people you need to develop new industrial projects. In that respect aerospace programs (think 787 for instance) are huge. The biggest and most complex project of all time is arguably the race to the moon (approximately $135 billion in 2005 dollars). The second one (if not first) is probably the Manhattan project. Another way of measuring program complexity is to check how late or how over-budget a program is.
In that respect too, aerospace programs are world champions. You can still think about the 787 (2 years late and counting). These programs are overtime and over-budget only because they are way under-budgeted in time and money at first. The main reason is that governments and private customers would simply not accept longer schedules nor higher costs. Fortunately, good commercials perfectly know how to sell you a not too expensive thing and then, once it is 2 years late they know how to explain you that you cannot cancel the project, given the amount of money you have already spent. The list of examples is quite long: besides the 787 you can think about the A380, the A400M, the JSF, the F22. Civilian and Military programs have both troubles. Safety is driving costs in civilian programs while performance is driving costs in military programs. In brief, compared for instance to rocket science, petroleum engineering is not that complex.
Nevertheless, petroleum industry is first because oil is the most useful thing around. Oil is energy and the world needs energy. There is a high demand for energy so energy should be expensive. OK but this does not explain why oil companies revenues per employee (and wages) and profits are so high. In fact, wages and profits should be greatly lowered by the expected high cost for crude oil (taken out the cost of extracting or distributing it). Cost of crude oil should appear in the balance sheet of an oil drilling company, and then in all the distribution chain. Well, crude oil costs do appear in terms of concessions. But they are way undervalued. As an approximation you can neglect these costs. You can think that current cost of unextracted crude oil is ZERO. “Petroleum is free”. That exactly means that nobody owns it and that reserves are unlimited. In my opinion everybody owns it, just like every natural resource, and it is limited. The market of natural resources (oil among others) should take into account in its pricing process all the natural reserves and not only the extracted reserves.

Petroleum industry is first not because of an internal complexity, but because demand is high and costs are low (“there is free oil”!).

Maybe you do not believe me when I say that oil is more profitable than finance. Indeed if you look closely at the chart, the profits per employee of Goldman Sachs are 380k$/E while it is only “379.18k$/E” for Exxon. That-is-to-say, it is about the same, but still finance wins.
So, to support my point, let me add other data: (from Fortune 2008 and 2009 - though notice that the results do not change much between both years)

  • List of the industries generating most revenues per employee
  • List of the 10 highest paid CEOs Ok the first one is from a finance company (Blackstone), the second one is from a software company (Oracle) but, be seated, “The next seven highest paid CEOs all helm energy companies: Ray Irani of Occidental Petroleum (OXY, Fortune 500), John Hess of Hess Corp (HES, Fortune 500), Michael Watford of Ultra Petroleum (UPL), Aubrey McClendon of Chesapeake Energy (CHK, Fortune 500), Bob Simpson of XTO Energy (XTO, Fortune 500), Mark Papa of EOG Resources (EOG, Fortune 500) and Eugene Isenberg of Nabors Industries (NBR).” (CNNMoney) Shouldn’t we feel sorry for traders who are not working in the oil industry?
  • 25 top-paying companies First one is a law firm (Bingham McCutchen), second one is a Medical Doctor firm (Lehigh Valley Hospital & Health Network), interestingly, the 3rd, 4th, and 5th company are also law firms (Orrick Herrington & Sutcliffe, Alston & Bird, and Perkins Coie). And the 6th one at last is an oil company: Devon Energy “The largest independent oil and natural gas producer in the U.S., Devon pumps half a million barrels of oil a day” (CNNMoney). One word about lawyers and MD: I am really not shocked to see them first because a lawyer or a MD has much more responsibility than an engineer. So even if their job may be in some cases less complex (does not mean easy obviously) than engineering, it is definitely worth more money per person. Back to our subject, Goldman Sachs is only 11th, behind, another oil firm (EOG Resources) and behind sofware companies (among other Adobe Systems).
  • Best big companies to work for The first one is… an oil company: Valero Energy the Largest oil refiner in North America! And the second one is nothing else than Goldman Sachs! However, notice that the ranking puts a high weight on the size of the company because else in the ranking of the best companies to work for Goldman Sachs is before Valero and that the first company is Google (2007).

Oil is first and it is logical because oil companies pump it up, pump it up, and “it” is free! However, notice that oil companies are not the only one that benefit from free oil. The final consumer also benefits from it. The cost of oil on the market, if it included unextracted oil price, would be significantly higher. So this not high enough cost directly leads to energy wasting, overconsumption, and then global warming.

2 Finance is only second most profitable.
I was surprised to see finance second and not first. But should I be surprised? Let’s just come back quickly to what money is. Money is time? If anything, money is energy. Nowadays people think about money as an exchange mean controlled by government. This is called fiat money. But this is not the best definition of money.
The best one - at least in my point of view - is the old one: money is price of gold. In this case, money is called Commodity money. We know that energy is mass (thanks Al, E=mc²). So saying money is energy, or gold (mass) or oil (mass) is about the same. Moreover, money, like energy, can be exchanged, converted and transformed. Therefore, defining money as energy includes both definitions: money is something that can be exchanged, and gold is the best way to stock money.
Coming back to our chart, fiat money is represented by finance, whereas commodity money is represented by oil industry. The chart shows that oil industry is the biggest money generating industry. In my opinion, the industry closest to money definition makes more money, and in this sense, the chart proves that the best definition of money is its definition as a commodity, and further in the analogy, as an energy. There was commodity money, there was fiat money, now is the time of energy money. And today, the best representation for (energy) money is petroleum. So, when a company is pumping free petroleum, it is exactly as if they were pumping free cash. Fact is this cash belongs to all people, else why not make pay for oxygen while we are at it. So there are a bunch of people that are being stolen.
How to integrate the internal value of resources in the law of supply and demand? Well, good question, glad you asked, if you have a decent proposal you are probably a good candidate for a next Nobel Prize.

Coming back to time is money: are you able to buy a travel in time with money? Are you able to buy more lifetime when you have a deadly disease? Not really. When speaking about “time is money”, one thinks that I can buy someone’s work to do my work, so that I have more free time. Or I can buy someone’s work to do more work and earn more money. Good, but what is bought here, is work and work is energy. However, I remind you that energy is proportional to the inverse of the square of time ([E=ML²/T²]). So energy, time and money are linked.

Just like Oil industry brings money into the system by bringing “liquid money” (oil) into it, finance is bringing money into the system by speculation and inflation. Basically only government can create money except that bankers have managed to escape this rule by creating extravagant interest rates, among others subprimes. Interest rate added to interest rate added to interest rate, is called speculation and it is basically what created undue inflation. Moreover, when a speculation bubble bursts, the money that was created and taken by banks is not destructed and reimbursed by banks.
At least petroleum industry pumps money that exists creating real value while finance industry pumps money that does not exist creating fake value. Note that forging fake money is a severely punished crime - compared to what is done (nobody is killed). Fake money is rightfully taken very seriously by states (15 years in prison in the US)… except when it is done by speculation.

If you wonder where insurances are, I am including them in finance. When they are not bankrupt, they are quite profitable. I have already talked about insurances: insurances create money based on a good old Ponzi scheme.

3 Oil and Finance are the 2 biggest problems of the day but they come first in this profitability ranking. Coincidence?
No, it is because of high abuse (free oil, free money) and lack of regulations that there are such troubles.
Notice that defense industry does not arrive in the first places. This is not obvious because along with energy or health, defense is among the primary needs of people. If weapons were traded as freely as petroleum or financial products, there is no doubt they would show way higher up in this ranking. Fortunately, arms trading is heavily regulated. I say fortunately. If you wonder why, I leave to your imagination to think about a world where everybody has a rocket launcher at home. However, heavy regulation means less sales and then less revenues. Besides, Aerospace and Defense industry is a heavy industry that does not require only minds (unlike Finance or Software industries). They require heavy machines and complex organisations that drive costs to very high values thus clearing hopes for profits.
In my opinion petroleum and money should be dealt with a lot like weapons are. That is finance and petroleum industries should be a lot more regulated.
A rule easy to add would be to make it compulsory for companies to publish their total wage bill that is to say the sum of all wages paid to employees, including bonuses, stock options, etc. And to go further, companies should publish all wages and remunerations, at least wages by categories of employee. This transparency would be a step towards more free circulation of information. According to the work of Nobel Prize Joseph Stiglitz, information symmetry is of paramount important for economic efficiency.

4 Oil is slightly higher in revenues than finance.
Exxon and Goldman Sachs have the same profit per employee. But Exxon has significantly higher revenues per employee. It shows that oil industry has more costs. This is the cost of heavy industry. Because, on the contrary to finance, petroleum industry requires also some complex infrastructures.

5 Finance is itself much higher than the rest.
Then, there is a real gap between Goldman Sachs (or Lehman Brothers) and Google (or GM). This is a huge gap between finance and the rest of the industry (factor 3 between Goldman Sachs and Google in revenues per employee). This gap is the one that should be regulated. Unregulated generation of money through speculation and lends to unsolvable people has proven deadly. Why not lend to the rich and give to the poor instead of doing the opposite?

Financial products are falsely complex. They look complex. However, when I say that an airplane is complex, I mean that it is hard to design, to simulate, to control, to produce. But most of all it is hard to guarantee that the product will meet its initial specifications. It is hard but it is done. All along the development, the performances of the airplane are estimated, simulated, and tested. Once the airplane is produced, its characteristics are very well known and simulated. What about a financial product, is its performance guaranteed? Not at all, fortunately for Goldman Sachs, else they would be also bankrupt (Global Alpha hedge fund tumbled 37% in the global credit crunch).
About regulation, financial products should be guaranteed (not insured). This would force to have much simpler products. You think it is stupid? Well, what about I tell you to board an airplane that has a 20% chance to crash?
So financial products are falsely complex because they are not guaranteed. Companies who sell financial products should be a minimum responsible for the performances of their product.

6 The Google case
Google is quite special. It looks like they are a regular software company making high but not that huge profits. It is not that simple. First, they are not a software company. At least they do not sell softwares at all. Their business is online advertisements trading. Moreover, they have a monopoly, or even they have 2 monopolies, one for internet search and one for online targeted advertising. The arrival of a competitor, the Bing search engine made by Microsoft is good to limit the trust situation. It is quite ironic to see Microsoft acting as an anti monopoly while they are still in a monopoly situation with Windows. When will Google have their revenge by making a computer Operating System? Perhaps soon. For now, online targeted advertising monopoly allows Google to actually make huge profits. But these profits are hidden by artificial costs that are also gifts to the world. Artificial costs are the number of Google projects not generating much profit. I bet that looking at Google’s revenues per employee when it was not public would be just stunning.
But the good thing with Google is that they have regulated themselves by distributing profits to R&D and by hiring a lot more employees. No wonder that Google was 1st in the 2008 ranking of the best companies to work for.

7 Wal Mart
In 2008 Wal-Mart was the leader of the Fortune 500 meaning they had the biggest revenues in 2007. Guess who is first now? Yes Exxon! But enough about Exxon. Wal-Mart has high revenues but no astonishingly high revenues or profits per employee. Business professors love to speak about Wall-Mart and its capacity to cut price. However, business being business unless you are creating money for free you will have costs. And all the magic of competition and liberalism is to drive these costs to the same amount as revenues. Just to add a layer liberalism means to set up rules to allow for fair competition. World needs more rules.

8 Mc Kesson
Mc Kesson a wholesaler in health care products appear here in this ranking. But quite logically they have high costs (the products they buy in large quantities) and then not so high profits per employee.
Revenues per employee is a very interesting indicator of global profitability. But obviously it must be considered along with profits (and return on revenue). I did not filter out Mc Kesson, it is a reminder that revenues per employee alone does not mean much.

Conclusions
Oil generates a lot of undeserved profits. Undeserved because:

  • costs do not account for unextracted crude oil price: oil is free.
  • petroleum engineering is complex but not that complex

Money is energy. Oil is energy, so oil is money, but oil is free so money is free. Hum there is something wrong here. The wrong thing is to consider unextracted oil as free.

Finance also creates money ex nihilo through speculation and other Ponzi schemes.

This makes Petroleum and Finance industries very profitable because they generate money without costs. At least for petroleum industry the money created is real, it is oil. However, money created by speculation is much like fake money and the 2008 global crisis proved this.

Oil and finance should be a lot more regulated, like arm trading is. World needs more rules. By the way, a simple rule to add to business is that the total wage bill should be publicly published along with income statement and balance sheet. (Unless you can find this in, for instance, Google’s annual report.)
A more complex rule is that companies who sell financial products should be a minimum responsible for the performances of their product.

This quick study of revenues per employee and profits per employee allowed us to visualize current troubles of the world:

  • free oil leading to energy waste and global warming
  • abusive speculation leading to financial crisis

(1) Notice that according to CNNMoney the technical name for the industry in which you find Goldman Sachs, Lehman brothers, Merrill Lynch and Morgan Stanley is… Securities Isn’t that deliciously ironic for an industry which is as far as possible from “secure”.

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All insurances are Ponzi schemes ?

Posted by Harry Seldon on June 30, 2009

Madoff is condemned. Good, he is the biggest swindler of all time. However, in this Madoff case the real question is: isn’t our western society a huge Ponzi scheme? Specifically, aren’t our insurances huge Ponzi schemes (Pension, unemployment, health (Medicare), but also finance, car and home insurances)?
The founding principle of an insurance is: the ones (young, employed, rich and healthy) pay for the others, provided that most people are young, employed, and healthy*. Even for private insurances (cars, home…) the principle is the same, everybody contributes, only a few people need insurance reimbursements. That is, some pay for the others. So what is the link with a Ponzi scheme? “Newcomers pay for the old ones”. Yes, it is the same!

Moreover, any insurance company will be in deadly troubles if all their subscribers happen to be eligible for a reimbursement. Let’s imagine the troubles if everybody was a little sick** or if everybody had a car accident today. Any insurance? No, not exactly, on the paper, if the insurance company sets a price that is equal to the maximum it can reimburse to you, there won’t be any trouble. But there won’t be any interest either! Thus the job of the insurance is to estimate the risks they have to reimburse you. Thanks to this reimbursement probability they will be able to set you up a price inferior to the maximum they may have to reimburse you.
Problem is this risk estimation is a very dangerous game. Most risk estimations are based on gaussian distributions of probabilities which are proved to be over optimistic. Benoit Mandelbrot, father of the fractal theory, proved that financial risks are way too often completely underestimated (see “The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward.” for instance). And that is the problem of our insurance companies (AIG, Medicare,…). To be perfectly clear, risks are totally underestimated even for private insurance companies.
Today, as a rule of thumb, and seen the current global systemic crisis, about all insurance companies (including most banks) underestimate risks, are thus at the mercy of a huge increase in reimbursements requests following some catastroph and are therefore simple Ponzi schemes.
To come back to the Madoff case, it blew up exactly like any insurance or bank can go bankrupt: when too many customers ask for their money. And this happened because of “a highly unlikely event”: the collapse of the market. The funny thing is that this market collapse is itself due to another Ponzi scheme: the mortgage insurances who allowed the subprimes market. The subprime crisis itself was due to a Ponzi scheme.

Conclusion

AIG, Lehmann Brothers (and the ones who did not yet go bankrupt), Medicare or Madoff it’s all the same. As long as it works we feel like billionaires and suddenly it blows up and we are in the shit for 150 years!

Bonuses

Some thoughts:

  • Get as many insurances as you can: it is not expensive (enough) and it can make you win a lot of money (Even if I, also, think that I am a milk cow for my insurers)
  • Do not be surprised if the insurance company puts a maximum of bad will to reimburse you. That is their job! That is why you pay them. If they had to reimburse easily everybody you would have to pay them a lot more.
  • I might be the only guy on Earth who think all insurances should be more expensive!

A few links about that

If you have another interesting link, feel free to leave it in the comments.

(1) Who coughed?
(2) Who said that it is the case? Again you?
(3) Not so unlikely, is it?

PS This article can be found in French as a comment for this Slate translation of this WSJ article.

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Yes, he can save the world !

Posted by Harry Seldon on February 23, 2009

He is from a minority. He is American, lives in the US but has a dual culture. He studied in the best universities. He is one of the smartest guys on Earth. He had many awards for his outstanding work along his long and brilliant career. He has always fought received ideas. He is not afraid of complexity but knows to recognize simplicity in the middle of intricated systems that most people consider as infinitely complex. He is not afraid of telling people when they are wrong. He is not afraid of telling them what to do. He does not hesitate to fight alone against the majority but definitely prefers to be with the majority. If listened to earlier, many casualties would have been avoided. He wants to change the world and he has a plan.
No, I am not speaking about Barack Obama. Let me continue. He is Franco-American. He studied aeronautics. He deserves a Nobel prize in all categories: economy, physics, medecine (biology), chemistry, and even litterature and peace, because his work helped describing and understanding the geometry of nature. His work can indeed be applied to stock market, natural borders, lungs description, fluid mechanics, animal population evolution, clouds. He wrote many inspiring books. If more listened to the world would be way more peaceful because better understood and less submitted to crisis.
Yes, I am speaking about Benoit Mandelbrot and the good news is: his work on finance is slowly being recognized by the media and by economists.

Listen to Mandelbrot and global warming, crisis and wars will just be bad memories. OK I am exaggerating, but I am not sure how much ;-).

PS If you know which conferences Mandelbrot is going to attend this year, please let me know in the comments because he is definitely the celebrity I would love most to meet.
mandelbrot antenna

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Good news from the combat against the crisis

Posted by Harry Seldon on February 22, 2009

Julia island
In my 2009 wishes, I wished that people better understand the world. For this purpose, I suggested they read The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward by Benoit Mandelbrot.
Actually, for one year and a half we have been inside this growing up crisis I have been appalled by the small number of articles in the media about Mandelbrot’s work on Finance and more generally by the small number of articles about chaos theory and economy. Indeed more than ten years ago, Mandelbrot explained why the finance world was walking on its head. To make it short, it is because financial theory fundamental principles are wrong and over-optimistic. These principles state that the hazard involved in the market theory is regular enough to be smoothed by the big numbers law. This hazard is “benign”. Basically, with the standard theory, crisis can’t happen. So yes, you must be dreaming, there is no crisis, unless you listen to Mandelbrot that tells you that the hazard is actually “savage” and potentially leading to a collapse of the market: a crash.

So where is the good news ?

It looks like main stream media are slowly understanding Mandelbrot’s work and they are speaking about it. I found yesterday an excellent article in one of the main French financial newspapers about Mandelbrot’s work on finance. The second good news, contained in that article, is that Mandelbrot’s book are being republished. A third good news, is that the author of the previous article, Philippe Herlin is very proactive and has just created a Facebook group called “Finance & Mandelbrot”. I joined immediately ! An instant interest of this group is that Philippe Herlin gives a list of news articles about the subject (given below). Please notice the link called How Fractals Can Explain What’s Wrong with Wall Street which is dated on February 1999. Yep, it is not a typo for 2009 !
Last but not least, there is a significant political news. Mandelbrot showed that the financial system was fractal, exhibiting the same behaviour at all scales. Actually that was the start of his long and brilliant career. Later on he showed the same behaviour for climate, geology, ecology, or biology. Actually about any natural system is fractal and even chaotical. However, there is a good way to smooth the behaviour of a system, it is called control. Our world needs more control (distributed control whenever possible). That is to say, more rules, more ways to enforce them and more ways to measure their efficiency. So the good news is today European leaders backed sweeping new regulations for financial markets. Questions remain, will the rules be good and will they be enforced?

By the way, if you want to understand a little better the whole world, if you want to hear about economy, climate, geology, ecology, or biology in less than 200 pages, just read these two amazing books. Your vision of the world will change and for almost free because these books are quite old (but have never been so fashionnable).

Nostalgia: I was offered these books 13 years ago. I read them then. They are definitely among the best gifts I have ever received. They stand in my bookshelf, one arm away from where I am writing these lines. Believe me these books are far easier to read than the Bible so you can give them to your children. I read them again 2 years ago after completing my studies in Dynamical Systems and Controls. I understood plenty of things I had missed in the first reading. So you can also offer these books to adults. They will learn quite a few things about the nature of our world.

Resources

In English

In French

If you know other good links about fractal, chaos theory and economy, please leave them in the comments.
Mandelbrot set

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Happy new year 2009! May we better understand the world!

Posted by Harry Seldon on January 02, 2009

I wish you all an excellent year 2009 filled with happiness in your private life as well as in your professional life.
Besides that, I wish you to better understand the world we all live in. For this purpose, here are some subjects that deserve all your attention and about which I will blog soon.

This beginning of the new year will be very busy around here. Indeed, I am going to make a major update for ThinkoSphere.com with the new design and I will start a blogging series about Control Systems. Later on I will blog about the fractal theory applied to finance because it is today the best theory explaining the crisis that I have found so far. I am currently reading the book “fractals, hazard and finance” from Benoit Mandelbrot*, father of the fractal theory. This book is amazing, it is ten years old but it looks like it was written 2 days ago, after the crisis.

Moreover, I also wish you to be better understood by your company, by your mayor, by your government. I wish you more democracy in your environment. This starts by giving more your opinion when you are polled. So I wish you more polls and finally I wish you to find your interest in ThinkoSphere.com.

* I am actually speaking about “fractale, hasard et finance” a book in French. Its equivalent in English is The (Mis)behaviour of Markets: A Fractal View of Risk, Ruin and Reward. This is probably the best quality and best quality/price ratio book about finance you can buy nowadays!

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LEND to the rich, GIVE to the poor (not the opposite)

Posted by Harry Seldon on October 11, 2008

We are in the eye of a stock market cyclone. How did we get there ? One humoristic explanation of the subprime crisis can be found here. Another way to say it is that the financial world completely inverted the roles by lending a lot of money (I am not speaking about microcredit) to the weaker classes and by speculating on them instead of lending money to strong companies.

When I was a child, I was always surprised when hearing the French proverb “people lend only to the rich”. As many, I was surprised because the first reaction is to think rich people do not need money, poor people do need it. So the logical thing seems indeed to lend to the poor. However, to lend is not to give. In fact, lending money is not only a time exchange. I transfer you this money now, you will transfer it back to me later. But it is even a sale. I am selling you this money for this price (interest rate). So some of our great financial engineers sold expensive products (home and loans) to people who could hardly afford them. Worst of all they speculated on these products, resulting in destroying the value of both the home and the loan. While they did that they GAVE money to the rich. Lehman Brother’s CEO made 500 million dollars in eight years and he was already rich before being CEO. More generally, the whole finance world created crazy wages.

At the same time, companies in the industry got troubles borrowing money and went on a harder pressure to make profits whatever it takes. One such extreme solution is offshoring. On the paper, it seems to generate profits, but globally it destroys value because it destroys the experience acquired by the workers, engineers and management teams (about everyone is impacted by offshoring). This experience is something totally concrete which has a high value. Unfortunately, this value might not be easy to fit in the math models our finance guys came up with.

So let’s summarize : the poor got a money they could never reimburse, companies did not get a money they could reimburse, the rich were given a real part of a money virtually created by speculation. These last ten years, finance seemed to work with this motto in mind : Lend to the poor, give to the rich. Therefore, it looks like this remainder is not superfluous : LEND to the rich, GIVE to the poor (not the opposite). With this crisis, there will sadly be plenty of new poor people and there will be plenty of companies desperately needing credits.

Thus, now is the time to actually apply this advice. And finally, if you hear again the proverb “people lend only to the rich”, just think back to the 2008 great crisis to remind you what it precisely means.

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