Posts Tagged ‘speculation’
“Gambling is a tax on ignorance”*…
And as Einstein observed, “two things are infinite: the universe and human stupidity; and I’m not sure about the universe.”
Gambling– and related specualtive investments– have always been, for the vast majority of punters, a sucker’s bet. But, as Paul Kedrosky explains, the growing prevalence of AI and the emergence of prediction markets have amplified that painful reality…
The return skew in prediction markets’ returns is startling. It is partly a function of their nature, but also of vibe-coding script kiddies attacking every market anomaly as quickly as it arises. Check a recent WSJ article for examples.
The same dynamic is now spreading across retail-dominated markets. A driver is how AI lowers the cost of systematic exploitation and exploration to near zero. What used to require infrastructure, data pipelines, and bearded quants is now accessible via off-the-shelf models, APIs, and loosely stitched “agent” workflows doing … stuff that even their users don’t fully understand.
The result isn’t democratization of returns. It is wider participation, of a sort, alongside the rapid re-concentration of profits. A small subset of users—those willing to iterate fastest, monitor continuously, and deploy capital programmatically—capture gains, with everyone else just liquidity.
They scrape sentiment, parse new information, and reprice positions in seconds, compressing the half-life of mispricings. That doesn’t eliminate inefficiency, but changes who harvests it. The edge shifts from insight to speed, coverage, and execution discipline—areas where even modest automation compounds quickly, and edges disappear overnight.
Prediction markets are simply the cleanest expression of this trend because they combine thin liquidity, discrete outcomes, and high retail participation. But the same pattern is visible in options flow, single-stock volatility events, and even online poker, which AI increasingly dominates.
As AI tools continue to scale, expect this to get worse: a small cohort running semi-automated strategies extracting semi-consistent edge, and a much larger base supplying them returns. Under the pressure of AI prevalance, markets don’t flatten, the return gradient steepens to a cliff…
Fewer and fewer winners take more and more of the pot. The mechanics of concentration: “AI is Eating Markets” from @paulkedrosky.com.
* Warren Buffett
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As we contemplate concentration, we might note that today is Mother’s Day. As noted yesterday, the observance became official on that date in 1914. But the quest to honor moms began a good bit earlier. On this date in 1908, Anna Jarvis held a memorial for her mother at St. Andrew’s Methodist Church in Grafton, West Virginia, the location of the International Mother’s Day Shrine. But her quest to create Mother’s Day had begun three years earlier when her mother Ann, a lifelong activist, died.
Ann had tried to start a “Mother’s Remembrance Day” in the mid-19th century. On her passing, Anna enlisted the support of retailer extraordinaire John Wanamaker, who knew a merchandising opportunity when he saw one, and who hosted the first Mother’s Day ceremonies in his Philadelphia emporium’s auditorium. In 1912, Anna trademarked the phrases “second Sunday in May” and “Mother’s Day”, and created the Mother’s Day International Association. By 1914, she and Wanamaker had built sufficient support in Congress to score the Congressional Resolution noted yesterday. (President Wilson, who was by current accounts uninterested in the move– distracted as he was by the beginnings of his ultimately unsuccessful effort to keep the U.S. out of the troubles in Europe that became World War I– nonetheless knew better than to take a stand against moms.)
“Private equity has absolutely no reason to exist. The private equity holder has all the upside and the banks all the downside.”*…
As private equity investors become much more active in the Global South, Farwa Sial adds local economies and their labor forces to the list of those shouldering the risks of falling into the hands of operators whose m. o. is “slash and burn” (or here). Her point of reference is, as you’ll see the U.K., where private equity has wreaked havoc with essential services. But she might well have cited examples from U.S. (e.g., healthcare [or here] or infrastructure [or here]…
The effectiveness of private equity has been a subject of ongoing debate in countries of the Global North. There is substantial evidence highlighting the extractive practices associated with private equity operations across Western nations. Examples include the decline of the British high street and the financial instability of local councils in the UK, particularly in the provision of child care. Similarly, in the United States, private equity has been linked to the attrition of an already fragile healthcare system. In France, Germany and the UK., its influence has contributed to the deterioration of care homes, raising significant concerns about its broader social and economic impact.
In a recent blog, Michael Roberts characterized private equity as “vampire capital“, encapsulating the widely recognized critique that private equity firms function through a rentier model. These firms are frequently associated with practices such as asset stripping, worker lay-offs, and opting for excess leverage that increases the debt burdens of their acquisitions, all while failing to provide compelling evidence of value creation. This perspective aligns closely with earlier criticisms of private equity. During the 2000s, private equity operations were similarly likened to a swarm of locusts, reflecting widespread disapproval of their extractive and often detrimental economic practices.
In summary, such analogies emphasize the aftermath of private equity operations, leaving behind “carcasses and barren landscapes.” Nevertheless, the evidence of a hollowed-out socio-economic landscape in the Global North has not deterred the international expansion of private equity into countries of the Global South. On the contrary, ongoing reports of American private equity capturing British markets have emerged in tandem with the globalization of Western private equity. In so-called “emerging markets,” this expansion manifests in various forms, including an enthusiasm for deploying “moral money” through international development initiatives.
This article examines the role of private equity in Global South countries, focusing on three key characteristics: the escalation of indebtedness, the weakening of public markets, and the public subsidy function of development finance in facilitating private equity investments…
Exporting pain: “Private Equity in the Global South: Locusts? Vampires? The contagion effect” by @farwasial in @DevEconNetwork.
* Nassim Nicholas Taleb
(Image above: source)
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As we muse on models of modernization, we might recall that on this date in 1995, the Japanese Nikkei index fell more than 1,000 points from 19,241 to 17,785 as traders panicked over the devastation of the Hanshin (or Kobe) Earthquake. In total, the Nikkei had fallen 7.6% since the earthquake on January 17th.
The decline was the leading trigger of the failure of the 232-year-old Barrings Bank. A young trader, Nick Leeson, had speculated on Japanese derivatives. By this date in 1995, Leeson had make big bets that the Nikkei would remain between 19,000 and 21,000. As the market sank Leeson added to his positions, eventually accumulating over 60,000 futures contracts. Within a month Leeson quit the bank and was on the run (eventually he was arrested and served 3 years in jail). The losses he accumulated took Barings down; it failed and was sold to ING for 1 pound on March 6th.
“It’s very easy for trusted companies to mislead naive customers, and life insurance companies are trusted”*…
Systemic risk in the financial system– the kind that can create devastation like the Crash of 2008— has been the province of regulators for many decades, primarily the SEC and the Federal Reserve. But as our financial system has become more complex and intertwined, that risk may have moved from the stock market and banks to other sectors, sectors less well regulated. As John Ellis explains in his terrific newsletter, News Items, we might do well to turn our attention to the seemingly staid insurance industry…
The Fed exists to oversee banking, but lately it’s been keeping an eye on life insurance, too. Its recent Financial Stability Report flagged some life-insurance practices that might make the system vulnerable. Some insurers invest in assets that “can suffer sudden increases in default risk,” the report said. And some use “nontraditional” funding sources that could dry up “on short notice.”
That sounds ominous. But not long after that, Jon Gray, the president of private-equity giant Blackstone, turned up in a Financial Times article, saying life insurers had the wherewithal to bolster America’s weakened regional banks.
Gray said private equity firms like Blackstone could get “very low-cost capital” from life insurers and extend it to regional banks, to fund their lending operations. That would be a boon, because the banks’ usual source of funding, customer deposits, has grown more expensive and flighty in the wake of this year’s bank failures. So the life insurers could help ease a credit squeeze.
And once the banks make the loans, Gray said, the insurers might like to acquire some of them as investments. Blackstone manages billions of dollars of insurance investments, and Gray said the firm was already talking with large, unnamed regional banks about such deals.
So, what’s up with life insurance? Is the industry so flush it can send money to shore up America’s weakened banks? If so, then what’s the Fed worried about?
As it happens, a group of Fed economists has some answers. They got under the hood of the life insurance industry and combed through the voluminous regulatory filings of more than a thousand life insurers in the years since the crash of 2008. The U.S. financial system was going through major changes then, and they wanted to understand how the insurers had navigated the changing landscape.
One trend they observed: First, America’s bailed-out banks, seen as having gambled with their depositors’ money, were brought under the broad financial-reform legislation known as Dodd-Frank. It steered them away from making any more loans to big, low-rated borrowers. Then, once the banks had departed that space, life insurers moved in.
As a result, “These insurers have become exponentially more vulnerable to an aggregate corporate sector shock,” wrote the three economists, Nathan Foley-Fisher, Nathan Heinrich, and Stéphane Verani, in a paper first published in February 2020 and updated in April of this year.
Their findings cast the life insurance industry in a very different light from the traditional image of dull, stable companies plodding along under the weight of big, safe, bond-laden investment portfolios.
“Within ten years, the U.S. life insurance industry has grown into one of the largest private debt investors in the world,” the three wrote.
At the end of 2020, life insurers managed one-fourth of all outstanding CLOs, or collateralized loan obligations – bond-like securities backed by pools of loans to large, low-rated borrowers. Because the underlying borrowers have low ratings, CLOs pay a higher yield than the high-grade corporate bonds a conventional life portfolio would hold.
The insurers were also using unusual sources of capital to fuel their growth (funding-agreement-backed repos, anyone?). Not all life insurers, but a certain cohort was doing the kind of business the big banks did before the financial crisis, “but without the corresponding regulation and supervision.”
The economists called it “a new shadow-banking business model that resembles investment banking in the run-up to the 2007-09 financial crisis.”
Their reports describe the trends in detail, but in measured tones. No flashing red lights or alarm bells. But they do tell how things could go south: “A widespread default of risky corporate loans could force life insurers to assume balance sheet losses” from their CLO holdings.
Institutional investors watch life insurers carefully and know where the shadow-banking activity is concentrated; they would presumably see the losses coming and withdraw from the affected insurers in time. That’s what we’ve been seeing in the regional banking sector this spring, where savvy investors have identified potential problem banks and sold or shorted their stocks. The trouble is, such trading can turn a potential problem into a real one.
Upshot: “U.S. life insurers may require government support to prevent shocks from being amplified and transmitted to the household sector,” the three warn…
[Ellis explains how this happened; TLDR: life insurers chased yield; private equity firms obliged.]
The Fed researchers said the private-equity firms appear to be giving their affiliated insurers “some of the riskiest portions” of the CLOs that they package. Since risk and reward go hand in hand, presumably the insurers are getting better returns than they would from safe bonds.
But still, should America’s insurance regulators be allowing this? Remember, America’s banks were told to stop.
The National Association of Insurance Commissioners has, in fact, proposed a change in the post-crisis rule that’s been letting insurers count risky CLOs as if they were safe bonds.
But the NAIC isn’t a regulator; it’s a non-governmental organization that represents America’s 56 insurance regulators (one for each state, five for the territories, and one for the District of Columbia). The regulators often have different priorities and viewpoints, and when the NAIC makes a proposal, it can take years to get the necessary buy-in.
So here we are. Countless policyholders and annuitants are diligently paying their premiums to keep their contracts in force, unaware of these trends. The Fed’s economists see undisclosed risk, but the Fed has no legal authority to regulate insurers. The insurance regulators don’t seem in any rush to rein in the risk-takers. Keep in mind: Life-and-annuity is a $9 trillion industry that doesn’t have anything like the FDIC…
Eminently worth reading in full (along with the report and the paper linked above): “Risky Business,” from @EllisItems.
(Image above: source)
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As we whack the mole, we might recall that it was on this date in 1931 that the New York Stock Exchange began regularly reporting short selling data for the first time. The Crash of 1929 had rocked the stock market; the Dow dropped 32.6% in 1930 as the American economy took a nosedive (unemployment doubled to 16.3% by 1931, as the Great Depression set in). But short sellers in the stock market made a killing. Consequently, those short sellers took a lot of heat for the stock market crash of 1929, which led to the enactment of the uptick rule (requiring that short selling orders be filled only during upticks in share prices and meant to mitigate the negative impact of short sales) shortly thereafter. The reporting of short orders/sales was another step toward reining in the phenomenon.
The uptick rule was abolished in 2007, just prior to the market crash of 2008.
“Financial crises are like fireworks: they illuminate the sky even as they go pop”*…
The unpredictable outbreak of the COVID pandemic caught the whole world off guard and brought strong economies to their knees. Has an exogenous shock ever blindsided markets like this before? As Jamie Catherwood explains, of course it has…
On the morning of April 18, 1906, at 5:13 AM, an earthquake registering 8.3 on the Richter scale tore through San Francisco. The earthquake itself only lasted 45-60 seconds, but was followed by massive fires that blazed for four days and nights, destroying entire sections of the city, Making matters worse, the earthquake ruptured the city’s water pipes, leaving firefighters helpless in fighting the flames.
Eventually, the earthquake and ensuing inferno destroyed 490 city blocks, some 25,000 buildings, forced 55–73% of the city’s population into homelessness, and killed almost 3,000 people. In a matter of days, the Pacific West trading hub looked like a war-torn European city in World War II.
The unpredictable nature of San Francisco’s earthquake made it all the more damaging, and had a domino effect in seemingly unrelated areas of the economy…
The stock market fell immediately in the aftermath of the disaster; but more damagingly, British insurers (who covered much of San Francisco) had to ship mountains of gold to the U.S. to cover claims… which led the Bank of England to raise interest rates… which raised them around the world… which squelched speculative stock trading… which led to the collapse of a major Investment Trust (a then-prevalent form of “shadow bank”)…
The fascinating– and cautionary– story of The Panic of 1907, from @InvestorAmnesia.
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As we prioritize preparedness, we might recall that it was on this date in 1933, in the depth on the Depression, that Franklin D. Roosevelt delivered his first inaugural address. Although the speech was short on specifics, Roosevelt identified two immediate objectives: getting people back to work and “strict supervision of all banking and credits and investments.”
The next day, cabinet members joined with Treasury and Federal Reserve officials to lay the groundwork for a national bank holiday, and at 1:00 a.m. on Monday, March 6, President Roosevelt issued a proclamation ordering the suspension of all banking transactions, effective immediately. The nationwide bank holiday was to extend through Thursday, March 9, at which time Congress would convene in extraordinary session to consider emergency legislation aimed at restoring public confidence in the financial system.
It was a last-ditch effort: in the three years leading up to it thousands of banks had failed. But a new round of problems that began in early 1933 placed a severe strain (largely, foreign and domestic holders of US currency rapidly losing faith in paper money and redeeming dollars at an alarming rate) on New York banks, many of which held balances for banks in other parts of the country.
The crisis began to subside on March 9, when Congress passed the Emergency Banking Act. On March 13, only four days after the emergency legislation went into effect, member banks in Federal Reserve cities received permission to reopen. By March 15, banks controlling 90 percent of the country’s banking resources had resumed operations and deposits far exceeded withdrawals. Although some 4,000 banks would remain closed forever and full economic recovery was still years in the future, the worst of the banking crisis seemed to be over.
“Seek truth from facts”*…
China’s property sector is enormous, under tremendous financial strain– and, as Jeremy Wallace explains, a very big contributor to climate issues (e.g., construction on China accounts for 5% of global energy consumption)…
China has ended zero-Covid. The resultant viral tsunami is crashing through China’s cities and countryside, causing hundreds of millions of infections and untold numbers of deaths. The reversal followed widespread protests against lockdown measures. But the protests were not the only cause—the country’s sagging economy also required attention. Outside of a few strong sectors, including EVs and renewable energy technologies, China’s economic dynamo was beginning to stutter in ways it had not in decades.
Whenever global demand or internal growth faltered in the recent past, China’s government would unleash pro-investment stimulus with impressive results. Vast expanses of highways, shiny airports, an enviable high-speed rail network, and especially apartments. In 2016, one estimate of planned new construction in Chinese cities could have housed 3.4 billion people. Those plans have been reined in, but what has been completed is still prodigious. Hundreds of millions of urbanizing Chinese have found shelter, and old buildings have been replaced with upgrades.
The scale of construction has been so prodigious, in fact, that it has far exceeded demand for housing. Tens of millions of apartments sit empty—almost as many homes as the US has constructed this century. Whole complexes of unfinished concrete shells sixteen stories tall surround most cities. Real estate, which constitutes a quarter of China’s GDP, has become a $52 trillion bubble that fundamentally rests on the foundational belief that it is too big to fail. The reality is that it has become too big to sustain, either economically or environmentally….
The “Chinese real estate bubble” is the world’s problem: “The Carbon Triangle,” from @jerometenk in @phenomenalworld. Eminently worth reading in full.
Analogically related (and at the risk of piling on): “China must stop its coal industry“
* Chinese maxim, popularized by Mao, then Deng Xiaoping
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As we get real about real estate, we might spare a thought for Deng Xiaoping; he died on this date in 1997. A Chinese revolutionary leader, military commander, and statesman, he served as the paramount leader of the People’s Republic of China from December, 1978 to November, 1989. Deng led China through a series of far-reaching market-economy reforms, earning him the reputation as the “Architect of Modern China”.
The reforms carried out by Deng and his allies gradually led China away from a planned economy and Maoist ideologies, opened it up to foreign investments and technology, and introduced its vast labor force to the global market, thus turning China into one of the world’s fastest-growing economies.
But China’s real estate bubble is a reminder that every solution can all-too-easily turn into the next problem.
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