Of Cockroaches And Markets

Interesting analogy:

There is a tendency we have to take the environment as we know it now, and think this is it, and construct things that are ideally suited to the current environment. The problem with financial markets is that we also know they can change in unexpected and unanticipated ways. My argument is that you want to construct the markets and construct the way you behave in the markets so that if the world tomorrow is exactly like the way it is has been for the last year, maybe what you are doing is not optimal. But if things change in surprising ways, what you're doing is more robust and there is a higher probability that you will do well in the long run.

Taking the cockroach as an example, as we look back hundreds of millions of years, we have jungles that became deserts, and the deserts turned into cities, and if somebody looked at the cockroach, it never would have won the Best Designed Insect of the Year award, because it's very simplistic in what it does. So in any one environment people would point to the cockroach or point to the market that was behaving the way that I would argue we should behave, and say: You're ignoring what's going on right now, you're not fine-tuned to the degree that you could be to do the best possible job in the present market.

But that's kind of like somebody saying: Hey, in this particular jungle there is a seed that is really abundant and unless you have an insect with a mandible that is designed in this particular way you can't really optimize on the abundant seed. But that insect doesn't survive if the environment changes and the plants with those seeds disappear.

...There's incredible volatility now. ... I do think that there is potential that this could be a very unusual crisis. Usually when we think of a market crisis we think of things that go boom, that sort of blow up, and then dust settles, and five months later it's back to normal.

But the current crisis could be different. It could be so long term that we could be in the middle of it and not really realize it. A great analogy for this is what happened in Japan, with the equity markets. A whole generation of people in Japan have grown up thinking that stock markets don't move because for 17 years or so the Nikkei has been bouncing around in the same trading range and hasn't gone anywhere. I'd call that a crisis. An equity market that is the same place 20 years later that it was before is the same thing as having an equity market that over the course of one year drops 50 or 60 percent and then just slowly crawls out from that pit.

So it may not even be that we see housing prices plunge 30 percent or 40 percent. It could just be that the housing market, which we have always thought of as not just being a store of wealth but something that appreciates, instead sits and stagnates or doesn't do anything for a number of years. And that would be a crisis that took place over a period not of months but of years. It could be a real slow burn.