Sometimes the first duty of intelligent men is the restatement of the obvious. – George Orwell

A faction of Congress is preventing action to increase the debt limit without significant fiscal tightening, and some are making a case that the US should not raise the limit under any circumstances, and that default on US obligations is preferable to raising the debt limit.

Meanwhile the bond market is rising, with the 10-year under 3%.

It might seem counterintuitive that bonds are going up while the Congress dithers about whether to pay them back. But it’s really not. Here’s why the bond market is doing well despite the debt ceiling debacle:
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The greater the institution, the greater the chances of abuse. – Mohandas K. Gandhi

Two diametrically opposing story lines, both true.

In one corner – ETFs are making mutual funds obsolete.

In the other corner – ETFs are a potential source of systemic risk. Also – ETFs – Worse Than I Thought. (more…)

Bitcoin is a fascinating experiment: digital currency that doesn’t depend on a central authority.
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So, where were we? Ah yes, yesterday we posed a math conundrum:

A hedge fund manager puts 100 traders in a room and instructs them:

“On the trading desk, there are 100 boxes. Each box has one of your names. You can go [one at a time] onto the trading desk and open any 50 boxes you choose, to try to find your name. If every one of the 100 traders in this room finds his or her name, you will each get a $1,000,000 bonus. If anyone fails, I will crush all your $100,000 BMWs to create my modern art masterpiece. You can devise a strategy before anyone leaves the room, but once a trader has opened the boxes, you must leave the trading desk exactly as it was before you entered and cannot communicate with anyone else.”

Questions: Should they take the bet? Is there a correct strategy? What is the probability all 100 will each find their name?

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A math/probability problem I think is awesome and counterintuitive, and may be instructive about financial markets:

A hedge fund manager puts 100 traders in a room and instructs them:

“On the trading desk, there are 100 boxes. Each box has one of your names. You can go onto the trading desk and open any 50 boxes you choose, to try to find your name. If every one of the 100 traders in this room finds his or her name, you will each get a $1,000,000 bonus. If anyone fails, I will crush all your $100,000 BMWs to create my modern art masterpiece. You can devise a strategy before anyone leaves the room, but once a trader has opened the boxes, they must leave the trading desk exactly as it was before you entered and cannot communicate with anyone else.”

Questions: Should they take the bet? Is there a correct strategy? What is the probability all 100 will each find their name?

A hint, if you want one, by copy and pasting the lines below.

Hint: the answer to the first question is yes. Try to work out the same problem with two traders and two boxes. What is the strategy and approximate probability of success?

Answer tomorrow.

You didn’t change the game, the game changed you. – Niko Bellic, Grand Theft Auto IV

Everything that’s already in the world when you’re born is just normal; Anything that gets invented between then and before you turn thirty is incredibly exciting and creative and with any luck you can make a career out of it; Anything that gets invented after you’re thirty is against the natural order of things and the beginning of the end of civilisation as we know it until it’s been around for about ten years when it gradually turns out to be alright really. – Douglas Adams

So here is my rant about CDS, a topic I know very little about.

Christine Lagarde has said that a Greek restructuring that would create a credit event is ‘off the table’. Now, inevitably, politicians talk out of both sides of their mouths to avoid roiling markets. But I have seen three different pundits talk about a Greek restructuring that would be done in such a way as to avoid triggering CDS default provisions. This makes no sense.

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‘Black swan’ is a term which is overused and under-understood.

1) Evolutionary psychology: Humans aren’t very good at math, but especially intuitions about probability, and improbable things happen more often than we expect.

2) Behavioral economics (or evolutionary psychology part deux) – we feel worse about negative outcomes – a small negative surprise is felt disproportionately sharply relative to a small positive surprise. When humans were evolving on the brink of survival, a small negative weather surprise was the difference between life and death.

So we are risk-averse, and more sensitive to downside risk. But 3) The universe is perverse. Edifices take years to build up. When someone screws up, they collapse or burn down in seconds. The character and probability distribution of downside risk is different from upside risk. When things go bad, they don’t break gracefully, but with chain reactions and unintended consequences. Then they get worse, when people panic and do precisely the wrong thing at the wrong time.

Call it Murphy’s law, or vol skew, the ‘black swan’ event is just another name for entropy in action.

Cover of Plato

As far as the laws of mathematics refer to reality, they are not certain, as far as they are certain, they do not refer to reality. – Albert Einstein

This is all Plato’s fault – he founded Western philosophy on a theory of absolute reality, which humans vainly attempt to discern, like cave-dwellers pondering the source of shadows dancing on a wall. 

A good metaphor, but modern science has given the existence of absolute reality a few hard knocks. Heisenberg showed that you can never perfectly know the location and velocity of an object. The more accurately you measure where it is, the less accurately you know where it’s going. It doesn’t even make sense to speak of particles as having absolute attributes, they are better understood as clouds of probability distributions. Space, time, mass stretch depending on the motion of the observer.

Interactions between particles seem more tangible than the particles themselves; you either observe an interaction, or you don’t. And what is a particle except how it interacts with other particles? Suppose there were only a single electron in the universe, would it still be meaningful to say that it has a charge of -1.602 x 10¹⁹ coulombs, if there were no other particles and fields for it to interact with? What is the sound of one hand clapping?

Is there a ‘form’ of a chair? Or is it a chair if it’s something you can sit on?

Which brings us to money.

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The Chinese government has taken insecurity and paranoia up a notch in the wake of the Jasmine uprisings in the Arab world. They have ‘disappeared’ dissident artist Ai Weiwei and cracked down hard on human rights activists, meddlesome lawyers, and dissidents.

That is reason number one there will be no revolution in the near future: the government is perpetually on guard against any threats. China is not a police state like East Germany was. Individualism thrives. But the government sets down bright lines. You can do or say anything you wish, as long as you do not threaten the legitimacy of the Chinese Communist Party’s hold on power. If you do, the full force of the state will be brought to bear.

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A question for Ben Bernanke at today’s press conference:

• In 2005 at your confirmation hearings, you said there was no housing bubble.

• In 2007, you said the subprime fallout was likely to be contained.

• In 2008, you said you didn’t expect a recession.

• In 2009, you said the Fed would not monetize US government debt.

• In 2010, you said inflation was too low.

Question: Are we supposed to laugh or cry?