Borrowing the east wind

Around 200 BC Chinese strategist Zhuge Liang first used a sales trick still re purposed by consultants and lawyers today.

Zhuge Liang was an amateur meteorologist, and he used this fact to convince people that he could control the weather. His knowledge of meteorology was very basic, something any farmer who paid attention would have known. Nonetheless his enemies didn’t have this knowledge. So it was easy to bamboozle them.

During one battle , he realized that the wind was likely to switch direction in a manner that was highly favorable for his army.

He made sure the enemy saw him do an elaborate ceremony that looked like black magic. He kept at it until the wind changed direction. As a result his reputation as a fearsome indispensable strategist grew massively.

This was featured in the historical fiction Romance of the Three Kingdoms  . The phrase “Borrow the East Wind (借东风) refers to this story.  Its sometimes used to described taking advantage of a situation.

A bit of dancing, drumming and smoke. Zhuge Liang took basic observation skills and sold them as black magic.

Modern knowledge work

I think of this anytime I see a knowledge worker selling their work makes it look more complex than it really is.

Jargon, chartporn and powerpoint replaces dancing drumming and smoke. Or alternatively with legal and compliance work, fear of regulatory risk leads to a company paying high fees to avoid problems. Even if all that is needed is filing a simple form at the right time.

There is a risk of a similar phenomenon in any business where there is a huge knowledge gap between seller and customer.  Will the seller take advantage of that gap in a way that harms the buyer?

Honest selling

It may seem like there is one fundamental problem with this comparison: Zhuge Liang was a diplomat/military strategist. A sales call isn’t a war. Its not supposed to be adversarial!

That might actually be the problem. An honest sales process is about helping the client see the value. The battle is against any misperception not against the client. A dishonest sales process is about taking as much from the client as possible.

Zhuge Liang’s life was on the line. And warfare (against sentient opponents) is all about deception. Deceiving competitors is justifiable. But deceiving customers is not. Some businesses may feel their life is on the line, but I bet they could make a good living by reducing complexity rather than playing it up.  I know I’m willing to pay up for reduced complexity!


Dealing with this issue has proved to be a major challenge in dealing with lawyers, compliance consultants and technology contractors. I’ll ask around and get quoted absurdly large price ranges for the same set of work.

I’m getting better at asking the right questions in order to see what services are really worth.

I place great value on lawyers, consultants and developers who can cut through the bullshit.

Cheap stuff and cheap capital

Two main factors drive an upsurge in entrepreneurship: cheap stuff and cheap capital. Cheap stuff is primarily a long run secular trend. Cheap capital is cyclical.

By cheap stuff I mean the inputs to a business, mainly technology. This has gone consistently down over time. One can build a website or an app for a few thousand dollars that is better than what they could have done for millions of dollars a decade ago.

Even if capital becomes scarce, cheap stuff will still be a positive factor driving entrepreneurship.

By cheap capital I mean the flood of venture capital. This is primarily cyclical. Consider this quote:

“There’s so much money chasing these deals that venture capitalists are in competition with each other. They spend their energies marketing themselves instead of screening the deals. It’s gotten silly”

Think it applies today? Or maybe to the late 1990s tech boom? This quote is from the WSJ in 1981, and referenced in this excellent article about 1980s venture capital.

During a boom its easy for most ideas to raise capital, regardless of business viability(as long as they fit with theme of the times). Indeed they can keep raising rounds in hopes of a profit decades in the future. After a bust its hard to raise capital, even for a great idea. Entrepreneurs need to bootstrap and get revenue a soon as possible.

Right now it seems there is a ton of venture capital financing companies that are losing money.

Cheap stuff and cheap capital are partly entangled. You might be reading this from within a WeWork. If they couldn’t keep raising cheap capital you think your rent is going to stay the same? Or maybe you are building a business on top of a money losing social media platform, or somehow benefiting from a thriving open source ecosystem.   On the other hand, its harder to source talent when there is a flood of capital, and certain commodity based goods can have their own production cycle.    Yet you can run your business from a garage and the new inventions of the latest venture boom aren’t going away.

Which is most important- cheap stuff or cheap capital ? I don’t know, but we’ll get to find out when this cycle turns. Creative entrepreneurs will still take advantage of technological improvements to bootstrap groundbreaking ideas, even if they can’t raise venture capital. Sometimes they do it out of choice, other times they do it out of necessity.

Once this cycle turns, we’ll go through a few years where most new businesses have no choice but to bootstrap.

This idea generally applies across all industries, not just venture funded. However in commodity based industries the cyclicality functions differently.  Cheap capital often leads to inflation in hard assets.   See also: Capital Returns: Investing Through the Capital Cycle

Thinking and Applying Minsky

Hyman Minsky developed a framework for understanding how debt impacts the behavior of the financial system, causing periods of stability to alternate with periods of instability. Stability inevitably leads to instability. Minsky identified three types of financing: Hedge financing, speculative financing, and ponzi financing.  It seems some people only remember Minsky every so often when there is a financial crisis, but the framework is useful in all seasons.

Hedge Financing

An asset generates enough cash flow to fulfill all contractual payment obligations. For example, a conservatively leveraged rental property that generates enough rent to pay down the entire mortgage over time, regardless of the change in quoted property prices. Or a company that issues some bonds, then pays them back using cash flow from the business Generally hedge financing units have a lot of equity down. Even a market crash, will not cause an investor to suffer permanent capital impairment if they only use hedge financing. The equity holder who uses hedge financing will never depend on the capital markets.

Speculative Financing

An asset generates enough cash flow to fulfill all debt payments, but not the full principal amount. In this case debt must be rolled over, or the asset must be sold, in order to pay back the full amount. For example, a rental property financed with some sort of balloon payment structure that generates enough cash flow to pay off mortgage payments up until the balloon payment at the end. When the balloon payment comes due, the investor must roll over the debt or sell the asset. An investor ttat uses speculative financing is dependent on capital markets. If there is a delay or a problem in refinancing, they could lose their investment.

Ponzi Financing

This is basically “greater fool” investing. Ponzi financing means there is so much leverage n an asset, that the investment must be refinanced, or sold at a higher price quickly, otherwise the entire investment is lost. Sometimes property purchases will be financed with shorter term bridge loan. If the bridge loan can’t be refinanced with longer term mortgage, the investor is out of luck. Towards the end of the market cycle, many companies will be issuing bank loans or bonds that can only be repaid by refinancing. If their unable to refinance, they go bankrupt.
Use of ponzi financing means the investor is highly dependent on capital markets. The slightest disruption in capital markets or change in interest rates/inflation results in a large capital loss.

Junk bonds are not inherently bad. A higher interest rate can in many cases compensate for greater risk, especially across a portfolio of non correlated investments. Howeve, duringthe junk bond era, many companies

Similarly securitization is not inherently bad. It can allow capital to flow more effeiciently. But often banks would end up aggressively securitizing, with the need to sell the loans they made quickly. But if they weren’t able to resell they couldn’t hold the loans. This happened to Nomura during the Asian financial crisis, as vividly told in this Ethan Penner interview. 

Ponzi in this case is not illegal activity, just extremely risky. Of course those investors who finance their activities ponzi style often end up feeling the need to commit illegal acts. The Minsky Kindleberger model is useful here.

The cycle repeats

During a recession is very difficult to get any debt financing that is not “hedge financing”. Lenders are scarred from the last cycle, and there is a paucity of available risk capital. But a price rise, and investors get more comfortable, more and more financing becomes ponzi units In fact. Lenders may lower their standards and become more accepting of ponzi units.
Throughout the market cycle, more and more financing is ponzi units. Eventually there is no greater fool to sell to. When many ponzi units are forced to sell at once, it eventually leads to a collapse in values. This is how stability inevitably leads to stability. The cycle repeats.

How to apply this?

To protect my capital, I look try to mainly expose myself to hedge financing, with a small amount of speculative financing. I position my portfolio so that I don’t need to refinance anything or sell anything in a rush. When I invest in leveraged companies with speculative or ponzi financing, I make it small position(always in some sort of limited liability structure), and generally won’t average down much if at all. Additionally, when I notice an increase in ponzi financing in the markets, I become more cautious.

Leverage, like liquor , must be consumed carefully if at all.


See also:

Minsky and the Junk Bond Era

is credit really the smart money?

Disequilibrium Analysis

John Boyd OODA Loop

The Life and Mental Models of John Boyd

“Fuck a wind tunnel. The biggest wind tunnel in the world is up there. Its called reality.”

-John Boyd

John Boyd’s OODA loop is in my opinion one of the most valuable mental models to apply in basically all aspects of life, especially  where there is high stakes competition. Boyd’s life makes for an entertaining bio, and Boyd: The Fighter Pilot Who Changed The Art Of War is one of the first completely detailed versions to cover his development as a person, and strategist.. The book develops his character through a series of political battles and personal trauma”. He had an intense belief in empirically testing everything, and he was willing to struggle in the wilderness for decades until he got everything right. His bio tracks how his thinking evolved over time, culminating in several important aeronautical engineering theories, along with the OODA loop.

“Do not write it as a formula. Write it as a way to teach officers to think, to think in new ways about war. War is ever changing and men are ever fallible. Rigid rules simply won’t work. Teach men to think.”

“If you want to understand something, take it to the extremes or examine its opposites,”

The OODA loop

The quick version:

… to shape the environment, one must manifest four qualities: variety, rapidity, harmony, and initiative.

A commander must have a series of responses that can be applied rapidly; he must harmonize his efforts and never be passive. To understand the briefing, one must keep these four qualities in mind. After marching through commander must operate at a faster OODA Loop than does his opponent.

Boyd said there are two ways to manipulate information gleaned from observation: analysis and synthesis. We can analyze whatever process or event we are observing by breaking it down into individual components and interactions. And from this we can make deductions that lead to understanding. Or we can synthesize by taking various sometimes unrelated components and putting them together to form a new whole.

Key quotes on the OODA loop and related theories:

The purpose of the briefing was not to reveal the “Answer” but to jar listeners out of complacency and into thinking on their own. Boyd abhorred the idea that his briefing might be considered dogma. In fact, he often said listeners should take the briefing out and burn it before they considered it dogma.
Boyd found many such instances in history, and in these victories by numerically inferior forces he found a common thread: none of the victorious commanders threw their forces head-to-head against enemy forces. They usually did not fight what is known as a “war of attrition.” Rather, they used deception, speed, fluidity of action, and strength against weakness. They used tactics that disoriented and confused—tactics that, in Boyd’s words, caused the enemy “to unravel before the fight.”

Becoming oriented to a competitive situation means bringing to bear the cultural traditions, genetic heritage, new information, previous experiences, and analysis / synthesis process of the person doing the orienting—a complex integration that each person does differently. These human differences make the Loop unpredictable. In addition, the orientation phase is a nonlinear feedback system, which, by its very nature, means this is a pathway into the unknown. The unpredictability is crucial to the success of the OODA Loop. Only three arrows are on the main axis, and these are what most see when they look at the Observe > Orient > Decide > Act cycle. But this linear understanding and its common result—an attempt to use the Loop mechanically—is not at all what Boyd had in mind.

Application of OODA Loop:

The ability of an aircraft to perform fast transients does two things, one defensive and one offensive: it can force an attacking aircraft out of a favorable firing position, and it can enable a pursuing pilot to gain a favorable firing position. The advantage gained from the fast transient suggests that to win in battle a pilot needs to operate at a faster tempo than his enemy. It suggests that he must stay one or two steps ahead of his adversary; he must operate inside his adversary’s time scale.

Thinking about operating at a quicker tempo—not just moving faster—than the adversary was a new concept in waging war. Generating a rapidly changing environment—that is, engaging in activity that is so quick it is disorienting and appears uncertain or ambiguous to the enemy—inhibits the adversary’s ability to adapt and causes confusion and disorder that, in turn, causes an adversary to overreact or underreact. Boyd closed the briefing by saying the message is that whoever can handle the quickest rate of change is the one who survives.

The danger—and this is a danger neither seen nor understood by many people who profess a knowledge of Boyd’s work—is that if our mental processes become focused on our internal dogmas and isolated from the unfolding, constantly dynamic outside world, we experience mismatches between our mental images and reality. Then confusion and disorder and uncertainty not only result but continue to increase. Ultimately, as disorder increases, chaos can result. Boyd showed why this is a natural process and why the only alternative is to do a destructive deduction and rebuild one’s mental image to correspond to the new reality. Thomas Kuhn, a philosopher of science, and Joseph Schumpeter, an economist, recognized the destructive side of creativity. But Boyd was unique in his explanation of how the process is grounded in fundamentals discovered by Godel and Heisenberg and by entropy.

What will be the scene at your funeral?

Boyd was both a thinker and a doer, the quintessential man in the arena.

Boyd saw himself as a man of principal fighting superiors to do what was best for his country. He wasn’t one to suffer fools, or careerists, or bureacrats beyond the minimum military courtesy required.He took enormous career risk in order to advance the intellectual caliber of the US air force. He document and codified with mathematics techniques that truly worked in the air. This made the world a safer place.

Over time he built up a team of proteges who admired him intensely.

“Boyd’s Acolytes minimize his faults. They say it is more important that his core beliefs were steel-wrapped and his moral compass was locked on true North, that he never misspent his gifts. His motivation was simple: to get as close as possible to the truth. He would have been the first to admit there is no absolute truth. But he continued chasing something that was always receding from his grasp. And in the pursuit he came far closer to the unattainable than do most men. “

This was the description of the eulogy that one of Boyd’s proteges gave for him:

“Not many people are defined by the courts-martial and investigations they faced,” raucous laughter echoed off the white walls of the chapel. Sprey told how Boyd once snapped the tail off an F-86, spun in an F-100, and how he not only stole more than $1 million worth of computer time from the Air Force to develop a radical new theory but survived every resulting investigation. Chuck Spinney, a boyish Pentagon analyst who was like a son to Boyd, laughed so loud he could be heard all across the chapel. Even those in the congregation who barely knew Boyd took a certain pride in his profanity and coarseness and crude sense of humor. He cared little for his personal appearance and could be demanding, abrasive, and unreasonable. And while in his professional life Boyd accomplished things that can never be duplicated, in his personal life he did things few would want to duplicate.

Work Habits

Boyd’s work habits, were, um, interesting. Here was the perspective of one of his colleagues:

He would look up from his work to see Boyd staring at the wall, oblivious to the world, for maybe fifteen or twenty minutes. Boyd was, as he described it, “having a séance with myself.” Then it was as if a switch had been turned on: suddenly Boyd spun around in his chair and picked up the conversation, waved his arms like a windmill in a hurricane, leaned across his desk.

Boyd went to the library—it was open until 1:00 A.M.—and continued working on equations. He made a list of what had to be done next, which equations had to be written and solved, what theories must be followed up and developed. He filled sheet after sheet of his yellow legal pad. When the library closed he drove up Buford Highway, turned onto McClave Drive, entered his home and continued working. Then he called Spradling( colleague with who he worked). It was about 4:00 A.M. in Atlanta, three hours earlier in Las Vegas.

Boyd, as a senior officer, lived in a trailer. By all accounts he worked eighteen- and twenty-hour days. He bought a reel-to-reel tape deck, and every night as he did paperwork his trailer was filled with the ominous “Ride of the Valkyries” or the majestic “Entry of the Gods into Valhalla.”

His search ranged far afield. From the base library he checked out every available book on philosophy and physics and math and economics and science and Taoism and a half dozen other disciplines. He was all over the map, searching but not quite knowing for what.

It was obvious from Boyd’s phone calls that he was not only spending a disproportionately large amount of his retirement pay on books but was reading them all. Christie’s phone might ring at 2:00 A.M. and when he picked it up Boyd would say, “I had a breakthrough. Listen to this.” And without a pause he would begin reading from Hegel or from an obscure book on cosmology or quantum physics or economics or math or history or social science or education. Christie thought Boyd had taken leave of his senses. Except for the year at NKP, the past nine years of Boyd’s life had been devoted to hosing his superiors. He was a man of action. But when he walked out of the Building, he walked into a world of ideas. There was almost no transition. One day he was on the phone checking on the progress of the F-16 and the next he was calling people at 2:00 A.M. to read German philosophy. And for what? What was this learning theory he kept talking about? He said he had begun work on the thing back at NKP and he still had nothing to show for it. Why didn’t Boyd just retire?


One of John’s favorite stories, one he was to tell all his life, revolved around entering high school on September 2, 1942. He said he took a series of tests, one of which showed he had an IQ of only ninety. When offered the chance to retake the test, he refused. The test gave John what he later said was a great tactical advantage in dealing with bureaucrats—when he told them he had an IQ of only ninety, they always underestimated him.

Of course Boyd did have an advanced degree in aeronautical engineering. So he obviously wasn’t dumb. Apparently he worked harder than anyone at checking every single equation he worked on. Even if he wasn’t the smartest, his intense study over his lifetime allowed him to make all the important contributions that he did.

The right side of history

The 1960s were years of protests and demonstrations on college campuses across America. But not at Georgia Tech. In 1961 the president of Tech called a mandatory all-student meeting and announced that the first black students had been accepted, that all students would welcome them in friendship and cordiality, and any student who behaved otherwise would be dismissed and there would be no appeal. Thus, Tech became the first desegregate peacefully and without being forced to do so by court order. Tech and its students were too serious about academics to become sidetracked by such issues. During the 1960s the most avant-garde activity at Tech was the English professor who sometimes held classes at Harry’s Steak House on Spring Street. This professor’s “liberalism” was the talk of the campus.

Unconventional technique of internal politics and internal diplomacy

If your boss demands loyalty, give him integrity. But if he demands integrity, then give him loyalty.

In his new job, Boyd saw problems that needed immediate attention everywhere he looked. But 7th Air Force sent down paperwork daily that took hours to answer. Boyd thought Air Force bureaucracy was keeping him from the job at hand. His solution was to respond but to add material that caused 7th Air Force more paperwork than 7th Air Force caused him. “Pain goes both ways,” he said. In only a few weeks the time-consuming requests from 7th Air Force shrank to almost nothing.

John Boyd as a diplomatic representative

Then there was the story of the junior officer who was having an affair with a Thai woman. There was nothing unusual about this. Thai women are extraordinarily beautiful and many American officers formed close relationships But this particular officer was married and soon was overcome with guilt. He broke off the relationship. The woman in question was the daughter of an influential village official who felt his family lost face when his daughter was spurned. He was about to charge the young officer with rape. Boyd said he called in the young officer and gave him the big picture of how many base activities depended on the good will of Thai officials. He ordered the young officer, guilty or not, to continue the relationship.

“I’m giving you a direct order to screw her every night until you are transferred out of here,” Boyd said he told the officer. “Sir, I don’t believe that is a lawful order,” the officer said. “Goddammit, I issued it and you better obey it. We’re at war and bigger things are at stake here than your guilt. Your dick can cause you problems but it is not going to cause problems for America. You do as I say or I will make your life a living hell

Hey, sometimes a guy needs to take one for the team.

Boyd also thought the Base Exchange (B-X) at NKP was an unnecessary indulgence. He said a store selling everything from hair dryers to television sets to stereos had no place on a combat base—that such things made Americans “soft.” Persky recalls that once, he and Boyd were talking when Boyd pointed at the B-X and said everything in the store should be loaded aboard C-130s and parachuted into North Vietnam. “Let them get used to the good life and then we can just walk in and take over,” he said. Boyd also dealt with situations

Seems Capitalism did sort of do this in the long run.

Decentralized Management

In a Blitzkrieg situation, the commander is able to maintain a high operational tempo and rapidly exploit opportunity because he makes sure his subordinates know his intent, his Schwerpunkt. They are not micromanaged, that is, they are not told to seize and hold a certain hill; instead they are given “mission orders.” This means that they understand their commander’s overall intent and they know their job is to do whatever is necessary to fulfill that intent. The subordinate and the commander share a common outlook. They trust each other, and this trust is the glue that holds the apparently formless effort together. Trust emphasizes implicit over explicit communications. Trust is the unifying concept. This gives the subordinate great freedom of action. Trust is an example of a moral force that helps bind groups together in what Boyd called an “organic whole.”


Antifragile Morning Routine

The idea of having “morning routine” is a favorite topic on the interwebs these days. Its now at the point where I can barely tell apart parody from serious articles. I think Tim Ferriss started it all by asking every single one of his guests their morning routine. Most people couldn’t resist listening. I know I couldn’t.

When a “high performer” provides a detail on their morning routine, they are merely providing an example of a thing that works for a very specific set of circumstances. Nothing more nothing less. Just because it worked for them, doesn’t mean it will work for you.

Nonetheless it is still a useful data point.  Weird low cost ideas are usually worth trying.

Eliminating decision fatigue

I view morning routines as constrained optimization problem that will have different solutions for different people. It might even have different answers on different days for the same person.

I’m generally skeptical of anything overly complicated. The key benefit of a morning routine is it reduces decision fatigue. The morning routine is a “default setting” . But if one is obsessed with following it, it becomes a burden and prevents serendipity.

Towards an antifragile morning routine

The ability to adapt to changing circumstances is more important than having a set routine.  Some days you have to work late.  Other days you may have an early meeting. Or maybe your child gets sick.  What if your spouse or mistress needs your support?  What do you do when you travel or are awoken by a phone call?  What then?

It doesn’t make sense to rigidly expect the world to conform to your plan. A fragile morning routine is worse than no morning routine. A robust morning routine is better. An antifragile morning routine is best.

Personally I have a “default setting” to do when I’m home and nothing special is happening. I have a handful of different algorithms I can enact depending on other circumstances that come up. This gives me the comfort of a routine without rigidity. If I’m travelling I’ll usually explore the local area just a bit.

Sometimes an emergency leads to a new insight.

What Private Equity Has In Common with Renaissance Charlatans

No man need despair of gaining converts to the most extravagant hypothesis who has art enough to represent it in favorable colors.
-David Hume

Sometimes the private equity industry reminds me of travelling charlatans in late Renaissance Europe. I recently reread Robert Greene’s The 48 Laws of Power, and realized that Law 32 “ Play on People’s Fantasies” must be the guide some people use to draft fund pitchbooks.

( I refer to“Private Equity” or “PE” , but the same general logic applies to the entire alternative investments industry.  This includes venture capital, some hedge funds, non-traded REITs, etc. )

PE funds have long term lock ups. The lack of mark to market smooths out volatility. It looks nice on a statement to see something holding steady as markets tank.  There can be good reasons for long lockups. Many investments genuinely take a long term to workout.  Most short term price fluctuation in the public markets is noise that some find hard to ignore. Warren Buffett once remarked that he bought stocks with the idea that public markets could close for a decade, and it wouldn’t bother him. But often unscrupulous fund managers use questionable marketing techniques and exploit the ability to keep money locked up for a long time.

Marco Bragadino, Private Equity Fund Manager

Often allocators or wealthy individuals will seek out private equity and other alternative investments because of frustration with public markets.  Maybe the mark to market volatility has been painful. Perhaps the index funds squeezed all the alpha out of the markets.  Maybe they feel that better connected people have access to investments. If only they also had access they too could grow their wealth for multiple generations.  Plus they might have something to brag about at cocktail parties or in the nursing home.

Similarly, Marco Bragadino, or Il Bragadino was a famous Charlatan who first targeted Venice in the late 1500s, a time that the city was gripped with the feeling that its best days were behind it. The opening of the “New World” transferred power to the Atlantic Side of Europe. Venice struggled to keep up with the Spanish, Portuguese, Dutch, and English. Worse yet, The Turks were making incursions into Venice’s mediterranean possessions.

Now noble families went broke in Venice, and banks began to fold. A kind of gloom and depression settled over the citizens. They had known a glittering past — had either lived through it or heard stories about it from their elders. The closeness of the glory years was humiliating. The Venetians half believed that the goddess Fortune was only playing a joke onthem, and that the old days would soon return. For the time being, though, what could they do?


Many alternative asset managers claim to have proprietary models, and tend to give of an air of exclusivity. Madoff, who managed a fraudulent hedge fund, was an extreme example of this. If only investors have the right “access”, they too can get exposure to that magic investment.  This is right out of Il Bragadino’s playbook:

In 1589 rumors began to swirl around Venice of the arrival not far away of a mysterious man called “II Bragadino,” a master of alchemy, a man who had won incredible wealth through his ability, it was said, to multiply gold through the use of a secret substance. The rumor spread quickly because a few years earlier, a Venetian nobleman passing through Poland had heard a learned man prophesy that Venice would recover her past glory and power if she could find a man who understood the alchemic art of manufacturing gold. And so, as word reached Venice of the gold this Bragadino possessed — he clinked gold coins continuously in his hands, and golden objects filled his palace — some began to dream: Through him, their city would prosper again.

Modern asset managers are known for having well scripted due diligence meetings that leave investors with a feeling of awe and urgency. Il Bragadino did this too:

Members of Venice’s most important noble families accordingly went together to Brescia, where Bragadino lived. They toured his palace and watched in awe as he demonstrated his gold-making abilities, taking a pinch of seemingly worthless minerals and transforming it into several ounces of gold dust. The Venetian senate prepared to debate the idea of extending an official invitation to Bragadino to stay in Venice at the city’s expense, when word suddenly reached them that they were competing with the Duke of Mantua for his services. They heard of a magnificent party in Bragadino’ s palace for the duke, featuring garments with golden buttons, gold watches, gold plates, and on and on. Worried they might lose Bragadino to Mantua, the senate voted almost unanimously to invite him to Venice, promising him the mountain of money he would need to continue living in his luxurious style — but only if he came right away.

But look at that Sharpe Ratio!

Some private equity fund managers will claim a superb track record without ever having an exit. Sometimes legacy funds will be valued higher, but fail to provide any cash flow. Sometimes those legacy funds work out, but sometimes are actually complete disasters and the manager is delaying the inevitable reckoning.

Again, this is something they could have learned from Il Bragadino:

Bragadino had only scorn for the doubters, but he responded to them. He had, he said, already deposited in the city’s mint the mysterious substance with which he multiplied gold. He could use this substance up all at once, and produce double the gold, but the more slowly the process took place, the more it would yield. If left alone for seven years, sealed in a cas-
ket, the substance would multiply the gold in the mint thirty times over. Most of the senators agreed to wait to reap the gold mine Bragadino promised. Others, however, were angry: seven more years of this man living royally at the public trough! And many of the common citizens of Venice echoed these sentiments. Finally the alchemist’s enemies demanded he produce a proof of his skills: a substantial amount of gold, and soon.

Sometimes mark to market is indeed mark to fantasy.

Finding new suckers

When an asset manager fails to deliver with one target fundraising channel, they look to others. There is nothing wrong with expanding and diversifying a business. But I get suspicious when a fund manager suddenly shifts their whole targeted capital base. Especially when they shift from institutional to retail. Like certain modern fund managers, Il Bragadino focused on finding new clients when became increasingly suspicious of his unfulfilled promises.

Lofty, apparently devoted to his art, Bragadino responded that Venice, in its impatience, had betrayed him, and would therefore lose his services. He left town, going first to nearby Padua, then, in 1590, to Munich, at the invitation of the Duke of Bavaria, who, like the entire city of Venice, had known great wealth but had fallen into bankruptcy through his own profligacy, and hoped to regain his fortune through the famous alchemist’s services. And so Bragadino resumed the comfortable arrangement he had known in Venice, and the same pattern repeated itself.

Believe in the smart people

Yet  fund managers, even bad ones, often get incredibly rich in spite of not adding much value to their investors. Their talent is in exploiting human psychology, not investing. It all links back to their ability to exploit people’s need to believe:

His obvious wealth confirmed his reputation as an alchemist, so that patrons like the Duke of Mantua gave him money, which allowed him to live in wealth, which reinforced his reputation as an alchemist, and so on. Only once this reputation was established, and dukes and senators were fighting over him, did he resort to the trifling necessity of a demonstration. By then, however, people were easy to deceive: They wanted to believe. The Venetian senators who watched him multiply gold wanted to believe so badly that they failed to notice the glass pipe up his sleeve, from which he slipped gold dust into his pinches of minerals. Brilliant and capricious, he was the alchemist of their fantasies — and once he had created an aura like this, no one noticed his simple deceptions.

Psychology of Avoiding Charlatans

There is a paradox here. In most cases, it is better to make investments with the intention of making money over decades, not quarters. Yet that is not a reason to not monitor progress. There are many great alternative asset managers who deliver massive value to their clients over decades.  I know from experience that they are usually straight shooters.

Charlatans exploit default tendencies in human psychology.  Therefore we must guard against this. Building wealth requires discipline. There is no magic investment that will solve everything. People don’t want to hear that, and the Bragadinos of the world prey on this by giving easy answers. Its critical to get comfortable with being uncomfortable. The market doesn’t owe anyone a good return. We must monitor our own psychology as much as the activity of our fund managers.

Constant vigilance is needed to avoid getting tricked by the Bragadinos of the investment world.

Why its wise to think in bets


The secret is to make peace with walking around in a world where we recognize that we are not sure and that’s okay. As we learn more about how our brains operate, we recognize that we don’t perceive the world objectively. But our goal should be to try.

Annie duke’s “Thinking in Bets” is basically long essay with an extremely valuable message. Under a plethora of entertaining anecdotes about professional poker it contains a valuable framework for making decisions in this uncertain world. This requires accepting uncertainty, and being intellectually honest. Good decision making habits compound over time
Thinking in Bets is a slightly less nerdy and less nuanced compliment to pair with “Fortune’s Formula”. It also fits in well with some of the more important behavioral finance books, such as…. Misbehaving, and Hour Between wolf and dog, Kluge, etc.

I’ve organized some of my highlights and notes from Thinking in Bets below.

The implications of treating decisions as bets made it possible for me to find learning opportunities in uncertain environments. Treating decisions as bets, I discovered, helped me avoid common decision traps, learn from results in a more rational way, and keep emotions out of the process as much as possible.

Outcome quality vs decision quality

We can get better at separating outcome quality from decision quality, discover the power of saying, “I’m not sure,” learn strategies to map out the future, become less reactive decision-makers, build and sustain pods of fellow truthseekers to improve our decision process, and recruit our past and future selves to make fewer emotional decisions. I didn’t become an always-rational, emotion-free decision-maker from thinking in bets. I still made (and make) plenty of mistakes. Mistakes, emotions, losing—those things are all inevitable because we are human. The approach of thinking in bets moved me toward objectivity, accuracy, and open-mindedness. That movement compounds over time

Thinking in bets starts with recognizing that there are exactly two things that determine how our lives turn out: the quality of our decisions and luck. Learning to recognize the difference between the two is what thinking in bets is all about.

Why are we so bad at separating luck and skill? Why are we so uncomfortable knowing that results can be beyond our control? Why do we create such a strong connection between results and the quality of the decisions preceding them? How

Certainty is an illusion

Trying to force certainty onto an uncertain world is a recipe for poor decision making. To improve decision making, learn to accept uncertainty. You can always revise beliefs.

Seeking certainty helped keep us alive all this time, but it can wreak havoc on our decisions in an uncertain world. When we work backward from results to figure out why those things happened, we are susceptible to a variety of cognitive traps, like assuming causation when there is only a correlation, or cherry-picking data to confirm the narrative we prefer. We will pound a lot of square pegs into round holes to maintain the illusion of a tight relationship between our outcomes and our decisions.

There are many reasons why wrapping our arms around uncertainty and giving it a big hug will help us become better decision-makers. Here are two of them. First, “I’m not sure” is simply a more accurate representation of the world. Second, and related, when we accept that we can’t be sure, we are less likely to fall

Our lives are too short to collect enough data from our own experience to make it easy to dig down into decision quality from the small set of results we experience.

Incorporating uncertainty into the way we think about our beliefs comes with many benefits. By expressing our level of confidence in what we believe, we are shifting our approach to how we view the world. Acknowledging uncertainty is the first step in measuring and narrowing it. Incorporating uncertainty in the way we think about what we believe creates open-mindedness, moving us closer to a more objective stance toward information that disagrees with us. We are less likely to succumb to motivated reasoning since it feels better to make small adjustments in degrees of certainty instead of having to grossly downgrade from “right” to “wrong.” When confronted with new evidence, it is a very different narrative to say, “I was 58% but now I’m 46%.” That doesn’t feel nearly as bad as “I thought I was right but now I’m wrong.” Our narrative of being a knowledgeable, educated, intelligent person who holds quality opinions isn’t compromised when we use new information to calibrate our beliefs, compared with having to make a full-on reversal. This shifts us away from treating information that disagrees with us as a threat, as something we have to defend against, making us better able to truthseek. When we work toward belief calibration, we become less judgmental .

In an uncertain world, the key to improving is to revise, revise, revise.

Not much is ever certain. Samuel Arbesman’s The Half-Life of Facts is a great read about how practically every fact we’ve ever known has been subject to revision or reversal. We are in a perpetual state of learning, and that can make any prior fact obsolete. One of many examples he provides is about the extinction of the coelacanth, a fish from the Late Cretaceous period. A mass-extinction event (such as a large meteor striking the Earth, a series of volcanic eruptions, or a permanent climate shift) ended the Cretaceous period. That was the end of dinosaurs, coelacanths, and a lot of other species. In the late 1930s and independently in the mid-1950s, however, coelacanths were found alive and well. A species becoming “unextinct” is pretty common. Arbesman cites the work of a pair of biologists at the University of Queensland who made a list of all 187 species of mammals declared extinct in the last five hundred years.

Getting comfortable with this realignment, and all the good things that follow, starts with recognizing that you’ve been betting all along.

The danger of being too smart

The popular wisdom is that the smarter you are, the less susceptible you are to fake news or disinformation. After all, smart people are more likely to analyze and effectively evaluate where information is coming from, right? Part of being “smart” is being good at processing information, parsing the quality of an argument and the credibility of the source. So, intuitively, it feels like smart people should have the ability to spot motivated reasoning coming and should have more intellectual resources to fight it. Surprisingly, being smart can actually make bias worse. Let me give you a different intuitive frame: the smarter you are, the better you are at constructing a narrative .

… the more numerate people (whether pro- or anti-gun) made more mistakes interpreting the data on the emotionally charged topic than the less numerate subjects sharing those same beliefs. “This pattern of polarization . . . does not abate among high-Numeracy subjects.

It turns out the better you are with numbers, the better you are at spinning those numbers to conform to and support your beliefs. Unfortunately, this is just the way evolution built us. We are wired to protect our beliefs even when our goal is to truthseek. This is one of those instances where being smart and aware of our capacity for irrationality alone doesn’t help us refrain from biased reasoning. As with visual illusions, we can’t make our minds work differently than they do no matter how smart we are. Just as we can’t unsee an illusion, intellect or willpower alone can’t make us resist motivated reasoning.

The Learning Loop

Thinking rationally is a lot about revising, and refuting beliefs(link to reflexivity) By going through a learning loop faster we are able to get an advantage. This is similar to John Boyd’s concept of an OODA loop.

We have the opportunity to learn from the way the future unfolds to improve our beliefs and decisions going forward. The more evidence we get from experience, the less uncertainty we have about our beliefs and choices. Actively using outcomes to examine our beliefs and bets closes the feedback loop, reducing uncertainty. This is the heavy lifting of how we learn.

Chalk up an outcome to skill, and we take credit for the result. Chalk up an outcome to luck, and it wasn’t in our control. For any outcome, we are faced with this initial sorting decision. That decision is a bet on whether the outcome belongs in the “luck” bucket or the “skill” bucket. This is where Nick the Greek went wrong. We can update the learning loop to represent this like so: Think about this like we are an outfielder catching a fly ball with runners on base. Fielders have to make in-the-moment game decisions about where to throw the ball.

Key message: How poker players adjust their play from experience determines how much they succeed. This applies ot any competitive endeavor in an uncertain world.

Intellectual Honesty

The best players analyze their performance with extreme intellectual honesty. This means if they win, they may end up being more focused on erros they made, as told in this anecdote:

In 2004, my brother provided televised final-table commentary for a tournament in which Phil Ivey smoked a star-studded final table. After his win, the two of them went to a restaurant for dinner, during which Ivey deconstructed every potential playing error he thought he might have made on the way to victory, asking my brother’s opinion about each strategic decision. A more run-of-the-mill player might have spent the time talking about how great they played, relishing the victory. Not Ivey. For him, the opportunity to learn from his mistakes was much more important than treating that dinner as a self-satisfying celebration. He earned a half-million dollars and won a lengthy poker tournament over world-class competition, but all he wanted to do was discuss with a fellow pro where he might have made better decisions. I heard an identical story secondhand about Ivey at another otherwise celebratory dinner following one of his now ten World Series of Poker victories. Again, from what I understand, he spent the evening discussing in intricate detail with some other pros the points in hands where he could have made better decisions. Phil Ivey, clearly, has different habits than most poker players—and most people in any endeavor—in how he fields his outcomes. Habits operate in a neurological loop consisting of three parts: the cue, the routine, and the reward. A habit could involve eating cookies: the cue might be hunger, the routine going to the pantry and grabbing a cookie, and the reward a sugar high. Or, in poker, the cue might be winning a hand, the routine taking credit for it, the reward a boost to our ego. Charles Duhigg, in The Power of Habit, offers the golden rule of habit change….

Being in an environment where the challenge of a bet is always looming works to reduce motivated reasoning. Such an environment changes the frame through which we view disconfirming information, reinforcing the frame change that our truthseeking group rewards. Evidence that might contradict a belief we hold is no longer viewed through as hurtful a frame. Rather, it is viewed as helpful because it can improve our chances of making a better bet. And winning a bet triggers a reinforcing positive update.

Note: Intellectual Honesty thinking clearly= thinking in bets

Good decisions compound

One useful model is to view everything as one big long poker game. Therefore the result of individual games won’t upset you so much. Furthermore, good decision making habits compound over time. So the key is to always be developing good long term habits, even as you deal with the challenges of a specific game.

The best poker players develop practical ways to incorporate their long-term strategic goals into their in-the-moment decisions. The rest of this chapter is devoted to many of these strategies designed to recruit past- and future-us to help with all the execution decisions we have to make to reach our long-term goals. As with all the strategies in this book, we must recognize that no strategy can turn us into perfectly rational actors. In addition, we can make the best possible decisions and still not get the result we want. Improving decision quality is about increasing our chances of good outcomes, not guaranteeing them. Even when that effort makes a small difference—more rational thinking and fewer emotional decisions, translated into an increased probability of better outcomes—it can have a significant impact on how our lives turn out. Good results compound. Good processes become habits, and make possible future calibration and improvement.

At the very beginning of my poker career, I heard an aphorism from some of the legends of the profession: “It’s all just one long poker game.” That aphorism is a reminder to take the long view, especially when something big happened in the last half hour, or the previous hand—or when we get a flat tire. Once we learn specific ways to recruit past and future versions of us to remind ourselves of this, we can keep the most recent upticks and downticks in their proper perspective. When we take the long view, we’re going to think in a more rational way.

Life, like poker, is one long game, and there are going to be a lot of losses, even after making the best possible bets. We are going to do better, and be happier, if we start by recognizing that we’ll never be sure of the future. That changes our task from trying to be right every time, an impossible job, to navigating our way through the uncertainty by calibrating our beliefs to move toward, little by little, a more accurate and objective representation of the world. With strategic foresight and perspective, that’s manageable work. If we keep learning and calibrating, we might even get good at it.

Hierarchies vs networks: Notes on the Square and the Tower

“Often the biggest changes in history are the achievements of thinly documented, informally organized groups of people. “

The Square and the Tower  examines the role informal networks have played throughout history. Its one of the few books I’ve seen that takes a rigorous, empirical and non-sensational look at what secret societies actually did throughout history. More importantly it delineates between societies/institutions that are driven by informal networks, vs those that are driven by formal hierarchies. The world kind of goes back and forth between the two over time. The spread of diseases and ideas follow similar processes and are both are heavily influenced by the role of networks and hierarchies in society. Among its most useful(and amusing) conclusions is that Martin Luther and Donald Trump have something very important in common.

Historical Background

The first ‘networked era’ followed the introduction of the printing press to Europe in the late fifteenth century and lasted until the end of the eighteenth century. The second – our own time – dates from the 1970s, though I argue that the technological revolution we associate with Silicon Valley was more a consequence than a cause of a crisis of hierarchical institutions. The intervening period, from the late 1790s until the late 1960s, saw the opposite trend: hierarchical institutions re-established their control and successfully shut down or co-opted networks. The zenith of hierarchically organized power was in fact the mid-twentieth century – the era of totalitarian regimes and total war.

Martin Luther and Donald Trump

The key insight is that Martin Luther and Donald Trump and their respective suorters both made highly skilld and aggressive use of a new communication medium to spread their message. Luther had ht ebrand new thing called the printing press. Trump had this brand new thing called social media(mainly twitter)

Without Gutenberg, Luther might well have become just another heretic whom the Church burned at the stake, like Jan Hus. His original ninety-five theses, primarily a critique of corrupt practices such as the sale of indulgences, were originally sent as a letter to the Archbishop of Mainz on 31 October 1517. It is not wholly clear if Luther also nailed a copy of them to the door of All Saints’ Church, Wittenberg, but it scarcely matters. That mode of publishing had been superseded. Within months, versions of the original Latin text had been printed in Basel, Leipzig and Nuremberg. By the time Luther was officially condemned as a heretic by the Edict of Worms in 1521, his writings were all over German-speaking Europe. Working with the artist Lucas Cranach and the goldsmith Christian Döring, Luther revolutionized not only Western Christianity but also communication itself. In the sixteenth century German printers produced almost 5,000 editions of Luther’s works, to which can be added a further 3,000 if one includes other projects he was involved with, such as the Luther Bible. Of these 4,790 editions, almost 80 per cent were in German, as opposed to Latin, the international language of the clerical elite.3 Printing was crucial to the Reformation’s success. Cities with at least one printing press in 1500 were significantly more likely to adopt Protestantism than cities without printing, but it was cities with multiple competing

Likewise, Trump was able to get an enormous amount of massive publicity do to his exploitation of social media. It also didn’t hurt that their were highly skilled foreign actors also using social media to spread his influence. Much of this was done in an automated fashion, using bots, etc. Social media allowed this message to spread directly without any filter from media gatekeepers.
Gutenberg’s printing press helped make Lutheranism. Twitter bots helped make Trumpism.

Difficult to suppress

Why was Protestantism so resistant to repression? One answer to that question is that, as they proliferated throughout northern Europe, the Protestant sects developed impressively resilient network structures.

Similarly, traditional political operatives have had difficulty penetrating the social media networks that Trump has so successfully exploited.

Bringing the medium to the masses

Just as the printing press caused a drastic fall in the price of written books, the falling prices of phones and PCs made the internet more widely accessible.
The decline in the price of a PC between 1977 and 2004 followed a very similar trajectory to the decline in the price of a book between the 1490s and the 1630s. Yet the earlier, slower revolution in information technology appears to have had the larger economic impact. The best explanation for this difference is the role of printing in disseminating hitherto unavailable knowledge fundamental to the functioning of a modern economy. The first known printed mathematics text was the Treviso Arithmetic (1478). In 1494, Luca Pacioli’s Summa de arithmetica, geometria, proportioni et proportionalita was published in Venice, extolling the benefits of double-entry book-keeping.

Luther and Trump both spread their message just as new technology was making it much easier for something to go viral. Luther upended the church hierarchy by bringing religious texts and thoughts to the common people. Prior to Luther religious text were almost exclusively in Latin, which the common people could not read or understand. The idea that common people could be allowed to read the bible was considered heretical (see a world lit only by fire). Luther spread his messages into far away villages causing the Catholic church to lose control of its traditional followers. Likewise, Trump upended the political hierarchy by spreading a populist message far and wide, even overtaking previously Democratic strongholds. Many people who felt abandoned by the political process went to his rallies. Washington insiders have been thrown out, an outsiders have taken control. Many readers of this blog may not want to think of Trump in this way, but the analogy is valuable in understanding why Trump has been so successful.

Spread of disease

The speed with which an infectious disease spreads has as much to do with the network structure of the exposed population as with the virulence of the disease itself, as an epidemic amongst teenagers in Rockdale County, Georgia, made clear twenty years ago. The existence of a few highly connected hubs causes the spread of the disease to increase exponentially after an initial phase of slow growth.7 Put differently, if the ‘basic reproduction number’ (how many other people are newly infected by a typical infected individual) is above one, then a disease becomes endemic;

Impact on economics

For economists, too, advances in network science had important implications. Standard economics had imagined more or less undifferentiated markets populated by individual utility-maximizing agents with perfect information. The problem – resolved by the English economist Ronald Coase, who explained the importance of transaction costs* – was to explain why firms existed at all. (We are not all longshoremen, hired and paid by the day like Marlon Brando in On the Waterfront, because employing us regularly within firms can reduce the costs that arise when workers are hired on a daily basis.) But if markets were networks, with most people inhabiting more or less interconnected clusters, the economic world looked very different, not least because information flows were determined by the networks’ structures. Many exchanges are not just one-off transactions in which price is a matter of supply and demand. Credit is a function of trust, which in turn is higher within a cluster of similar people (e.g. an immigrant community). This has implications not only for employment markets, the case studied by Granovetter. Closed networks of sellers can collude against the public and deter innovation. More open networks can promote innovation as new ideas reach the cluster thanks to the strength of weak ties. Such observations prompted the question of

Spread of ideas

The key point, as with disease epidemics, is that network structure can be as important as the idea itself in determining the speed and extent of diffusion. In the process of going viral, a key role is played by nodes that are not merely hubs or brokers but ‘gate-keepers’ – people who decide whether or not to pass information to their part of the network. Their decision will be based partly on how they think that information will reflect back on them. Acceptance of an idea, in turn, can require it to be transmitted by more than one or two sources. A complex cultural contagion, unlike a simple disease epidemic, first needs to attain a critical mass of early adopters with high degree centrality (relatively large numbers of influential friends).In the words of Duncan Watts, the key to assessing the likelihood of a contagion-like cascade is ‘to focus not on the stimulus itself but on the structure of the network the stimulus hits’. This helps explain why, for every idea that goes viral, there are countless others that fizzle out in obscurity because they began with the wrong node, cluster or network.

That is because so many real-world networks follow Pareto-like distributions: that is, they have more nodes with a very large number of edges and more nodes with very few than would be the case in a random network. This is a version of what the sociologist Robert K. Merton called ‘the Matthew effect’, after the Gospel of St Matthew: ‘For unto every one that hath shall be given, and he shall have abundance: but from him that hath not shall be taken away even that which he hath.’* In science, success breeds success: to him who already has prizes, more prizes shall be given. Something similar can be seen in ‘the economics of superstars’. In the same way, as many large networks

Just like the printing press destroyed the ruling classes monopoly on spirituality, social media has destroyed the “establishment’s” monopoly on political ideology.

Martin Luther and Donald Trump would agree on this

The value of improvisation and informal processes

Seeing Like a State: How Certain Schemes to Improve the Human Condition Have Failed summarizes the key dangers of centrally managed social engineering projects. Its a bit dense, but well worth it. It shows similarities between many seemingly different disasters caused by top-down control and central planning. Case studies include modernist architecture, Soviet collectivization, herding or rural people into villages in Africa,and early errors in scientific agriculture, etc.

Anyone trying to build and manage an organization needs to be aware of the lessons in this book.

One key lesson is that practical knowledge, informal processes, and improvisation in the face of unpredictability are indispensable.

Formal scheme was parasitic on informal processes that alone, it could not create or maintain. The the degree that the formal scheme made no allowance for those processes or actually suppressed them, it failed both its intended beneficiaries and ultimately its designers as well. “

Radically simplified designs for social organization seem to court the same risks of failure courted by radically simplified designs for natural environments.

It makes the case for resilience of both social and natural diversity, and a strong case for limits about what can be known about complex social order. Avoid reductive social science.

Four elements of centrally planned disasters

According to the book, there four elements necessary for a full fledged disaster to be caused by state initiated social engineering.

  • Administrative ordering of nature and society
  • “High Modernist Ideology” a faith that borrowed the legitimacy of science and technology. Uncritical unskeptical public and therefore unscientific optimism about possibilities for comprehensive planning of human settlement and production. Often with aesthetic terms too.
  • Authoritarian state willing to use the full weight of its coercive power for #2
  • Prostrate civil society lacking capacity to resist these plans.

“By themselves they are unremarkable tools of modern statecraft; they are as vital to the maintenance of our welfare and freedom as they are to the designs of a would be modern despot. They undergird the concept of citizenship and the provision of social welfare just as they might undergird a policy of rounding up undesirable minorities.”

Overlooking ecology

The discussion of the ecological disasters caused by forestry regulation in 18th and 19th century Germany is instructive:

The metaphorical value of this brief account of scientific production forestry is that it illustrates the dangers of dismembering an exceptionally complex and poorly understood set of relations and processes in order to isolate a single element of instrumental value. The instrument, the knife, that carved out the new, rudimentary forest was the razor sharp interest in the production of a single commodity. Everything that interfered with the efficient production of the key commodity was implacably eliminated. Everything that seemed unrelated to efficient production was ignored. Having come to see the forest as a commodity, scientific forestry set about refashioning it as a commodity machine. Utilitarian simplification in the forest was an effective way of maximizing wood production in the short and intermediate term. Ultimately, however, its emphasis on yield and paper profits, its relatively short time horizon, and , above all, the vast array of consequences it had resoloutley bracketed came back to haunt it.

Department of unintended consequences

I like to joke about wanting to start a department of unintended consequences to oversee economic policy. Often central planners fail because they arrograntly fail to foresee unintended consequences of their policies.

“ the door and window tax established in France under the directory and abolished only in 1917 is a striking case in point. Its originator must have reasoned that the number of windows and doors in a dwelling was proportional to the dwelling a size. Thus a tax assessor need not enter the house or measure it but merely count the doors and windows. As a simple, workable formula, it was a brilliant stroke, but it was not without consequences. Peasant dwellings were subsequently designed or renovated with the formula in mind so as to have as few openings as possible. While the fiscal losses could be recouped by raising the tax per opening, the long-term effects on the health of the rural population lasted for more than a century. “

See also: Goodhart’s Law

Carl Icahn: Capitalist Kingpin

Carl Icahn is one of my favorite capitalists. For all his flaws, his glory days were epic. He shook up the corporate aristocracy, and created massive value for his early financial backers. The economy has benefited from the disruption of complacency led by corporate raiders like Icahn.

Carl Icahn’s bio covers the evolution of his takeover style and thought process.  It pairs well with Tobias Carlisle’s work, including The Acquirer’s Multiple,  and Deep Value.

Below  are some of my notes from Icahn’s bio:

The importance of philosophy

Icahn studied philosophy in college. This proved useful in understanding markets and navigating high stakes situations. He focused on the concept of empiricism.

Empiricism says knowledge is based on observation and experience, not feelings,” Icahn said. “In a funny way, studying twentieth-century philosophy trains your mind for takeovers. “. . There’s a strategy behind everything. Everything fits. Thinking this way taught me to compete in many things, not only takeovers but chess and arbitrage.

It seems to me that the quest for an explication of the empiricist meaning criterion, as it has progressed, may be likened to the tale of the city that suddenly finds itself in possession of a great homogeneous mixture of gold and sand. If the gold could be separated from the sand it would prove a great deal more valuable to the inhabitants. The wise men of the city diligently search for a method of separation. By so doing they not only vastly increase their insight into the nature of gold, sand, homogeneous mixtures, etc., but also produce a series of increasingly potent methods of separating the chaff from the gold, the meaningless from the significant.”

Waiting for the right opportunity to pounce

He waits until someone is so stretched out and in need of a deal that he can come in and buy under the most favorable terms.

From the PPM/pitchbook for Icahn’s first fund:

It is our opinion that the elements in today’s economic environment have combined in a unique way to create large profit-making opportunities with relatively little risk. Our nation’s huge need for energy has resulted in a massive flow of dollars abroad. This, coupled with huge deficit spending and decreasing productivity, has caused a high inflation rate and a sharply declining dollar. As a result, the value of gold and goods in general has skyrocketed. An obvious corollary to this is that the real or liquidating value of many American companies has increased markedly in the last few years; however, interestingly, this has not at all been reflected in the market value of their common stocks. Thus we are faced with a unique set of circumstances that, if dealt with correctly, can lead to large profits…

Non linear thinking

Like most great investors, Icahn is a non-linear thinker.

In part, his success is based on an intellectual skill that enables him to plot dozens of moves in advance. While his adversaries are thinking in linear fashion—”If I can get from A to B, then I’ll proceed to C”—Icahn sees dozens of possibilities on a single screen. The mental agility that enables him to zigzag from C to F to Z and back to R, leaves his opponents so thoroughly confused and frustrated they are on the verge of shorting out. “In trying to beat Carl, and failing to do so, people come away baffled,” said Brain Freeman. “But I can tell them why they fail. Because they think they know what Carl’s goal is when in fact he has no fixed goal.

Expanding options

Presented with an ultimatum in which he is told to choose between evil A or lesser evil B, Icahn moves into intellectual overdrive, expanding the range of options. In this way, he turns the tables on his adversaries, who find themselves facing a more ominous threat than they hurled at the raider.

Limitations of Icahn’s approach

Icahn was a great liquidator, a great investor in asset intensive businesses, but sticking too closely to his methods would cause a modern investor to miss great opportunities to invest in rapidly growing businesses. Additionally, based on the performance of IEP, its possible that he has failed to adapt to recent technological disruption, and the age of asset lite businesses.

Carl is a smart Neanderthal,” said Marty Whitman. “He’s a Neanderthal because he doesn’t listen. He has fixed ideas. He doesn’t see that you can’t make money by investing in a business. He only wants to cash out—to get cash flow. He doesn’t understand that most of the great businesses built in this country were cash consumers. They used public markets and consumed cash to build fabulous wealth for their owners. But Carl just wants the cash-out approach.

As with most corporate titans, sometimes his ego gets the best of him. He nearly went bankrupt messing around with airlines, for example. Nonetheless his story is valuable and entertaining, and he wrote the playbook for many situations faced by investors today.

See also:

The Next Level of Shareholder Activism

The Icahn Manifesto

Insecurity Analysis