03 September 2018

Quants' Hubris - part the fourth

The more things change, the more they stay the same. The perpetual mantra of the financial quant, horrid experience to the contrary.

And so back to the main question - can quants actually predict the future? Quants depend on the past, as manifest in their data, being the same as the future. For natural phenomena, that's true. The problem for quants in that space is knowing what God's Rules really are. Black plague is carried by rat fleas, not a punishment for impiety.
Because they did not understand the biology of the disease, many people believed that the Black Death was a kind of divine punishment - retribution for sins against God such as greed, blasphemy, heresy, fornication and worldliness.

But, in time, a scientific explanation emerged:
The most authoritative account at the time came from the medical faculty in Paris in a report to the king of France that blamed the heavens, in the form of a conjunction of three planets in 1345 that caused a "great pestilence in the air". This report became the first and most widely circulated of a series of plague tracts that sought to give advice to sufferers. That the plague was caused by bad air became the most widely accepted theory.
[the wiki]

Well, may be not so much science. Or, as Mellencamp has sung, "people believe what they want to believe when it makes no sense at all."

We saw just this happen when the quants enabled the Great Recession; believing that house prices could rise, everywhere, like a rocket forever. After all, the data proved it. What the data didn't prove was why so many wonky mortgages could be made. The answer to that question was simple, if not widely expressed: the Powers That Be had changed the rules for making a mortgage. The old data was under the old rules. Not the new mortgages. Oops.

Recent reporting brings us another example of data lagging reality. And, perhaps, just as unpleasant results. You should read it up, if you only follow Fox News. It's worth noting that fracking is nothing really new. Tertiary extraction, which has been used for decades, works by the same principle: force out trapped oil with high pressure fluid. What's new, to me, in this article is this:
A key reason for the terrible financial results is that fracked oil wells show a steep decline rate: The amount of oil they produce in the second year is drastically smaller than the amount produced in the first year. According to an economist at the Kansas City Federal Reserve, production in the average well in the Bakken — a key area for fracking shale in North Dakota — declines 69 percent in its first year and more than 85 percent in its first three years.

IOW, fracked oil is not sustainable, either in terms of output or financially. Which leads to the second question: if these well go dry as fast as a high school lineman sucking up a milkshake, how is output sustained? A good question, it seems to me.
Because the industry has such a voracious need for capital, and capital costs money, fracking could not have taken off so dramatically were it not for record low interest rates after the 2008 financial crisis. In other words, the Federal Reserve is responsible for the fracking boom.

The problem with QE, not so much TARP, was that it didn't make any requirement for sensible use of the capital. So, sense went out the window. The article ends thus
But rhetoric doesn't produce profits, and most things that are economically unsustainable, from money-losing dot-coms to subprime mortgages, eventually come to a bitter end.

Another voice in the choir of quant hubris and the asymptote of progress. If welfare queens had been given the moolah, and went out and bought crack and Cadillacs, ya think the billionaire donor class might have yelled and screamed? Ya think?

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