Monday, October 31, 2011

I'll Listen to Your Offer, but First Tell Me How You're Going to Screw Me

Michael Lewis
I'm too lazy to look up who said that to whom, but it was from an article at by Michael Lewis. The context was a trader on Wall Street wanting to sell another perhaps savvier trader a product, and that savvier trader wanting to get to the nub of the offer. "First tell me how you're going to screw me," the savvy one asked; "I don't know what you mean," replied the first trader. "Then we can't do business," countered the savvy one, getting up to go. So the first trader gives in and tells the savvy one how he was going to screw him, after which the savvy one sits back down. He can deal with a truth teller.

I loved the exchange because I could never have been that gutsy, which is why I'm more gullible than many other people who get into the markets. The Lewis article entitled "The End" is still available here. Three years ago when I first read it was the moment in time when I began to understand how screwed we were and why. Around that time TARP was enacted, and the great unraveling was well underway.

Now, today, I read a blog post from Brad DeLong that is equally enlightening. Read it. Here's the nitty-gritty:
There are three ways in which a financial transaction can be a good deal for both sides.
First, people have different time preferences: I have money now that I do not want to spend on some useful commodity until sometime in the future, while you may have no money now and need some but anticipate being flush in the future; then we both benefit if I lend you the money--at interest. Second, risks distributed and diversified are risks dissipated, and so even though the average customer pays money into the insurance system insurance is still a valuable thing to buy because the insurance company pays you when you really need the cash. Third, economies work best when benefits and losses run with decsion-making: those whose actions create or destroy value pay attention when they have "skin in the game", and financial transactions are a good way to make sure they have that "skin in the game".
Those three sources of value for both sides in financial transactions are powerful.
They motivate net investments and drawdowns, insurance and diversification, and the creation of equity interests for managers, partners, homeowners, and others.
They drive perhaps 1/1000 of the transactions we see on financial markets each day.
All the other transactions are driven by two different factors:
First, in some transactions one or both sides are simply swept up in the excitement of the game. Second, in many transactions one or both sides has simply gotten the odds wrong, and they do not understand what they are doing.
Many economists these days talk about trade in financial assets as being motivated by "disagreement": I think I can make money by doing X, you think you can make money by doing Y, because we disagree about how the world works both X and Y are compatible, and so we trade and we both go away happy--until time passes, uncertainty is resolved, and I learn that you were right and I was an idiot.
UC Berkeley's Brad DeLong
  This is the best advice a potential investor -- or voter -- can receive. Both Michael Lewis and Brad DeLong, in turn, are telling us something very useful. When you listen to financial advisers, insurance salesmen, or political candidates, you should keep the phrase "How are you going screw me?" in mind.

Wouldn't it be wonderful if, when Rick Perry appeared on Meet the Press, David Gregory asked, "Governor, before we go on, could you tell us who's really going to get screwed by your 20% flat tax plan?" And when Perry answered, "Why, no one gets screwed," Gregory would then say, "Sorry, Governor, looks like we've got nothing more to discuss. Good luck with your campaign."

Hey David, this is not what I meant, you know?
And to be fair, let's imagine President Obama getting the same treatment over his desire to close corporate loopholes and raise the marginal tax rates on the wealthiest individuals. Wouldn't it be wonderful to hear him say, "Well, David, I suppose you could say that my plan screws the rich. Fair enough. But that's a feature, not a bug. And two of the richest people in the world, Warren Buffett and Bill Gates, have agreed with me. They like my plan."

Wait. That's just what Barack Obama has been saying all along. Rick Perry with his 20% flat tax and Herman Cain with his 999 plan always have to bob and weave when it comes to who's getting screwed. The same goes for Paul Ryan and his budget plan. He bobs and weaves when it comes to admitting his plan screws seniors. The closest he comes to admitting it is when he promises the current seniors that they are safe. His plan only screws future seniors, a fact he's loathe to admit.

No wonder these guys don't mind paying a little extra...
So here's my advice: when we listen to anyone who wants our money, or wants to cut our benefits, or raise our taxes -- or lower them for some, for that matter -- try to listen to find out who's getting screwed. If you can't figure it out, don't just gut-react with a "I trust conservatives," or "I believe Obama." Research until you are satisfied that you've got the closest to a complete answer, an answer that encompasses more than just your own self-interests. If that means your taxes are going to go up but you'll get value for your investment, then fine. And if it means your taxes will go down but our country will fall apart or go broke, then resist it. Figure out what's best and fight for it.

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