More on the Swiss Franc move

The always excellent Matt Levine has reported in Bloomberg (with respect to the recent removal of the cap on the price of the Swiss Franc) that:

Goldman Sachs Chief Financial Officer Harvey Schwartz said on this morning’s earnings call that this was something like a 20-standard-deviation event

While mathematically this might be true, the question is if it makes sense at all. Since it is mathematically easy to model, traders look at volatility of an instrument in terms of its standard deviation. However, standard deviation is a good descriptor of a distribution only if the distribution looks something like a normal distribution. For all other distributions, it is essentially meaningless.

The more important point here is that the movement of the Swiss Franc (CHF) against the Euro had been artificially suppressed in the last three odd years. So from that perspective, whatever Standard Deviation would have been used in order to make the calculation was artificially low and essentially meaningless.

Instead, the way banks ought to have modelled it was in terms of modelling where EUR/CHF would end up in case the cap on the CHF was actually lifted (looking at capital and current flows between Switzerland and the Euro Area, this wouldn’t be hard to model), and then model the probability with which the Swiss National Bank would lift the cap on the Franc, and use the combination of the two to assess the risk in the CHF position. This way the embedded risk of the cap lifting, which was borne out on Thursday, could have been monitored and controlled, and possibly hedged.

There are a couple of other interesting stories connected to the lifting of the cap on the value of the CHF. The first has to do with Alpari, a UK-based FX trading house. The firm has had to declare insolvency following losses from Thursday. And as the company was going insolvent, they put out some interesting quotes. As the Guardian reports:

In the immediate aftermath of Thursday’s move by the Swiss central bank, analysts at Alpari had described the decision as “idiotic” and by Friday the firm had announced it was insolvent. “The recent move on the Swiss franc caused by the Swiss National Bank’s unexpected policy reversal of capping the Swiss franc against the euro has resulted in exceptional volatility and extreme lack of liquidity,” said Alpari.

The second story has to do with homeowners in Hungary and Poland who borrowed their home loans in Swiss Franc, and are now faced with significantly higher payments. I have little sympathy for these homeowners and less sympathy for the bankers who sold them the loans denominated in a foreign currency. I mean, who borrows in a foreign currency to buy a house? I don’t even …

There is a story related to that which is interesting, though. Though Hungary is more exposed to these loans than Poland, it is the Polish banks which are likely to suffer more from the appreciation in the CHF. The irony is that the Hungarian market was initially much more loosely regulated compared to the Polish market, where only wealthier people were allowed to borrow in CHF. But in Hungary, the regulator took more liberties in terms of forcing banks to take the hit on the exchange rate movement, and the loans were swapped back into the local currency a while back.

In related reading, check out this post by my Takshashila colleague Anantha Nageswaran on the crisis. I agree with most of it.

 

Finally some sensible Uber regulation

Ever since Uber launched, regulators worldwide haven’t had a clue as to how to regulate it – it has been such a big disruptor in the taxicab market. Some countries and cities have taken to banning it outright (the list is too long to post links here). Others (such as some states in India) have tried to get Uber to register itself as a “taxicab company”.

The problem with all these regulations is that the Uber model (being replicated by firms such as Ola and TaxiForSure in India) is a fundamental gamechanger. As I have written in this earlier post, the on-demand model propagated by Uber implies that a number of the inefficiencies in the taxicab market don’t exist any more. In this context, trying to regulate it by moving it back to the earlier (extremely inefficient) model is extremely regressive. The right way to regulate is to create a level playing field for taxicab aggregators (which includes Uber) and move the market to a regime where the new technology-enabled efficiencies are made good use of.

And that is precisely what Los Angeles has done. In a rather progressive move (which ought to be copied by other states and cities and countries), the city has decreed that all city-based cab operators need to offer app-based booking services. The interesting bit in the regulation (see link above) is that drivers who fail to install the e-hail app are actually going to be fined.

What this will lead to is that the local taxi market is itself going to become more efficient which should definitely increase both profitability for the local cab industry and also availability of local cabs to the people of LA. What this will also do is to give people of LA a choice between using Uber and the traditional taxi app, which will lead to an improvement in Uber’s service levels. As things stand now I don’t see any downside from this LA regulation.

I hope the model succeeds in LA and other cities see the brilliance of the model and accept the efficiencies brought into the market thanks to this model and adopt similar regulation. I see this kind of regulation coming into the Bangalore market though the backdoor though. Ola already helps match auto rickshaws to customers and now TaxiForSure is also getting into that market. Will this mean that autos won’t have to line up for hours together in front of Lalbagh gate for passengers arriving in the city by bus?

Oh, and LA is not the first city to implement regulations requiring taxis to be “hailable” via an app. When I visited Singapore in November 2013, I found that cabs in the city worked the same way. Locals had an app which they would use to call taxis. The problem there though was that the app was only available to locals (your android/iOS had to be registered in Singapore for you to be able to even install the app), which made it a nightmare for us tourists to move around.

Oh, and while on the topic, a good revenue source for companies such as Ola or TaxiForSure would be to provide the technology backbone to cities that are seeking to use app-based hailing services for their cabs.

 

Pakistan, Swiss Franc and the costs of suppressing volatility

Back in 2008, during the CDO/MBS/Lehman/… induced financial crisis (and also a time of domestic political crisis in Pakistan since Musharraf had just resigned),  Pakistan set a funny rule – they ruled that stock prices could not fall below a particular limit. So there was no trading, since the crisis meant that no one wanted to buy shares at prevailing prices. And then after a long time the ban got lifted. And shares promptly fell. Check out the graph of the MSCI Index for Pakistan from that time here (from FT):

Check out the late 2008 period when shares were virtually flat. And then the fall after that

Sometime back, Switzerland decided that its Franc was appreciating too much and put a ceiling on its price by pegging it to the Euro. The Franc can be worth no more than five-sixth of a Euro, they decreed. And the Franc stayed flat, close to the limit. And then in a sudden move yesterday, following instability in the Eurozone which meant the Euro has been getting considerably weaker, the Swiss National Bank decided that continuing to maintain the peg was costly. And they pulled the plug on the peg (couldn’t resist the alliteration). The graph is here, snapped off Yahoo Finance (took screenshot since I couldn’t figure out how to embed it):

This graph shows the number of Euros per Swiss Franc. There was a floor of 1.2 till 14/1/15 which was suddenly removed on 15/1/15

I chose the 5-day chart since on any longer horizon yesterday’s drop was hardly visible. With time, once we have a longer time scale available, we will see that this graph will again start looking like the Pakistan graph.

Thanks to the sudden appreciation in the CHF,  there has been bloodbath in the markets. Some FX traders have gone down. Alpari has declared itself insolvent. Global Brokers NZ is closing down. US-based FX trader FXCM is in trouble. And there could be lots of trouble in Poland where people took home loans denominated in CHF (this might sound heartless but such utter stupidity – like taking a home loan in a foreign currency – deserves to be punished).

The broader point I’m trying to make here is a paraphrasing of the old adage “still waters run deep”. When something seems unusually quiet, either held in place unnaturally or even if there is no apparent force holding it in place unnaturally, it is usually a sign that when the floodgates open much will get washed away (apologies for the surfeit of metaphor in this paragraph). When you suppress “local volatility”, the suppressed entropy builds, and when there comes a time that it can be suppressed no more, it acts with such force that there will be much damage.

As Nassim Nicholas Taleb argues in the black swan (link to my paraphrasing of his argument), countries with short-term political instability such as Italy or India or Japan are much less likely to face any major political instability. On the other hand, countries like China, he argues, where small instability has been artificially held down, when instability hits, it will hit in a way that it will hurt real bad.

I’ll end this post with a page from Taleb’s first book Dynamic Hedging, which he tweeted earlier today (I haven’t read it but want to read it but haven’t been able to procure it). Read and enjoy:

 

Depression and TARP

When the US Treasury initiated the Troubled Asset Relief Program (TARP) in the aftermath of Lehman Brothers’ collapse, they imposed one condition on banks – banks were forced to borrow money under the scheme irrespective of how they were doing. So you had banks that weren’t doing badly such as Goldman Sachs and JP Morgan taking TARP money, and getting flak for giving fat bonuses (“from TARP money”, as the press claimed) to their employees who had helped them survive the crisis.

The reason even well-to-do banks were forced to take money under TARP was for the signalling effect. If only banks that really needed the money were to take money from TARP, then banks who really needed the money would be loathe to take it, for it would them mark them out as being ‘in trouble’. By making the well-to-do banks take money under TARP, this stigma of borrowing under TARP was removed, and the American banking system was “saved”.

The reason I got reminded of this was this piece on actor Anupam Kher coming out with his depression. This is on the back of actor Deepika Padukone coming out with her depression, which was reported yesterday. From the article on Kher’s “coming out”:

Kher says what Padukone had done is a very brave and wise thing to do. “People look up to her. When they know that she is consulting a therapist, they will understand there is no problem in getting help, and it is an okay thing to do,” he says.

 

The thing with depression is that it affects people from all over the spectrum – some of them are wildly successful despite their depression, like Kher or Padukone, while depression ruins some others. And then there are others who are ravaged by depression, and lead mostly “middling” lives.

Depression is an illness to which much stigma is attached. Especially in India, if you are consulting a therapist, or taking psychiatric drugs, people assume something is “wrong” with you, and discriminate against you. This gives people with depression a strong incentive to hide their illness, and appear to the world as if they’re fine.

The consequence is that people end up not seeking help even when it is prudent for them to seek help, and this leads to their depression possibly consuming them, sometimes even leading to fatal consequences.

In this context, when you have people who have had successful careers despite being ravaged by depression “coming out”, it makes depression a little more “normal”. On the margin, it can lead to the depressed person seeking help, and potentially getting better, rather than letting depression continue to waste them. Thus, successful depressed people owning up to depression makes it easier for less successful people (who might be worried about the stigma attached to mental illness) to come out with their condition and seek help.

In that sense, “coming out” with depression is similar to banks that were not in trouble taking TARP funds! Oh, and while on that topic, here is my “coming out essay”, from almost three years back.

Analysing Premier League Performance So Far

English Premier League tables can be misleading in that they are a function of the fixture list. At this point in time it doesn’t matter so much since we’re only 2 games into the second half of the season but in the middle of the half of the season it is important.

From this perspective, it is important to compare this season’s results against comparable fixtures of last season to know where teams are. Last season I had a calculator that would run every week. This year, thanks to Liverpool’s indifference performance (as you can see in the first chart), I’ve been late on this.

The list of Premier League teams changes every year, though, thanks to relegation and promotion. For this purpose, we replace teams placed 18,19,20 last year respectively with the Championship winner, runner-up and winner of playoff. So we substitute Leicester, Burnley and QPR respectively for Norwich, Fulham and Cardiff from last year’s table.

So the first graph shows the difference between a team’s points tally this year and the team’s points tally from the corresponding fixture of last year. This illustrates why as a Liverpool fan I’ve put so much NED – they’re the second worst team this year compared to last year, after city rivals Everton.

PLchange15

The most improved team is, of course, West Ham United. Also having improved significantly are Swansea and Chelsea. At the other end, after last year’s high-flying Liverpool and Everton, we have relegation-threatened Crystal Palace and West Brom, along with Arsenal. And QPR is worse off compared to Cardiff last year!

Next, if we assume that the rest of the season goes identically to last year’s corresponding fixtures, what will the final table look like? It will look like this:

pointstable15

 

 

According to this, Palace should hang on, but West Brom and Hull will go down, as will QPR. Surprisingly, this says that Arsenal and Spurs will get the last two Champions League places (notice the gap between 2 and 3 here).

A mechanical achievement

I’m an engineer. Rather, I have an engineering degree. I have an engineering degree from what is supposed to be among the best engineering colleges in India. If you look at my grades, you might think I did rather well in my engineering (CGPA of 8.91 out of 10). So you might assume that I’m a good engineer.

In my engineering I studied Computer Science. I consider myself to be pretty good at building algorithms and coming up with heuristics (better at latter than former). But I can’t write production code. I can’t write systems code. Fixing together a computer terrifies me. Any “normal engineering thing” is well beyond me.

My father used to rile me about going to IIT and yet being a poor engineer. “What did they teach you at IIT if you can’t even fix a lightbulb properly?”, he would ask. It didn’t help that he was pretty good at the small engineering stuff around the house, despite being an accountant by training and profession. Every time I did something stupid while trying to fix something, he would just say “IIT”. That didn’t mean that I made an effort to improve myself.

My father passed away in 2007. In 2010, I got married, and the wife took his place in riling me as a poor engineer. She is also an engineer by training, but she knows how to fix things. When our invertor gave way two years back, it was she who diagnosed what the problem was and what part should be replaced. Her father, also an engineer and also quite hands-on, procured the necessary part and fixed our invertor. I was quite lost. To give another example, I procured a lightbulb (a slightly complicated one, this one, for a fancy lamp) two months back. And then I waited another month till the wife came home for her vacation to get it fixed!

In this context, what I achieved this morning is surely a spectacular achievement. As I had mentioned on this blog earlier, I was going to meet my friend on Wednesday when my bike refused to start. Despite hitting the electric starter multiple times, despite kicking till my legs almost gave way, and holding down the choke while I was at it, there was no response. I ended up taking the bus that day.

I was dreading having to call Royal Enfield On Road Service and waiting for them to come and fix the bike. The bike is already due for service (I’ve taken an appointment for Tuesday), so I was wondering how I could avoid another round of repairs before that. In an earlier avatar, I would have just prayed (despite being mostly atheist) that the bike starts. This time, however, I was more resolute and decided to see if I can fix it myself.

A little bit of thinking convinced me that the problem was with the spark plug. I had replaced my battery just six months ago, so that was unlikely to be the problem. The noise when I tried holding down the electric starter convinced that. And considering that there was nothing else that was likely to have changed since the last ride (and there was fuel in the tank), and that the problem was in starting, it was clear that the problem was with the spark plug.

After putting NED for 2 days (the diagnosis happened on Wednesday), I decided this morning that I’ll fix it today. I googled for “how to change spark plug in Royal Enfield Classic 500”, and that gave me a few videos which told me where the spark plug is and how I should use a combination of the spark plug spanner (I had always wondered why I had such strange-shaped spanners) and the tommy bar to pull out the spark plug. And so I picked up my toolkit (for the first time in four years) and went down to check.

I located the spark plug (after all I’d seen in the video where it is) and pulled out its covering. The plug stood there bare. I now had to extract it. I tried with my hands and it didn’t work. I then found the spark plug spanner which fit over this plug snugly (a little bit of trial and error was involved in the process). Then came the problem of turning the spanner, which I knew I had to do with the tommy bar. So in went the tommy bar, and one whack I gave, and I felt something move. Soon the thing started getting unscrewed and I didn’t need to use the tommy bar any more. Presently the plug came out.

I realise I’d never seen a spark plug before, to know whether it was sooted and dirty. All I saw was one black tip, and assumed that that was the end that needed cleaning (I’d forgotten to see a video on how to actually clean a spark plug). So I picked up a cloth and wiped it. It took some effort but after some time most of the black stuff was gone from that end. I assumed that this should be enough to make my bike run until the service on Tuesday.

When you’ve debugged code, the greatest trepidation comes in the time when you’re testing the code after you’ve debugged it. For you know that if it doesn’t work now you’ll have to do it all over again! So it was with that trepidation that I fixed the spark plug back in its place (using first just the spark plug spanner and then adding the tommy bar). And I pressed the electric starter. And the engine roared to life!

I know this is trivial – that this is the first bit of motorcycle maintenance that everyone learns, and that an enfield owner is supposed to know something about maintenance and all that. Yet the fact that I managed to diagnose the problem and actually fix it is making me supremely happy. You can put this down as another item in the checklist that contributes to the “late bloomer” phrase in my twitter bio.

The importance of a vice-captain

On the cricket field, people imagine that the role of the vice-captain is one of the most pointless roles ever. Perhaps only marginally pointful than the role of the captain in a game of football. The only time when a vice-captain is called for to show off his vice-captaincy is when the captain is unavailable (due to injury or whatever). And in cricket, that is not particularly common. So the vice-captain’s role is mostly pointless.

Some teams manage by committee – this is where you see the captain, vice-captain and two other (senior) guys assisting a bowler set his field. There the vice-captain might have a job to play. But in general the job is so pointless that sometimes teams don’t even bother naming a vice-captain, and name one only at the point of contingency. At other times, a senior player is made vice-captain (since it is a pointless role anyway) without really testing his fit for the role.

And sometimes, it can backfire spectacularly. I’m reading Martin Crowe’s account of the semi-final loss to Pakistan in Auckland in 1992, and he puts the blame squarely on his then vice-captain John Wright. Crowe got injured while batting and didn’t take the field. Wright led instead and made a mess of Crowe (a master tactician)’s carefully laid out plans. And Pakistan won in a canter. Quoting the article,

Crowe, meanwhile, was fidgety and restless in the dressing room. Along with New Zealand coach Wally Lees, he had laid out an elaborate bowling plan with a heavy emphasis on rotating bowlers. As many as 17 bowling changes were planned and Crowe had worked out how many over spells each of them would bowl in the chase.

“I was the only one who knew the script really,” Crowe says. “Lots of bowling changes, short spells, was the key really because that would not allow any batsman to get in.” But Wright decided to attack straightaway.

 

The point to be noted is that Wright had not even been part of the team for most of the earlier games in the tournament, where Crowe had come up with some revolutionary tactics such as quick bowling changes involving wibbly, wobbly, dibbly and dobbly (there were only three of those in this game, for Rod Latham had been dropped to make way for Wright), opening with Dipak Patel and careful use of bursts by Danny Morrison.

So when called upon to lead the team in Crowe’s absence, Wright was pretty much clueless, for he had not seen the plan of action from the field too much earlier in the tournament. And he made a mess. And New Zealand lost. Possibly their best ever chance of winning the World Cup till date.

Taking Crowe’s injury a given, would Pakistan had still won if someone else (say Ken Rutherford) who had played a full role in the tournament had taken over? The problem with Wright was twofold – he hadn’t played enough to be familiar with his team’s tactics, and he was probably too senior to just follow Crowe’s advice. The lack of thought in selecting the vice-captain had been shown up.

Management Guru Alert: So the point is that even if a role looks mostly pointless, you need to pick it carefully, and on merit. Because in a contingency the role stops becoming pointless, and you need the best available person for the job then.

Irreversible policies

Some policies are so badly designed that they become irreversible. Take, for example, the “5/20” rules for airlines in India. For an airline registered in India to fly abroad, it needs to have been in operation for 5 years and have at least 20 aircraft. The rule is silly, and the government wants to change it. But established players say that changing the rule will be unfair to them, for they have sunk costs in order to comply with the rule and want newer competitors to go through the same.

Now, given that the airline industry is dynamic in terms of firms going in and out of business, there will always be new firms and old firms in the market. And given that the rule is fundamentally senseless, there will be proposals to change it at many points in time. Now, notice that the arguments that today’s established players are making can be made at all those points in time! In other words, if you were to postpone changing the rule because older airlines are going  to be unhappy, you are giving reason to postpone the rule change indefinitely!

When you design a policy, you should keep in mind that there is a chance that changed market environments might render it useless/absurd (as for the 5/20 rule, it was absurd from inception!). Hence, you need to consider how easy the rule is going to be to dismantle when it goes past its use-by date. If such a “poison pill clause” doesn’t exist in the rule, then it will be very difficult to undo and the absurdity will propagate into perpetuity, causing much more damage than necessary!

Then again, if the rule has been framed due to the influence of bootleggers (the 5/20 rule definitely has indications of that, and it is hard to identify any “baptists” who could have backed the rule), then the bootleggers are likely to prevent any such “poison pill clause” from being put in. Such are life.

When do you take a bus?

By now I’m supposed to have met my friend. If my bike hadn’t acted up this morning that is. It started but then I turned it off for a minute to close the gate and after that it didn’t start. Several futile kicks later I decided to take an auto rickshaw. And then I saw a bus come that way and decided to hop on. I’m sitting in the bus as I write this.

I’m thinking of when you take an auto and when you take a bus. In order to understand it let me list out the reasons I took a bus today.

Most importantly the bus takes the same route that an auto would have. This is not true for most routes in Bangalore – for most pairs of points in the city the bus connection takes a convoluted route. For various reasons, the most important of which is that it is infeasible to connect every pair of points in a city by a bus taking the shortest route.

Secondly the bus was empty. Effort enough for me to find a seat comfortably. But it’s been a rather bumpy ride so far

Thirdly the likelihood of the bus getting crowded en route was small. This is again an important consideration since a crowded bus move s slowly.

Fourthly there were few stops on the way – another rather important consideration. The reason a bus is slower than other means is that it stops along the way.

Finally and most importantly the bus will drop me close to my destination so it’s only a short walk.

That said my destination is here now so I’m getting off and closing this post.

Op-Ed in Mint on Environmentalism, Baptists and Bootleggers

After a very long time (~7 months) I’ve written an Op-Ed in Mint. It got published in the physical paper this morning. I’ve used the “Baptists and Bootleggers” framework propounded by economist Bruce Yandle in 1983 to analyse the hijacking of the green cause in India. An excerpt:

In the context of Indian environmental regulation, bootleggers refers to the vast coalition that seeks to profit from curbing industrial growth and development. This includes but is not limited to industries seeking to stifle competition (by preventing competitors’ plants from being built), political parties that rely on people’s poverty and backwardness in order to come to power, and local politicians with vested interests.

The baptists are environmentalists, conservationists and people who are truly interested in the green cause and ensuring sustainable development. Their motivations are straightforward, in that they do not want any developments that could cause lasting damage to natural resources, and they believe that strong environmental regulations are necessary to guard natural resources and ensure sustainable development.

While I was writing the piece I found that Yandle himself has written about the application of the framework to climate change, Kyoto Protocol, etc. This paper (possibly paywall, I only read the abstract) and this one (I’ve read it, and it’s good) are some suggested readings if you want to know more of the concept.