When E.F. Hutton Talks

Tyler Durden's picture

Authored by Epsilontheory.com


If you like your health plan, you can keep your health plan.

      – Barack Obama


Of course, one objective of both traditional and nontraditional policy during recoveries is to promote a return to productive risk-taking.

      – Ben Bernanke


Most people are other people. Their thoughts are someone else’s opinion, their lives a mimicry, their passions a quotation.

      – Oscar Wilde (“De Profundis”)


Don’t piss down my back and tell me it’s raining.

     – Fletcher (“The Outlaw Josey Wales”)


     – Paul Samuelson, Nobel Prize winner, author of all-time best-selling economics textbook


Through his research, teaching, and writing Paul Samuelson had more impact on the economic life of this country and the world than any government economic official and many presidents.

      – Larry Summers, former Treasury Secretary (and Paul Samuelson’s nephew)


      – Edward Thorp, hedge fund manager, author of all-time best-selling gambling textbook


Edward O. Thorp and the Kelly criterion have been a lighthouse for risk management for me and PIMCO for over 45 years. First at the blackjack tables, and then in portfolio management, the Kelly system has helped to minimize risk and maximize return for thousands of PIMCO clients.

     – Bill Gross, Co-CIO PIMCO

When E.F. Hutton Talks

The concept of utility is the most fundamental concept in economics. It gets wrapped up in impressive sounding terms like “exogenous preference functions”, and written in all sorts of arcane runes and formulas, but all utility means is that you like something more than something else. The assumptions that economic theory makes about utility are really pretty simple and mostly about consistency – if you like vanilla ice cream more than chocolate ice cream, and chocolate more than strawberry, then economic theory assumes you also like vanilla more than strawberry – and continuity – if you like one scoop of vanilla ice cream, then you like two scoops even more. But as far as what you like, what your tastes or preferences are in ice cream or music … or health insurance plans … economic theory is intentionally silent. Economics is all about making rational decisions given some set of likes and dislikes. It doesn’t presume to tell you what you should like or dislike, and it assumes that you do in fact know what you like or dislike.

Or at least that’s what economic theory used to proclaim. Today economic theory is used as the intellectual foundation for a political stratagem that goes something like this: you do not know what you truly like, and in particular you do not know your economic self-interest, but luckily for you we are here to fix that. This is the common strand between QE and Obamacare. The former says that you are wrong to prefer safety to risk in your investments, and so we will fix that misconception of yours by making it extremely painful for you not to take greater investment risks than you would otherwise prefer. The latter says that you are wrong to prefer no health insurance or a certain type of health insurance to another type of health insurance, and so we will make it illegal for you to do anything but purchase a policy that we are certain you would prefer if only you were thinking more clearly about all this.

Anyone who believes that this political maneuver is inherently a phenomenon of the Left is kidding himself. The Right – in the form of sectarian or secular authoritarianism that imposes behavioral politics on the justification that this is how to get into heaven or demonstrate true patriotism – is no stranger to exactly this sort of political aggrandizement. Nor am I arguing that it’s smart to put your money under a mattress or that it’s wise to use the local emergency clinic as your primary care provider. What I’m saying is that the notion that we know your interests better than you know your interests is inherently an anti-liberal position, whether it comes from the Left or the Right. That’s liberalism with a small-l, the liberalism of Adam Smith and John Stuart Mill, not Walter Mondale … a political philosophy that argues for your right to be as stupid as you want to be in your personal economic decisions.

While there are hundreds of examples of anti-liberal policies in the annals of Western history, QE and Obamacare stand out in two important respects.

First, they’re big. Really big. Either policy on its own would be the largest instantiation in human history of what the French call dirigisme, at least on an absolute scale. I suppose you could argue that the US Social Security system has evolved into something even larger, but that took 70+ years to match what QE and Obamacare have accomplished in a few dozen months. I’ve written at length about the manner in which emergency policy responses to national traumas like wars and depressions are transformed into permanent government programs, so I won’t repeat that here. Suffice it to say that it’s not a coincidence that Social Security is a child of the Great Depression in the same way that both QE and Obamacare are children of the Great Recession. The institutionalization and expansion of centralized economic policy is what always happens after an economic crisis, but the scale and scope of QE and Obamacare, particularly when considered together as two sides of the same illiberal coin, are unprecedented in US history.

Second, and this is what really distinguishes the dirigiste policies of today from those of the past, the political and bureaucratic advocates of QE and Obamacare have co-opted the Narrative of Science to promote these policies to the public. If you look at the financial media’s representation of monetary policy during, say, the Volcker years, you see a curious thing. These articles almost never mention academic papers or Fed research. Today you can’t go a week without tripping over a prominent WSJ or FT article trumpeting this Fed publication or that IMF working paper as the reason behind a monetary policy rhyme. The authority vested in the Volcker Fed was based on a Narrative of Experience, an argument for trust based on a representation of personal leadership and experiential wisdom. Today, the argument for trusting the Fed places zero weight on the real-world experience or personal wisdom of the Fed Chair. Instead, both Bernanke and Yellen are presented as Wizards who channel the transcendent magic of economic theory. For better or worse, a popular faith in Economic Science is the source of their authority.

As for healthcare policy … the entire edifice of Obamacare has been presented as a self-consciously scientific, enlightened economic argument. This allows its political adversaries to be painted as bizarrely opposed to an objectively correct scientific position, as either know-nothing rubes who probably don’t even believe in evolution or as greedy stooges of the criminally rapacious insurance industry. Contrast this to the media presentation of healthcare policy initiatives in the 1960’s, particularly the establishment of Medicare as part of Johnson’s Great Society. As the phrase “Great Society” implies, arguments for Medicare had nothing to do with macroeconomic theories of efficiency and everything to do with political theories of justice. All of Johnson’s political initiatives, from Medicare to the Civil Rights Act, were based on a Narrative of Social Justice, an explicitly political argument that made little pretense of marshaling social science to prove the point. Seems like a more honest mode of politics to me, one that recognizes and embraces the hot-blooded nature of politics for what it is rather than hiding it within a cool armor of Science, and maybe that’s why Johnson’s policies have stood the test of time.

Why has the Narrative of Science been co-opted in this way? Because it works. Because Science is the dominant religion, i.e. belief system in transcendent forces, in the West today. Because politicians have always sought to direct or tap into these belief systems for their own ends. In exactly the same way that French kings in the 13th century used ecclesiastical arguments and Papal bulls to justify their conquest of what we now know as southern France in the Albigensian Crusades, so do American Presidents in the 21st century use macroeconomic arguments and Nobel prize winner op-eds to justify their expansionist aims. Economists play the same role in the court of George W. Bush or Barack Obama as clerics played in the court of Louis VIII or Louis IX. They intentionally write and speak in a “higher” language that lay people do not understand, they are assigned to senior positions in every bureaucratic institution of importance, and they are treated as the conduits of a received Truth that is – at least in terms of its relationship to politics – purely a social construction. I’m not trying to be flippant about this, but when you read the history of the Middle Ages I find it impossible not to be struck by the similarity in social meaning between clerics then and economists today.

So why does this bug me so much? What's the big deal about wrapping a political argument in the mantle of Economics in the same way that it used to be wrapped in the mantle of Catholicism? Isn’t this what powerful political and commercial interests have done since the dawn of time, drawing on some outside source of social authority to support their cause?

Part of the answer is that as a limited government, small-l liberal I’m on the losing side of this particular political argument. I believe that it’s crucial to allow everyone to be as stupid as they want to be in their personal economic decisions because a) economic vitality and growth in the aggregate requires plenty of individual mistakes and losers along the way (sorry, but it does), and b) the alternative – allowing or requiring government to make these decisions on our behalf – inevitably creates a terribly fragile system where a single poor decision can lead to permanent ruin. Is it difficult and at times inefficient to maintain limited government in a mass society? Absolutely. Should we make small exceptions to these liberal principles to grease the wheels of effective governance in ordinary times, and big exceptions to these principles in a national emergency? Without a doubt. I think Lincoln saved the United States in 1861 when he suspended habeas corpus and imposed martial law in wide swaths of the country. I think Bernanke saved the world in 2009 when he implemented QE 1. But like the Roman dictator Cincinnatus, a great leader goes back to the farm after he saves the Republic. It’s the hardest thing to do in politics … to voluntarily relinquish emergency powers used wisely for the common good, to maintain a personal humility and trust in the system in the aftermath of great success. George Washington did it, and that’s why he’s the greatest President this country ever had. I understand that it’s not terribly likely we’ll ever see Washington’s like again … different times, different world, etc., etc. … but hope springs eternal.

The other part of the answer is that using Science for political ends subverts its usefulness (as does using Religion for political ends … just ask Martin Luther). We lose something very important when we associate a particular social scientific hypothesis with a winning policy outcome or a losing policy outcome, and that’s the recognition that social science – particularly economic science – is never True or False, but only more or less useful depending on whatever it is in life that you value … your utility function. Both as individuals and as collectives, we can achieve much greater levels of utility – we can be happier – if we maintain this agnostic view of Truth when it comes to social science. Politicians want to sell us on the notion that they have The Answer, that they can deliver the good life if only we keep them in power. Social scientists – or at least honest ones – recognize that there are no Answers in the patterns and relationships they identify, even if those patterns can be written in the highly precise language of mathematics. There is More Useful and Less Useful in social science … that’s all … and claims to the contrary detract from the very real benefits and advances that social science can provide.

Here’s a concrete example of what I mean …

Let’s say that you’re interested in wealth maximization, that this is the utility function you are most concerned with as an investor, and you want to know what percentage of your wealth you should allocate to the different investment opportunities you can choose from. Paul Samuelson, the most influential economist of the post-World War II era and the first American winner of the Nobel prize in Economics has an answer for you: . Translation: the more confident you are in the expected return of the investment choice, the more you should allocate to that choice, but in a more or less linearly proportional manner. On the other hand, Edward Thorp, author of “Beat the Dealer” and evangelist of the Kelly Criterion – an algorithm designed by mathematician John Kelly at Bell Labs in the 1950’s and used by investors like Warren Buffett, Bill Gross, and Jim Simons (if you’ve never read “Fortune’s Formula”, by William Poundstone, you should) – has a different answer for you:  . Translation, the more confident you are in the expected return of the investment choice, the more you should allocate to that choice, but in a logarithmically proportional manner.

The difference between investing on the basis of linear proportionality and logarithmic proportionality is vast and incommensurable. With the Kelly criterion, even a small expected advantage in the investment odds – say a 52% chance of doubling your investment and a 48% chance of losing it all – requires you to invest a significant portion of your overall wealth, in this case about 2%. With a larger expected advantage in the investment odds, the recommended allocation gets very large, very fast. If the odds are 60/40 on doubling up/losing the entire investment, Kelly says invest 20% of your total wealth; if the odds are 80/20, Kelly says invest 60% of your total wealth in this single bet! Definitely not for the faint of heart, and definitely a far riskier strategy at any given point in time than the straightforward Samuelson expected utility approach. But you never lose ALL of your money with the Kelly criterion, and over a long enough period of time (maybe a very long period of time) with infinitely divisible bet amounts and correct assessment of the investment odds, the Kelly criterion will, by definition, maximize the growth rate of your wealth.

These are two VERY different answers to the wealth maximization question by two world-class geniuses, each with a legion of world-class genius supporters. Samuelson is a lot more famous and received far more public accolades; Thorp made a lot more money from investing (Kelly died of a stroke at age 41 in 1965 and never made a dime from his theory). But they can’t BOTH be right, the politician would say. What’s The Answer to the wealth maximization question so we can institute the right policy? Well … they ARE both right, there is no Answer, and the correct choice between the two depends entirely on your individual utility function. In fact, choosing either wealth maximization algorithm and imposing it on everyone is guaranteed to make everyone worse off in the aggregate.

How’s that? Let’s say I’m investing my life savings, and I’ve only got one shot to get this right. Not one investment, but one shot at implementing a coherent investment strategy for this, the only life’s savings I will ever have. If that’s my personal situation, then I would be nuts to choose the Kelly criterion to drive that strategy. It’s just too risky, and if I’m unlucky I’ll be down so much that I’ll hate myself. Maybe in the long run it maximizes my wealth growth rate, but in the long run I’m also dead. On the other hand, let’s say I’m investing a small bonus. It’s not the only bonus I’ll ever receive, and in and of itself it’s not life changing money. If that’s my personal situation, then I would be nuts NOT to choose the Kelly criterion because it has the very real possibility of transforming the small bonus into life changing money.

No one’s utility function for money is linear – $20 has more than 20 times the utility to me than $1 – and no two people have the same utility function for money – I’m sure there are people out there who care as little about $20 as I do about $1. Everyone’s utility function for money changes over time, and most are contextually dependent. It is impossible to design a one-size-fits-all wealth maximization formula, which is why human financial advisors have such an important job. It’s also why government efforts to force us to converge on a utility function for investment choices, healthcare choices, or any other sort of personal economic choice result in such a widespread gnashing of teeth and popular dissatisfaction. At best, it’s a myopic conception of how to generate more economic utility. At worst, it’s an intentional subversion of useful social science to cloak politics as usual. In either event, it’s something that deserves to be called out, and that’s what I’ll keep doing with Epsilon Theory.


Two quick points on portfolio management, utility functions, and the Kelly criterion that I’ll present without elaboration and will probably only be of interest to professional investors who are immersed in this sort of thing.

1) In several important respects, risk parity investment allocations are to 60/40 stock/bond allocations what the Kelly criterion is to Samuelson expected utility.

2) The allocation of capital by an investment manager who wants to establish multiple independent Kelly criterion strategies across traders or sub-investment managers, each of whose individual utility functions favors a fractional Kelly or Samuelson expected utility function, is a solvable game.

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22winmag's picture

People listen... baby!

The Alarmist's picture

I still have fond memories of Hutton as my first job out of the military, so it is a bit annoying for you to slime them by comparing them to the Chicago Five.

tsx500's picture

When B.H. Obama Talks .....

tsx500's picture

.... nobody listens !

XitSam's picture

Wrong! Obama listens!

bunzbunzbunz's picture

<----- Bunz is a shameless prick

<----- I want to diversify my SHTF fund with free bitcoins: http://freebitco.in/?r=25727

Say What Again's picture

Ok, let me guess.

Bunz is a shameless p...

derek_vineyard's picture

"we make money the old fashioned way, we steal it"



A Nanny Moose's picture

it means the teleprompter is functional.

Seize Mars's picture

Oh yeah those guys were great. Just fucking great.
Remember that little check kiting thing?
What, pray tell, would happen if an ordinary shmoe did that? Hm, my guess is prison. How did it work out for Bob Fomon?

aVileRat's picture

Glad TD spelled it out. Need to show newbies who may not be getting this depth from their equity sales manager and/or pit boss why the current situation is getting pretty bad. vol. is starting to feel like a Michael Bay movie.

Hutton unlike the Thundering Heard was up there with Burns Fry and Bear 1.0 (not the Flud factory). Not the biggest book maker on the street, but when you asked the brokers for 'the short side' they actually would talk the trade with you. Check kiting was not the whole place bro, that's like saying the whole MF global trading bench was in on Corzine's rubber-bond trade.




A. Magnus's picture

Fuck Royalty; bunch of non-productive welfare queens they are. Can't even wipe their own asses without paying someone to do it for them. Worthless fucktard examples of our species, not unlike trust funded CEOs who bring no new products or services to market...

TBT or not TBT's picture

That's outrageous talking about the Kennedy clan that way.

Newsboy's picture

Where's that "Plain Talk Express" these days?

NoDebt's picture

Is that Steve Liesman in the left hand photo serving drinks?

RMolineaux's picture

This item does not mention the role of massive advertising pressure through main stream media in forming consumer choices.  It is another case of simple-minded anti government propaganda.

A. Magnus's picture

Bullshit. It doesn't mention mass media because mass media IS government propaganda. ALL major media companies in the US got TARP bailout money in 2008/09; they are effectively state-run media now. The CIA tells CNN how to position its stories (since '97 at least). Sixty percent of all news stories originate as GOVERNMENT PRESS RELEASES!!!. And guess who pays off all the politicians come legislation or election time? The corporations in bed with the....wait for it...GOVERNMENT!

If there is ANYTHING simple minded here, it's the knee-jerk 'Defend the state no matter how rotten and corrupt it is' impulse you're displaying...

MeelionDollerBogus's picture

only affects dumb people. I filter out all advertising but if I happen to see an ad it has no effect on me.

homiegot's picture

People glisten?

infinity8's picture

This is a great article - Thanks ZH! (I only wish that I knew more than 2-3 people who will read and understand it.)

NOTaREALmerican's picture

Good article.   Thanks for posting it.

There are really very few small L liberals running about.    It's way to much fun for the "Conservative" and "Liberals" to run a government big enough to maximum the utility of annoying people.

Spumoni's picture

I disagree sir...there are many small-L liberals running about. We read the definition in Webster's, Oxford and found good company hidden among all the tribes.

MeelionDollerBogus's picture

personally I think Murrika would be better off & far more entertaining  to take all the "Conservatives" and "Liberals" and throw them in an arena. Gladiators.
From the Left, Liberons, armed with bong cannons.
From the Right, Conservatons, crushing & smashing with bible-dozers.
Think about it.
Free pizza for the first 1000 in the audience and a chance to compete - FREE!

TBT or not TBT's picture

A.K.A. "tyranny", as described by the founders.

TrustWho's picture

Economists play the same role in the court of George W. Bush or Barack Obama as clerics played in the court of Louis VIII or Louis IX.

I say people who get a PhD in social science become Pastors. Climate scientist always have a problem when prior to human existence this earth has been completely frozen and completely free of ice. Climate scientist can predict short term risk, but they can not predict the future climate metrics with any precision. Same for the best economist, especially the Fed, their models have little precision and almost no prediction power as human pyschology maybe irrational more than we think.

I think I like clerics more. At least they allow me to participate through prayer and meditation. 

Spumoni's picture

Sure they do - their prayers and approved meditations. These were the same guys who burned hundreds of thousands of people at the stake, for praying and meditating in a non-Papal-approved fashion. Not terribly different from what we are seeing in the economy, healthcare or most religions of the world today.

There's a lesson for us all in it- Catholicism claims to represent a god of love while practicing genocide, rape and pillage over centuries against Cathars, Bogomils and others, who actually practiced their religion as if love was the law and virtue a thing to cherish.

If Jesus does come back, I hope he can clear the temple of merchants before we crucify him again.

MeelionDollerBogus's picture

actually no, the climate scientists have been consistently right so far.

darteaus's picture

Instead of Left/Right, I evaluate according to who is trying to take my money and freedom:


Classical Liberalism--------------------------------------Fascism/Socialism/Communism/Kings/Emperors

Tea Party------------------------------------------------Statists

Rand Paul------------------------------------------------Barrack Obama


Mediocritas's picture

Try this, it's similar to what you're getting at here: http://www.politicalcompass.org/test

The basic idea is that it's too simplistic to describe politicians in one dimension (left vs right), and instead adds a second dimension. The 1st dimension is economic, the 2nd is social.

Doing it this way, it concludes that most of the US politicians who get described as libertarian aren't particularly libertarian at all (objectively), just that they are more so than Obama (subjectively).

Meanwhile, all of them, including Obama, are very much right wing. Most of the governments in the OECD today are right wing authoritarian (according to this 2d method). The tea party is best described as right wing neutral (a lot of US "libertarians" have a wide authoritative streak and tend to think more along the lines of, "get your hands off my stuff and stop telling me what to do", rather than "I'll take my hands off your stuff and stop telling you what to do").

Stalin: left wing, authoritarian
Gandhi: left wing, libertarian
Thatcher: right wing, authoritarian
Friedman: right wing, libertarian

blindman's picture

when e.f.hutton's place in brookville, n.y. was demolished a few years back
i got the marble mantle, fireplace surround stuff-thing and installed it at my house just for the joke
of it, the fun and depreciated statement of it all; true story and
mostly no one gets the joke.
it is for sale for $350,000 if anyone is interested. it appears to be
a beautiful yellow variety beige Italian marble, 9" compounded ogie affair inside
dimensions of 32 1/2 high by 36 1/2 wide.
when you tell the truth no one hears/believes you, "when e.f. hutton talks,
people listen."
anyway ....
call me if interested.

billwilson's picture

Single payer ... the only way to go!!!!!!


Screw the health/sickness industrial complex.

darteaus's picture

How about you pay for yourself, and I pay for myself?

blindman's picture

when you pay for yourself you will also necessarily
pay for the structure and function of the system to which
you entrust/deposit your health care. when i think about the cost
of that care, structure and training i wonder
if anyone can actually afford it when denominated in
federal reserve notes in the usa.
has nature itself been criminalized, declared a terrorist?

MeelionDollerBogus's picture

if you want but it does cost a lot more than single-payer.
In Canada we do single-payer & it costs a lot less without debt or overhang or bad budgets.


If you like what you don't know you like, you can keep what you don't know you like. But only after WE tell you what it is you don't know you like.

Spumoni's picture

"Everything not prohibited is proscribed. Everything not proscribed is prohibited." (source: R.A.Wilson) quote of the Midget (AKA Mgt.)

IndyPat's picture

"You'll pay to know what you really think"

- J.R. "Bob" Dobbs

Golden Showers's picture

Here's my problem: penny nickel dime quarter fifty cent dollar coin dollar bill 1 2 5 10 20 50 100. In a cash box. Get money, make change, get check.

How does one transition an entire world of people from token exchange to a new deal? I submit that the conditioning process for today's human is to get them to accept tokens and count change. Put some plastic crap in a plastic bag and hand it over. In our minds we believe it is money going through our hands. In our minds we believe something is bought. This is not true. There is no money of value. There is no spoon. Separate a person from their money and watch them become insane, a threat to themselves an others. All a belief that there is such a thing as value in chips, tokens, and plastic crap. Scare someone who is innured in money exchange and they will hoard and steal. This is what we see today, because times are uncertain and the rules are changing. The gap widens between college curriculum and street play. The indoctrination process has achieved success in cognative dissonance amongst our investment advisors, investors, and pigs.

Then, there's the "smart" folks: people who derive money from secondary sources: Cash is first, then checks, then stocks, bonds, then shorts and derivitives and algos. Dig a hole. The further a nonexistant substance is rationalized the more amazing the methods, arguments, rationalizations and actions people will succumb to for begging, borrowing and stealing from one another. All missing the point.

There is no such thing as money. It's just a very deep programming tool to keep you occupied and pre-occupied. The problem is that some folks are deciding to change this a little and it's a tough thing for educated, indoctrinated, serf slaves to comprehend.

Just shut up, go back to sleep and let the experts take care of their complete lack of control and stupidity over this transition peroid. Blame whom you will.

I remember Hillary trying to push a socialized medicine deal a few years ago. Welcome home. How about just ignoring and not consenting? But this is impossible for well conditioned token-pushers, whores, and junkies. Just shut up. Just go back to sleep. Just watch some TV or occupy your incredulity while the bulldozer clears a path to your door. After all you are all far more highly educated than I. I come to learn and get confused with acronyms and dumb shit. How about just consider the possibility that all the experiences in your life have been manipulated by people who want to exploit you and perpetuate their fraudulent existence as leaders and controllers. There is no money. There is no time. Just sit back, relax, and retire. Everything is fine. This is all for our best interest. We're being taken care of. Don't you feel it?

MeelionDollerBogus's picture

tangible goods are money. Pills, food in cans, tools, gold coins, etc., are money.
They are actual value, not a promise of value.
The only reason a person might desire the promise up front is because it's light-weight.
So no, I don't feel what you feel - quite the opposite.
Money is hard, real, important & the structure of life itself.
That which is not money is not physically in existence. It's faith or delusion. All other physical things are money to me, all.