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The Herd Mentality – The Left Tail Will Follow The Right Tail

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Submitted by Guy Haselmann of Scotiabank

The Herd Mentality – The Left Tail Will Follow the Right Tail

Last Friday in NY, I attended a fabulous Monetary Policy Forum sponsored by the Initiative on Global Markets, a thought-leadership-medium set-up within the University of Chicago Booth School of Business. This annual event is increasingly being viewed as ‘Jackson Hole East’. Eight current members of the FOMC were in attendance including Stanley Fischer (not yet confirmed). Former Treasury Secretary Robert Rubin gave the keynote lunch address.

Each year the conference begins with a highly-topical report co-authored by a few economists and academics, and which serves as the basis for initial discussion. This year’s paper was entitled “Market Tantrums and Monetary Policy” (on website). The paper was successful at proving that there is the potential for financial instability even with subdued leverage in the banking system.

The authors drew five conclusions:

1) the absence of leverage in the banking system is not a sufficient reason for Monetary Policy to disregard concerns for financial stability

2) the usual macroprudential toolkit does not address instability driven by non-leveraged or non-bank investors;

3) forward guidance (like ZIRP – my words) can encourage risk taking that can lead to risk reversals;

4) financial instability need not be associated with insolvency of financial institutions; and

5) Tradeoffs for monetary policy are more difficult than portrayed.

The tradeoff is not the contemporaneous one between more versus less policy stimulus today, but is better understood as an intertemporal tradeoff between more stimulus today at the expense of more challenging and disruptive policy exit in the future.

The paper did not comment on how policy makers fundamentally assess and mollify the tradeoff between attempts at stimulating real economic activity and financial stability. I was surprised that Fed officials so openly admitted their policies cause moral hazard problems and power the ‘search for yield’. One interesting point is that Fed officials seem to tacitly admit that supervisory tools alone may be insufficient to protect markets against excessive risk-taking and that monetary tools may be required.

The word “tantrums” referenced in the title was the paper’s attempt to explain adverse market reactions, e.g., last year’s reaction from ‘taper-talk’. The authors stated that risk premiums can jump quickly, simply because non-bank market participants (read: mutual funds) are motivated by their peer performance rank. The authors had 3 subsequent conclusions:

1) the relative peerperformance race causes momentum in return;

2) return chasing can reverse sharply; and

3) changes in the stance of monetary policy can trigger heavy fund inflows and outflows.

These conclusions partially explain (empirically) the herd mentality and momentum in recent years behind tight credit spreads and elevated equity prices. Investors are so fearful of missing the upside and underperforming peers that they frantically scramble to remain ahead of them (i.e., seek risk). However, the conference and paper suggests that there is a threshold point during the Fed’s attempt to normalize policy where the tide reverses and investors join in a selloff in a race to avoid being left behind. This is why I’ve been calling it the greater fool theory.

The most surprising part of the conference was Rubin’s keynote speech. Most thought he said little, but I found the topic of his speech a bit startling. Rather than speak about Washington’s messy politics or such, he basically gave a speech that criticized and questioned Fed policy.

He began by saying that forecast models don’t work; particularly with the complexities of today’s modern world. He said that it was unwise to depend too much on  models and that nothing can replace experience and intuition. He said, there is never perfect information and uncertainties always exist, so decisions must be made through judgment about the probabilities of potential outcomes. He suggested that anecdotal information was as helpful as quantitative analysis. As a case in point, he mentioned a recent dinner with 10 senior corporate executives who all unanimously said that business investment and growth were sluggish.

Rubin said the Eurozone is more vulnerable than most think, especially given EM exposures. He suggested there is great tail risk that is not properly reflected in market prices. He said tail risk always exists, but it can’t be ignored. He said the best way to deal with it today given high probabilities and low risk premiums is to reduce exposures.

The last part of his speech continued to criticize the Fed in his friendly and humble way, often saying that “you know more about this than me, but….”. He thought the risks to QE3 far outweigh the benefits. He blasted Fed policy for elevating moral hazard and encouraging excessive risk taking. He commented on the unpredictable market reaction from, and difficulties in, unwinding the balance sheet and trying to normalize policy. He said the ultimate effects cannot be ascertained by models (rub it in). He blasted forward guidance as having no validity saying that it is impossible to know what is going to happen in 6 months.

Cracks in the foundation are evident. Buy Volatility.

“Two roads diverged in a wood, and I – I took the one less traveled by, and that has made all the difference” – Robert Frost

 

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Wed, 03/05/2014 - 20:24 | 4514411 Rakshas
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HA HA HA HA ....... What's this got to do with Ukraine??

 

 

 

 

 

oh yeah Beans Bullets Silver and Gold ....... long term investment

Wed, 03/05/2014 - 20:26 | 4514422 zorba THE GREEK
zorba THE GREEK's picture

Zorba will follow some tail now and then.

Wed, 03/05/2014 - 20:29 | 4514436 fonestar
fonestar's picture

Turn you lives over to Satoshi Nakamoto!  The end fiat times are at hand!

Wed, 03/05/2014 - 20:35 | 4514451 LawsofPhysics
LawsofPhysics's picture

...says J.P. Morgan.  (yes, everything will be absolved once you confess)

 

Where have we heard this before? Fucking troll is still giving himself the "up arrow".

Wed, 03/05/2014 - 20:38 | 4514475 fonestar
fonestar's picture

and you a down arrow!

Wed, 03/05/2014 - 20:39 | 4514479 LawsofPhysics
LawsofPhysics's picture

So how are things at the morge?

Wed, 03/05/2014 - 20:41 | 4514489 fonestar
fonestar's picture

What morgue?

Satoshi lives!!

Wed, 03/05/2014 - 20:44 | 4514497 LawsofPhysics
LawsofPhysics's picture

In your imagination. 

 

Maybe you don't work for the morgue, they do understand one thing after all; " when fraud is the status quo, possession is the law"

 

There is a quote out there about real money too...

Wed, 03/05/2014 - 22:28 | 4514816 philipat
philipat's picture

And JPM will only get interested in Cryptocurrencies when they can finally, after 150+ failed attempts, get something patented. There's no money to be made in things that don't provide monopoly/oligopoly protection for manipulation and fraud.

Wed, 03/05/2014 - 21:03 | 4514601 nmewn
Wed, 03/05/2014 - 21:12 | 4514651 NemoDeNovo
NemoDeNovo's picture

Oh man nmewn, PLEASE don't give him any more ammo, I have been 'hoping' he would just go away, now he will pimp that one when btc dries up and blows away.

Wed, 03/05/2014 - 21:16 | 4514666 fonestar
fonestar's picture

That fonestar would go away?  fonestar has been here longer than you moron!  And Flexcoin was an exchange, not an altcoin.

Wed, 03/05/2014 - 21:35 | 4514765 nmewn
nmewn's picture

And Flexcoin & Mt Gox going tits up are doing what to the percieved value of BitCoin?

Wed, 03/05/2014 - 21:34 | 4514755 nmewn
nmewn's picture

lol...the lawyers & regulators are going to have a field day with these bitcoin exchanges going TU. The people who were robbed aren't going to take this laying down and the story will be...wait for it...Crypto-Coiners ask government to intercede...almost comical.

But what the hell, its not like we didn't warn them.

Wed, 03/05/2014 - 20:57 | 4514577 zionhead101
zionhead101's picture

Satoshi like Jesus Christ, was banned/deleted and purged from ZH a long time ago foney and you know it.

Wed, 03/05/2014 - 20:24 | 4514416 Lumberjack
Lumberjack's picture

Be watching the energy sector closely. There is some serious shit happening.

Wed, 03/05/2014 - 20:28 | 4514432 Rakshas
Rakshas's picture

which areas of operations man ........ What'd ya got?? 

 

I gotta catch a flight back into the belly of the beast in a few days appreicate a heads up por favor

Wed, 03/05/2014 - 20:36 | 4514472 SameAsItEverWas
SameAsItEverWas's picture

Be watching the energy sector closely. There is some serious shit happening.

Thanks!  CL is at 101.00 now and looks like it'll retest 100, with the 0.621 of January's 91.24 to 105.22 rally being around 99.9. 

Wed, 03/05/2014 - 20:25 | 4514418 LetThemEatRand
LetThemEatRand's picture

"The paper did not comment on how policy makers fundamentally assess and mollify the tradeoff between attempts at stimulating real economic activity and financial stability."

The paper did not comment on how policy makers fundamentally don't give a shit about attempting to stimulate real economic activity and instead just want to line the pockets of the bankers and oligarchs and enslave the population.  Fixed it for you, Scotiabank.

Wed, 03/05/2014 - 20:32 | 4514446 LawsofPhysics
LawsofPhysics's picture

There you go, now about the sustainability of all this activity...

Did I mention I bat last?

Wed, 03/05/2014 - 20:56 | 4514570 zionhead101
zionhead101's picture

They must be maintaining two set's of books, that they're modelling.

I suspect the 'slave model' is 100% following plan.

1.) The Slave book, everything on schedule according to plan

2.) The fake economy book, ... Houston we have a problem

Me thinks in actuality, they are manufacturing a crisis,and #1 is the solution.

Wed, 03/05/2014 - 21:00 | 4514584 LetThemEatRand
LetThemEatRand's picture

No doubt.  All according to plan, including all of the recent manufactured military posturing among the various world powers that will convince the sheep that we need to keep printing to fund the MIC even if it means we're all eating cat food for dinner.

Wed, 03/05/2014 - 22:32 | 4515028 Luckhasit
Luckhasit's picture

C'mon whose gonna junk that!

Wed, 03/05/2014 - 20:35 | 4514448 carbonmutant
carbonmutant's picture

He began by saying that forecast models don’t work... after wasting $Trillions

Which is good 'cause Yellen's not going waste time on any inconvenient truths....

Wed, 03/05/2014 - 20:33 | 4514449 Cursive
Cursive's picture

Friendly and humble way?  Robert Rubin?  A conference as seen through the eyes of a bankster sychophant.  Bullshit on this whole piece.

Wed, 03/05/2014 - 20:35 | 4514450 ebworthen
ebworthen's picture

Rubin is part of the "baffle 'em with bullshit" brigade.

A gentle dissenter here and there adds to the validity of the Ponzi.

Kind of like the plant in a crowd listening to the snake oil salesman:

"How do I knows that thar elixir works Mister?"

"Here you are sir, try a free sample."

*Gulp-gulp-gulp*

"Whoo!  Tarnation!  It didn't fix mah bum leg but this tooth ain't as sore and I feel younger!  I'll take three!"

He is still drawing a salary, I presume.

Wed, 03/05/2014 - 21:25 | 4514637 RaceToTheBottom
RaceToTheBottom's picture

He has sure helped Citi out........  LOL

I guess when you are once on "the committee to save the world",  peon roles like chairman are too pedestrian for him to take any responsibility for....

Wed, 03/05/2014 - 21:19 | 4514680 nmewn
nmewn's picture

Rubinomics.

A douchebag extraordinaire, I can't believe people still listen to him, even bother to comment on what he says, let alone pay him to say it.

The author even mentioning him rates it a one.

Wed, 03/05/2014 - 20:34 | 4514460 i_call_you_my_base
i_call_you_my_base's picture

I wouldn't be caught dead at something described as a "thought-leadership-medium".

Wed, 03/05/2014 - 20:36 | 4514470 trustee
trustee's picture

Hey Guys! I thought JPMorgan was supposed to collapse on its short silver position and gold should be at 100k/ounce by now? What happened?? O whats that? It was all garbage speak by a bunch of goons who think they can predict the collapse???

Wed, 03/05/2014 - 20:40 | 4514483 LawsofPhysics
LawsofPhysics's picture

We underestimated the ignorance of the sheeple and the power of the printer.

Wed, 03/05/2014 - 22:35 | 4515040 Luckhasit
Luckhasit's picture

Ha!

Wed, 03/05/2014 - 20:41 | 4514487 i_call_you_my_base
i_call_you_my_base's picture

He's an idiot:

" forecast models don’t work"

"through judgment about the probabilities of potential outcomes."

 A probability is a model.

"He suggested that anecdotal information was as helpful as quantitative analysis."

Anyone who uses anecdotes to analyze the world is a sucker.

Wed, 03/05/2014 - 20:42 | 4514491 zionhead101
zionhead101's picture

"Our shit don't Work"

"What are the paying us for?"

Keep it secret, keep it safe.

*

How would you feel to be an economist, and your job was to make an irrational INFINITE-FIAT-FOR-FREE paradigm appear rational, in an irrational world.

To keep up the chin day in and day out, and keep the narrative that the USA is a debt based democracy, when in fact the emperor pull's infinite FIAT out of his for free, and the taxpayer is a NON-EXISTENT animal.

Wed, 03/05/2014 - 20:41 | 4514492 NoDebt
NoDebt's picture

And all this discussion ends with what?  Certainly not with a simple approach called "allowing failure".  Without the possibility of failure, all rules, all "models" become meaningless.  If not allowing their outright failure, at least breaking up the big banks would have been possible a few years ago, but not now.  Now the concrete has set around everyone's ankles.

Wed, 03/05/2014 - 20:45 | 4514507 LawsofPhysics
LawsofPhysics's picture

LOL!  fucking beautiful.

Wed, 03/05/2014 - 20:49 | 4514530 zionhead101
zionhead101's picture

The pattern is that all post's say nothing, ... because if you actually said anything you would be banned from 'jackson hole' east or west.

Certainly the Tyler's can find a man on the face of the earth that has something to actually say?

*

The problem here is what they should be saying is ..

1.) "OUR MODELS AREN'T MAKING MONEY"

2.) "Its impossible to take the facts on the street and create rational models to meet manufactured government statistics"

*

I agree that those with this "PROBLEM" concrete on the ankles, just means that now is the time for NIMBLE men, to make some real money.

Money is always to be made in any economic cycle, but its CLEAR the PTB have PHD's MORON's feeding them shit for their decision making.

Probably better to follow the CIA/MOSSAD/NSA model of MONEY-MAKING "HAVE GUN, GO SHOPPING"

Wed, 03/05/2014 - 20:50 | 4514536 i_call_you_my_base
i_call_you_my_base's picture

See, you're not getting it. The model factors in 0% failure and suggests you BTFD.

Wed, 03/05/2014 - 20:54 | 4514552 zionhead101
zionhead101's picture

10 senior corporate executives who all unanimously said that business investment and growth were sluggish.

*

Let's see the COP-SHOP, and ZIO- have euthanized the ameriKKKan male, drugged the children, and made whores of the women, and now the CEO's bitch about SLUGGISH markets.

The FED (CIA/MOSSAD/NSA) has exported all the jobs, and culled the population, and manufactured war's worldwide, leading to massive deflation. In order to force the world to CONTINUE using the USD for trade ( black market ).

Why can't everybody not work in social networking, or GOOGLE(NSA) spying,... its fairly obvious that traditional american BIZ is kaput.

Wed, 03/05/2014 - 21:05 | 4514611 LawsofPhysics
LawsofPhysics's picture

And yet they still sell bullets on the open market.  Something doesn't add up.

Wed, 03/05/2014 - 21:11 | 4514649 rosiescenario
rosiescenario's picture

Obviously these ten did not want to be invited back to yet another rubber chicken dinner.

Wed, 03/05/2014 - 21:13 | 4514656 rosiescenario
rosiescenario's picture

" He said tail risk always exists, but it can’t be ignored."

 

Wow....what insight....Tyler I have been on this board since the start and this is my first criticism....you can do better than this article.

Wed, 03/05/2014 - 22:41 | 4515067 madbraz
madbraz's picture

Obama is a Rubin puppet. Summers, Geithner, Bill Dudlrypretty much every Citibanker and Goldmanite in a position of power is there because of Rubin.

Quite possibly the world's most despicable wall streeter.

Do NOT follow this link or you will be banned from the site!