“How to Lie With Statistics” a/k/a Ben Stein’s Modus Operandi

This is the title of a legendary book written in 1954 by Daniel Huff. In short, it explains to the layperson how they can be misled by the way information is presented, how those serving up the figures can be economical with the truth and to generally be on guard when consuming numbers, charts and graphs. Well, my bells were going off as if I were in the midst of a five-alarm blaze as I read Ben Stein’s piece in yesterday’s New York Times. It is articles like these for which Mr. Huff’s book was written: reader beware. Because if you take Mr. Stein’s figures on their face, you might actually believe his thesis. However if you dig down a few layers and think a little bit, it doesn’t take long for you to realize that what he is saying is the same weak-minded analytical drivel that he has been dishing out with such frequency of late. Why I do not know, but what I do know is that articles like these are dangerous because they contribute to a perception - no, a mania - that Wall Street is rotten to the core. And this is simply not true. Do problems exist? Of course, they do everywhere. But the extent of Mr. Stein’s indictment is both factually inaccurate and actually destructive of the conversations we should be having on how things should be fixed (like, say, the post I wrote yesterday concerning lessons we can learn from the recent crisis). In any event, the article was truly a drivel-fest and worthy of much scorn and derision.

In short, Mr. Stein’s thesis is that traders push the market around, plant stories with the press, get the hype machine going, and make a ton of money on the backs of dumb retail investors like you and me. Sure Ben, I’m sure every trader out there wishes it were only that easy. Unfortunately it isn’t. Your deep-seated conspiracy theories are coming to the surface again, Ben. There are the little issues of the depth of liquid markets (in terms of being effective in pushing it around except around small moments in time, i.e., the close) and the shallowness of illiquid markets (in terms of how do I get out without giving up all my ill-gotten gains?). The world has gotten very flat when it comes to the liquid markets, and if certain traders are trying to push the market in irrational ways there are always those who are willing to take the other side and push back just as hard. Eventually the market settles where it should based upon fundamentals, but for short periods of time it can deviate for any number of reasons. But to say that a trader’s core strategy is to establish a position, devote massive energy to hype it and then have the ability to profitably exit is a pure flight of fancy. It’s just not that simple. Sorry.

Now here is one of those number “facts” you’ve got to view with a jaded eye.

Note that the losses in United States markets alone are on the order of about $2.5 trillion
in recent weeks. How can a loss of roughly $100 billion on subprime —
with some recoveries sure to come as property is seized and sold —
translate into a stock-market loss 25 times that size? The answer is
trader realism.

Ok, now maybe it’s just me, but I’ve come to believe that the subprime issue has moved well beyond subprime portfolios themselves, no? In fact, I’ve written about this, and others have written about this extensively. Falling housing prices. Less purchasing power. An over-leveraged and distressed consumer. Locked credit markets. Falling corporate profits. Broken bank balance sheets. Diminished earnings expectations. Might this, when you capitalize the impact of these adverse events, equal 25x the subprime losses? I’d say so. And this doesn’t even take into account the possibility of subprime losses far exceeding the $100 billion mark. This isn’t called trader realism, Ben. It’s called reality.

Here is yet another example of twisted math:

The losses in the stock market since the highs of October 2007 are
about 14 percent. This predicts — very roughly — a fall in corporate
profits of roughly 14 percent. Yet there has never been a decline of
quite that size for even one year in the postwar United States, and
never more than two years of declining profits before they regained
their previous peak.

Here we’ve got the issue of a “stock” versus a “flow,” namely, the difference in accounting parlance between those things that are measured at a point in time (i.e., a balance sheet) versus those that occur over time (i.e., financial projections).  How does one equate a present value decline with an annual measure of a like amount? I’m not sure how Ben found economics so easy in school as his powers of numerical reasoning are sorely challenged.  A 14% drop in the value of the stock market (a stock) equates to a fraction of the present value of an expected 14% decline in corporate profits into the future (a flow). Why he attempts to link these two disparate concepts is a mystery to me. I’m still scratching my head over this one.

And his grand conclusion in the wake of such analytical and logical rigor:

In other words, traders are sending stocks down by a fantastically
larger amount than is warranted by a recession or the losses in
subprime. How and why does it happen? As someone said in the movie:
“Forget it, Jake. It’s Chinatown.” It’s just Chinatown in trader-land,
where money is made and there is no perspective.

So when you see
the market gyrating wildly downward and hear some pundit saying it’s
because of this or that data or this paradigm or that ratio, remember
trader realism. The traders move the market any way they want, any way
they think they can make money, and then they whisper a reason to
journalists later in the day. Then the journalists print it or say it
on television, and the amateurs believe it. And the traders snicker.

I think maybe he and Charlie Gasparino have been hanging out and sharing conspiracy theories while bowling or something. They both purport to “know” Wall Street and to “understand” the trading community, but little in what they say or write comports with any experience I’ve ever had in my 20+ years in the financial markets. I am much more concerned with compensation regimes, risk-taking and risk measurement on Wall Street, the real factors which drive trader behavior. With increased market liquidity, “dark pools” and the rise of offshore exchanges, it is harder than ever to game the system (smacking the close, trying to skew VWAP, stuff like that). And the thought that each trader has their little hotline to their journalist of choice is sheer fantasy. They are trying to manage their book and not get slammed while taking a piss. Because in today’s hyper-volatile, super-flat world, you’d better get your positions straight or you could meet with an unhappy fate. But Ben would have you believe that all these traders are just having a grand old time and laughing at us all the way to the bank. Yeah, right.

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COMMENT:

AUTHOR: peter

EMAIL: petervc@web.de

URL: 

DATE: 01/29/2008 02:45:19 AM

This is why blogs are invaluable. thanks.

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COMMENT:

AUTHOR: CoryS

EMAIL: mail@corysorice.com

URL: 

DATE: 01/29/2008 01:54:48 PM

As a non-savvy investor, Ben’s words are easy to want to believe as there have been enough examples of material abusive trading examples, even very recent ones (=www.sgcib.com), that make an outsider wonder what’s really running under the hood of the car they hold a key to.

Simple math - if a ‘flow’ drops by 14% and then reverts back to expected growth of 5% v. consistent flows of 5% previously expected, isn’t the resulting drop in NPV ~19% (over 5 years, with a terminal, 10% disc rate)?  

I’m with you that there are a lot of worse issues in the trading arena, but that’s why I’m reading up.  Thanks for the post to hit the other side of the conversation.

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COMMENT:

AUTHOR: Greg Battle

EMAIL: gbattle@gmail.com

URL: 

DATE: 01/30/2008 03:10:15 PM

You TOTALLY nailed him on the 14%.  He clearly has no idea what a stock is or what a stock price represents.  I’m shocked that people get away with writing such bullcrap.

His whole notion of trader realism is trite oversimplified hogwash by someone who just doesn’t get it at all.  

A little bit of knowledge is a dangerous thing.

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COMMENT:

AUTHOR: snaxalotl

EMAIL: snaxalotl@gmail.com

URL: 

DATE: 01/30/2008 10:42:00 PM

Ben learned a lot of what he knows from Trading Places, and the reason he seems a bit backwards is that he’s still waiting for Trading Places 2 to hit the theaters

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COMMENT:

AUTHOR: James Hanley

EMAIL: jhanley@adrian.edu

URL: http://uncommonliberty.blogspot.com

DATE: 01/31/2008 12:41:36 PM

I found this post through a link on The Panda’s Thumb.  It’s always nice to find someone who understands economics. Unfortunately most of what you read in the  op-ed pages of newspapers is written by amateurs like Ben Stein.

 A 14% drop in the value of the stock market (a stock) equates to a fraction of the present value of an expected 14% decline in corporate profits into the future (a flow). 

There are numerous things wrong with Stein’s numbers here, and I’m glad you pointed out his foolishness.  I’d say that he also seems to think the arrow of causality runs from stock prices to corporate profits (as though you selling a stock to me directly affects the corporation’s income).  

But, heck, any of my students understands the concept of discounting future flows.  If I ask them if they’d prefer $10 today or $10 2 months from now they always give the right answer.  I think Ben Stein would be stumped.

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2 years ago | view comments |  Wall Street