Allison's Ode to the Second Moment


Welcome to the 58th issue of Allison’s Ode to the Second Moment, a newsletter about risk where you least expect it—even if it makes us angry and uncomfortable.

Furious about fallacies

In the past two weeks, there has been some stock market volatility. The Bull Market has been steady for almost a decade now. Every dip now leads people to worry this is it—a crash is imminent. But, as all us risk geeks know, timing is futile. If people aren’t comfortable with the possibility of losing money, then they probably should not own stock.

Now, some—or most—people will tell you that even if the stock market drops, if you wait long enough, it will come roaring back. There is less risk if you have a longer investment horizon. But that’s plain wrong. The Economist has a nice story on the fallacy of time diversification. True, longer time horizons have lower volatility relative to their mean, but there is also a serious tail risk that you will get decades of bad returns. Longer time means more risk—not less. This can be proven mathematically, just look at theta in Black Scholes. And yet the idea that time heals all stock corrections is still pervasive in personal and behavioral finance. Trust me, people get angry when you challenge the prevailing wisdom.

Now you might be thinking, well, I can’t think of a time an asset class did not eventually recover. To that, I say look at bonds. Prices have been trending up for two decades! People now say, in major news publications, rates will never rise back to their historical averages.

There have been serious costs to decades of low rates. It made low-risk or risk-free strategies incredibly expensive. This leaves people and institutions with two choices: save more or take more risk. We still don’t know the long-term consequences of putting investors in this position. I am starting to wonder if persistently low rates are the real retirement crisis, not under-saving.

This shows an asset class can trend just one way for decades. We need more financial literacy.

Russian Pensions

When I went to Russia a few years ago, I realized everything I thought I knew about the Russians was wrong. I figured a recession, driven in part by international sanctions brought on by Putin’s foreign exploits, would make him unpopular. But I spoke to many people who had genuine enthusiasm for him. No ruler they could recall brought economic prosperity. "Capitalism" in the 1990s was not so great for most households either.

Russians forgive their leaders for things we won’t, except for one thing: pensions. Yes, it always comes down to pensions. Even Putin may lack the political capital to raise the retirement age to 65. Perhaps pensions, not foreign sanctions, not political isolation, not a recession, or not murdering citizens and squelching free speech will be what finally breaks him.

If You Are Over 40, You May as Well Give Up

The announcement of the Nobel Prize in Economics is always a painful reminder of the benefits of youth. Prize winners are often over 60, but the prize is normally for work done decades ago. So if you have a Nobel in you, odds are you’ve written that prize-winning paper before turning 35.

Does that mean we are smarter when we are young? I am not sure. There are different kinds of intelligence that vary over the life cycle. Economists face more incentives to publish big papers when they are younger. Romer and Nordhaus provide two different examples. Romer did less research as he aged, and instead applied his research in practical ways and worked to reduce poverty. Nordhaus kept pushing the knowledge frontier forward. So maybe genius comes down to incentives and preferences.

RIP Dennis Hof

Dennis Hof, the owner of the Bunny Ranch, a Nevada brothel, died last week. I am quite sad about it. In the past two years, everyone I featured in my book grew to feel like a close friend. I have complicated feelings about him. But I can't deny there were aspects of him I genuinely liked and admired.

My complicated feelings keep drawing me to his story. We live in an era that seeks perfect victims and villains, but no one in the brothel fits either of these profiles. Dennis profited off women selling their bodies, he had sexual relationships with his employees, and he rewarded them for it. He also spent time with some unsavory characters.

The women in the brothel are equally complicated. Each one is there for different reasons and came from a variety of backgrounds. But many came from poor, broken families where men don’t work, drug addiction is rampant, and few have bank accounts (let alone saving). They do things and make choices many people don’t understand. They don’t totally fit in the #MeToo era, which aims to take sex out of the workplace. They don’t make for sympathetic victims and don’t want to be seen as victims.

But that does not mean they don’t have needs. Hof offered all the women good business advice and the most effective financial literacy training I’ve ever seen. Most critically, he asked every woman in his brothels to set life goals beyond the brothel. He once told me most of the women won’t be there long and will never make that much money again. He wanted them to plan for the future and use their money to lift them to something better.

Yes, there is something icky and self-serving in all this, but let’s face it: For many of these women, no one else told them they could achieve their dreams or offered a way to work towards them.

Without Hof, the future of legal brothels is uncertain. We might wish the industry didn’t exist but it does and always will. Legal brothels are safer than the illegal alternative. Hof took a large cut for providing this safety, that was his business model, and anyone who reduces risk is worth knowing in my opinion.

I visited the brothels to learn how safety is priced—and I was never comfortable there. But there was something refreshing about them, I had never been in any other place so free of hypocrisy.

Until next time, Pension Geeks!