The sacrifices I make for you people
I know that you all have a lot of concerns and questions regarding the oil spill in the Gulf of Mexico. Rather than leave your concerns unaddressed I went to get answers for you. I spent the last week travelling the Florida panhandle. I was up and down the Florida coast from Destin down to Carrabelle, through pines and palmettos, past the bays, the emerald waters, white sandy beaches, and palm trees, and all along the Gulf, and I did it all for you. Very selfless…I know.
The plan was to work during the day and be back at the house in the afternoon to hang out with the family…a combined work/family trip. The timing of my trip was accelerated due to the BP Oil spill. I’ve wanted to fish Apalachicola Bay for as long as I can remember and I thought that if I didn’t do it NOW then it might be a decade or more before it was fishable again.
Along the way I interacted with bankers, local folks, fishing guides, tourism employees, and workers at the local grocery store. I briefly flirted with the idea of attending a meeting at city hall to listen in on the latest thoughts and plans for the oil spill but the wife drew the line there. No municipal meetings for me while on “vacation”. She stopped just short of actually calling me a nerd but I could see from the look on her face that it’s what she wanted to do.
After a week of travelling, meetings, and conversations (all done for your benefit) I grabbed a 60 lb sack of oysters, two lbs of shrimp and a 6 pack of beer one evening and I sat down on the third floor deck that overlooks the Gulf of Mexico. From this lofty perch I watched the sun set and listened to the waves crash on the shore. The Gulf breezes blew, the dolphins played in the surf in front of me, and I sat back and thought about everything I’d seen and heard over the preceding days.
Lessons
The first thing I’m always reminded of is just how good of a barometer a community banker is. They always have their finger on the pulse of the local economy and are very good at providing you with the vital signs of their community. One of my banker friends that I met with had just done a tour of the public beach parking lot. At first I thought “wow…this Florida banker gig is a really cool job…he’s cruising the beach during the middle of the day.” As it turns out a parking lot is a very good source of real-time economic intel. On that particular day there were only two parking spots open…a sign of pretty healthy activity in the beach area. This is the type of thing a local banker would know to do. As a tourist I’d never pick up on it…I’d be too busy griping that there are no good parking spots. So at the moment activity is pretty good…but the cloud on the horizon is that there are a lot of people cancelling their vacation plans…even though there is no oil on their beaches. It’s guilt by association at this point.
The second thing is that I met nobody looking for a bailout of any sort. The Americans that I met wanted to WORK. That’s all they wanted…they wanted for people to come to the beach so that they could make a living. They weren’t asking for government funds, no handouts, no government dole. They just want the opportunity to work. That is a very refreshing change of pace from a lot of the news you see now-a-days. It’s nice to get away from the headlines and go meet real people that just want to work for a living, no complaints, no asking for handouts, they just want to keep doing their jobs and live the American dream…its America the way you remember it…before bailout fever broke out.
The third thing I realized is that there were no signs of oil anywhere I went. The beaches in Destin are still the picture perfect turquoise-water and white-sand gems that they have always been. Apalachicola Bay is still pristine and full of seafood waiting to be caught and eaten (that’s my view…if you take the Disney view of the world then it’s full of sea creatures living in harmony and talking with each other). If you’re looking for great beaches and a great vacation then I would urge you to ditch work next week and head to Florida.
Central Banks are like Sand Crabs
The other night we were walking on the beach…the whole family. My 10 year old son and 7 year old daughter were chasing sand crabs as we went. At one point they had chased a crab so far from his hole that his back was against the surf and they stood directly between him and the safety of his hole in the sand. The crab had run from his problems for so long that when he finally turned to face them head on he literally had nowhere to run and nowhere to hide.
These are no ordinary problems…from a sand crab’s point of view they are almost insurmountable. The crab is two inches tall weighs maybe an ounce…and he’s up against a combined weight of 100 lbs of my kids (these are your standard kids…their destructive force is approximately 200 times their combined weight…the crab has no chance).
To my astonishment, as the kids slowly moved in on him…he got all bowed up like he was going to fight. The look on its crustacean face seemed to say “don’t make me!” I couldn’t believe my eyes…who did this crab think he was fooling? He was posturing to make himself look as big as possible in an attempt to fool the world into thinking that he had some hope of controlling the issues in front of him. Moments later he was buried alive by a torrent of sand.
I laughed when I realized that this little sand crab trying to bluff my kids into backing down is a bit like a central bank trying to bluff the world into thinking that they can solve all of our problems with a bit of monetary policy and some market manipulation. With a balance sheet that has swelled to over a trillion dollars, economic problems raging on a global scale, and interest rates at zero I can only hope we don’t get buried alive as well.
Sub-prime Mortgages, shark fishing, and risk management
As I strolled on the beach with the family one evening I happened upon on a guy with a fishing pole. It was a picture that could have been taken right out of a salt-water fishing magazine…the sun had just set and he was out there with his family and he was surf-fishing…it was awesome. As I got closer I could hear the drag on his reel just singing as something stripped line from it. Despite the apparent action he looked fairly calm. I asked him “I hear your drag screaming…what do you think it is?” He pointed out into the Gulf and he said “it’s my dad”. I looked out in the direction he was pointing and about 300 yards out there was a guy in a small kayak…waaaaaay out there.
I then asked the next logical question “what’s he doing?”
The answer was that they were shark fishing and his dad was taking the bait out (they wanted the bait further out than they could cast…so they used a kayak). I told him good luck and began to walk off. Before I got a few steps away it hit me, and I turned around and congratulated him for being smart enough to send someone else out into shark infested waters at dusk in a small boat full of dead fish to get the bait right where they wanted it. He laughed and said that he himself had made the first six trips and this was his dads first.
Now…I love fishing…and catching sharks is pretty manly…but even I have to question the judgment involved with paddling out into previously chummed water at dusk in a small kayak full of shark attractant. I began to wonder if these guys get the Discovery channel. Surely they’ve seen sharks hammer things about the size of that kayak…its dramatic footage. I saw no beer anywhere near them…these looked like sober decisions.
It’s the kind of event you think about for a while. The first thought I had was that I need to buy a kayak ‘cause I’M DOING THAT next time I come down…but with beer so I have an excuse for the paramedics on my flight to the hospital.
So as I reflected on this shark-fishing technique from the tranquility of my beer and oyster infested balcony I realized that their method of catching sharks isn’t a whole lot different than the risk management analysis employed by sub-prime borrowers and investors.
Like the sub-prime borrower/investor the shark guys are completely ignoring the “tail risk” in the distribution of potential outcomes. The tails of a distribution are where the low probability events live. It’s the stuff nobody thinks about because “oh the chances of that happening are so low…blah blah blah”. If the severity of the low probability outcome is low…then it’s no big deal…you don’t get hurt too bad if the unlikely event comes to fruition. On the other hand…if the low probability event is accompanied by a high severity outcome then you could be in real trouble if you ignore it.
These guys are hoping that there is a big shark in the area. In a wonderfully ironic twist, if they are correct, and there is indeed a big shark in the area, then the severity of the low probability outcome increases dramatically…thus skewing their risk/reward tradeoff. This is a lot like the sub-prime borrower/investor assuming that home prices will never drop because it almost never happens…there is a very low probability of that outcome occurring so they ignored it. However…what they also ignored is that given their exposure, the severity of such an outcome would be crippling.
The way the shark guys are looking at it is this: if they are successful they might catch a three foot shark, if they are really successful they might catch an eight-footer...if unsuccessful they catch nothing. It’s a pretty sweet risk reward profile. It offers plenty of reward and not too much risk.
A more realistic view of their risk/reward profile is that if they are successful they catch a three-footer, really successful an eight-footer, unsuccessful they get nothing, and by using the fish-covered kayak they are really upping the probability of the previously unmentioned “very unsuccessful” scenario where the whole family gets to watch as one of them is eaten “Discovery Channel style” by an eight-footer. Given this more inclusive risk/reward profile people might make a different decision on how they fish for sharks.
In summary: when the low probability events just hurt you then you can probably get away with ignoring them. If however the low probability events can actually KILL you…then you need to pay more attention to them.
From a risk management standpoint fishing from the beach is a hedged bet. Using a kayak full of dead fish at dusk in shark filled waters to get your bait right where you want it is a leveraged bet. The risk/reward profiles can be wildly different. This provides a nice analogy for our sub-prime mortgage investors.
Chumming shark infested waters from a small kayak during prime feeding times for sharks isn’t all that different from buying houses in a real estate bubble using neg-am, interest only, whole loan hybrid arms and betting on the appreciation of the property to get you out of the loan.
They are both classic examples of low probability/high severity combinations. Both could easily kill you if the dice come up wrong.
In closing
Ultimately I’d say that if you want to help out in any way with this oil spill then the best way to do it is to go to Florida right now. Hit the beaches, enjoy the seafood, take in the sunsets…it’s all still there. I don’t know if the oil will hit these places at a later date or not…but I do know that it’s not there right now.
From Destin to Panama City, Port St. Joe, Apalachicola, Carrabelle and beyond it’s all pristine Gulf of Mexico beaches, waters and bays…and it can’t be beat. If you make the trip I know they’ll be glad to see you, you’ll help some hard working American’s keep their jobs, and you might even be able to see some sub-prime investors get eaten by sharks. What could be more fun than that?
Steve Scaramastro, SVP
800-311-0707
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