Summer is fleeting. Who is really in charge? Market solutions for social problems.
Summer is fleeting. The point where you tend to realize with some wistfulness that you didn't do half the things that you set out to do.
Markets are eager to put the depths of the pandemic in the past; favoring a forward-looking stance as reopening’s become a reality. While the transition to a new normal is far from complete, the return of commerce in many parts of the economy will mark an important inflection point.
Attention will continue to be paid to the Covid-19 variant stats and risk assets could lay vulnerable to a spike in cases; however, for the briefest of moments the good weather and increased daylight rekindle childhood memories of summer camp, BBQs, and in-range, low volatility financial markets.
Historically the end of summer is characterized by limited investor conviction and low trading volumes; the Pandemic challenges this typical pattern. In other words, blind faith in the weight of past patterns makes no more sense than completely ignoring them. Especially as we have just witnessed:
- One of the largest pandemics to reach us since the Spanish Flu of a century ago.
- The biggest economic contraction since 1929.
- The largest and fastest oil-price decline and bounce-back in the OPEC era.
- A historically unprecedented amount of central bank intervention and fiscal response.
Covid-19 and the subsequent, unprecedented degree of chaos have sparked two distinct fascinations. It has introduced a general societal ambiguity, and the ultimate consequences of all the novel policy initiatives will not be understandable for a considerable period of time. It has also served to fast-forward and solidify trends previously percolating well before the Pandemic. Working from anywhere being on the top of the list.
And yet we hold that the future for all these things (Pandemic, Covid-19 variants, economy, markets, society) is clearly unknowable. We have no reason to think we know how they will function in the months ahead, how they will interact with each other, and what the consequences will be for everything. Yet, that does not keep one from reaching conclusions about it all and holding them firmly.
Who’s Really in Control?
“Markets change, as do plans, circumstances, luck; even destiny can shift, ripple. Markets rise and fall, and with them the investors who ride upon this wave, believing they are somehow in control.” (“From the Pits” Newscorp Publishing, Larry Shover, 2016).
The fundamental problem with financial risk, be it market, credit, or operational risk, is that it is based on the notion of probability. What is probability? In its most basic form probability can be defined as the chance of a particular event occurring. But this chance, this probability is a figment of our imagination and one that only exists in our minds.
First, probability exists in our minds and is simply a reflex of how much information we possess. Second, we cannot observe probability - catch it in the act like watching a sun rise or attending a baseball game.
Say, I am holding a coin in one of my folded palms and ask you what the probability is that the coin is in my right palm? You would immediately answer 50% as your estimate is based on lack of information on your part. However, I know exactly in which of the palms I am holding the coin it is indeed in my right palm then, for me, the probability of the coin being held in my right palm is 100%.
Now addressing the second point, you cannot catch probability in the act. The probability measure exists in our minds and is hidden inside a mathematical model. It can never be observed as reality unfolds.
Real estate prices, and indeed the prices of all financial assets are assumed to move randomly. This randomness is all about probability. And since this random number is a probability measure there are infinite probability as to where the property will be priced tomorrow given where it is today.
Physicists can tell you when Hailey’s comet will return or when the next solar eclipse will happen. Doctors can more or less tell a pregnant woman as to when precisely she can expect her baby. Their mathematical models produce precise dates and times for the happening of such events. But an investor forecasting the value of a southwest Florida property doesn’t have this luxury. They are at the mercy of a model that is totally depending on “probability distributions” and the notion of randomness.
Rewind your favorite thriller movie and watch it backwards. As the movie runs backwards, you would see all the randomness has vanished. The story – in reverse – has an exact order to it and fits in to the last detail. Where did the randomness go?
Market Solutions for Social Problems
Imagine if all the speculative fervor in 2020 and 2021 could have been channeled into a productive venture or asset that benefitted society as a whole. What if, for example, the Robinhood / Reddit faithful were investing in opportunity zones (or something of that sort) instead of meme stocks? If there was a way to get these traders excited about investment opportunities advancing society, imagine what could get funded and accomplished?
History demonstrates this has happened before. With lower-income housing becoming a real issue in Victorian England, a solution was developed that combined the same concepts driving impact investing today: Positive Social Impact & Investment returns.
In fact, investors at this time had another term for what we call this type of investing: “Philanthropy & 5%”. The idea being that investors could commit to a philanthropic cause, while earning a 5% dividend or return on their investment. The market solution to Victorian London’s housing problem was ‘Model Dwelling Companies’, or MDCs.
In nineteenth-century England the most innovative response to the problem of providing decent working-class housing in inner-city areas was developed, not by charities or the public sector, but by a group of market institutions, called model dwellings companies (MDCs), which sought to demonstrate that there was no necessary contradiction between private profit and social welfare objectives.
MDCs attempted to develop an institutional form and system of operation which could provide affordable and more salubrious accommodation for the working classes and generate a ‘fair’ return for those who financed this provision. ‘Five per cent philanthropy’, as the model dwellings movement has become known, has generally been dismissed as a failure. Earlier studies have asserted that these companies provided an insignificant amount of working-class housing, and that they were unable to provide adequate financial returns to investors. This dismissal has, however, been somewhat hasty and premised upon assumptions about the inevitability and superiority of subsequent state provision. The study of the outputs of these organizations in social welfare terms has been incomplete, and the economics of their operation has barely been considered.
Dividends were comparable with those paid by other property companies and for most of the period the annual average realized returns offered were not markedly different from those paid to holders of other domestic assets.