Changing my mind about the value of the FDA and the sanity of the stock market.
When they change their minds it’s called “flip flopping”, when we do it it’s called “updating on evidence”.
As a rationalist, it bugs me to no end that changing one’s mind is considered a sin for politicians when it should count as a great virtue for everyone. I don’t know if it helped or hurt Hillary Clinton’s election chances, but it was painful to watch her pretend to have always supported gay marriage when she and her husband clearly opposed it in the early nineties. Would anyone have held it against her if she said that she spent a decade listening to LGBTQ folk describe their struggles and they changed her mind? I have seen people in my life update their attitude on gay rights and admired them for it, I would be proud to support a politician who did that.
Since I’m utterly unelectable as it stands I can admit freely: I change my mind all the time. Almost certainly, I don’t do it often enough. To encourage this process, the least I can do is get a blog post out of it whenever I flip flop. Here’s part 1, with many more hopefully to come.
Flip Flop #1 – I no longer believe that the FDA harms more lives than it saves
So put your matches away until further investigation. A lot of commenters on “EpiPenomenon” and on Reddit disparaged me for being a “101 economist” naively applying simplistic models to complex subjects. These comments did absolutely nothing to convince me. They neither offered a better model, nor told me something I did not know about drugs, nor refuted Economics 101 – that incentives drive decisions. Ultimately, these are genetic arguments – attacking the presumed source of my belief (a blind faith in markets) instead of the arguments themselves (that the FDA is incentivized to err strongly on the side of approving too few drugs too late).
What changed my mind was my mom, a chemist working in the pharmaceutical industry, who explained in detail the rules the FDA plays by and how they go about their job. In particular:
- The FDA has fast track programs with hard approval deadlines for important breakthrough drugs.
- The FDA relies on a global network of independent testing laboratories, which are subject to audit. These audits include FDA people physically looking over people’s shoulders and nitpicking their procedures. This network of labs requires a consolidated regulator enforcing a single standard, it wouldn’t work as well with the multiple competing xDAs I proposed.
- I underestimated the damage historically caused by untested drugs, the worst of which do their damage over a long period of time (e.g. through birth defects). This prevents a quick public reaction to harmful drugs that would limit the number of victims.
There was clearly a lot of direct evidence regarding the FDA I was unaware of, but many people found it easier to assume that I’m a brainless libertarian than to google any of it. The hierarchy of ways to change my mind on an issue is quite clear. Please keep the chart below handy when trying to convince me of something:
- Direct evidence
- Large bribes
- Circumstantial evidence
- Modest bribes
- Genetic arguments
Flip Flop #2 – I no longer believe in a weakish form of the Efficient Market Hypothesis, namely that prolonged market distortions are limited by the amount of money at stake
Election night didn’t change my mind about what is possible in politics. Besides having a different president, a country of 49% Trump voters is the same country as one with 51%. But a core belief of mine was shaken on election night: the efficient market hypothesis.
In the long-gone days of my carefree youth (2009-2010), I worked as a day trader for a hedge fund. My job consisted of reading economics news and clicking “buy” and “sell” as asset prices danced a merry jig on my five PC monitors. Then I read Nassim Taleb’s Fooled By Randomness, learned about efficient markets, realized that my trading returns are indistinguishable from random noise, quit my job and came to the US. Needless to say, the efficient market hypothesis played quite a role in my life.
A lot of my smartest friends work for hedge funds as quants and traders, and I understood that markets may be mistaken about a 0.1% discrepancy in the price of pork belly futures in Frankfurt and Chicago. Catching these mistakes is worth enough to keep my friends fed and clothed, but the amount of these mistakes is limited by the profitability of catching them.
I still believed that the markets are generally efficient with regards to common knowledge – that the current price of any traded asset (like a stock) completely reflects everything that is known to the public regarding that asset. I fully believed that all the way through business school, where every single finance professor endorsed weak form EMH and where I rejected several opportunities to go back to the investment management industry. I kept absolutely believing in weak form EMH up until 4 am on election night:
At least since October, the US stock market projected that a Trump victory would drop American stocks by 10%-12%. This wasn’t hot air spewed by talking heads on TV, it was reflected in the actual behavior of stock prices, in every buy and sell by a trading desk in Hong Kong or an algorithm in Greenwich. For this projection to be wrong meant that there was a pile of 2 trillion dollars, twice the GDP of Russia, free for the taking. The efficient market hypothesis doesn’t rely on all market participants being sane or even a majority of them, just enough sane people to grab 2 trillion dollars of free money.
The 10%-12% projection more or less matched the stock market behavior on election day, with stocks rising 2% as Trump’s chances dropped from 30% to 10% in the early afternoon, then crashing in the evening as Trump’s victory became likelier and likelier. And then, at 4 am, all the humans and robots who until that point believed that “Trump = 10% drop” changed their minds simultaneously and US stocks hit historical highs.
I have read several explanations of this, and they are all obviously fake in the sense that believing the “explanation” and knowing the election results ahead of time would not have caused you to predict the stock market movement that occurred. The stock market could not rise 10% on news of a Republican senate because the senate races were decided by 11 pm and the odds of a Republican congress given a Trump win were around 90% anyway. The stock market could not have risen on confirmation of a peaceful transition of power because Hillary was winning the popular vote and there’s no way that massive protests seemed less likely at 4 am than the day before.
A lot of very smart people built very complex models that had to account for all eventualities, from a recount in 5 states to a terror attack the morning of the election. The actual outcome (Trump win, Republican senate, Clinton concession, conciliatory victory speech) landed well within the anticipated range. And then, suddenly, everyone decided that the models were wrong after all and Trump is good for US stocks.
This leaves us with three options:
- Everyone trading US Stocks was collectively insane in their projection of the election’s impact, and there were indeed 2 trillion dollars up for grabs for almost a month, up until election night.
- All the models before the election were correct, and everyone is insane right now due to runaway optimism bias. This means that there are 2 trillion dollars available this very moment to anyone shorting US stocks.
- Everyone was insane, is insane, and in fact the stock market is not driven by the correct pricing of publicly available knowledge but by restless voodoo spirits flitting to and fro likes yo-yos in the hands of capricious gods.
Take your pick, and let me know if your hedge fund is hiring.