Schmalpha
Alpha versus Schmalpha. Timothy Geithner, I remember that name. Here he is in 2004, feeling sunny about the world. Saying, you know, we do need to worry about these systemic crisises, but on balance, the positive aspects dominate the less positive. Shocks may act more quickly, but they can be more easily diffused and absorbed. Institutions and markets seem better positioned to handle a substantial degree of stress. Shocks may be less likely to result in the type of trend-amplifying, signal-reinforcing dynamics for sustained periods of time that can threaten stability of the financial system. Okay, let's talk about selection and adverse selection. I don't know who I am. I'm just some guy. Is this the person you want at the helm? Is this the best person for this job? I mean, I, I'll take that he's got tons of expertise. I'll take that we want him on our team. But is this the right person to be running the show? Same time, I was running around like a chicken with my head cut off saying, "We've got a real problem out here." We have got terrible analytics. The analytics are being gamed, and the fact of the matter is, is that this system is going to be a threat to those of us who make their money in the financial markets, to investors, and I don't wanna make my money this way. I got a decent enough life as it is. I don't need to, to participate in this.
So we define Schmalpha to be excess value extracted, not from the capital markets, but from the investors in the capital markets. And the idea is that Schmalpha is easy to create if the analytics are all messed up. So these mortgage-backed securities with these big wide regions of uncertainty with no methodology for pricing are a place where schmalpha is going to collect. And in fact, you get this crazy notion. Instead of having a haircut, a discount, because of this extra risk, you in fact have a premium because there is more ability to hide, so that things that are more opaque command some kind of a premium because the people who are gonna manage the assets are dying to have more freedom to mark things wherever they want, rather than having their hands tied. So what we were predicting that we would get people providing Alpha and Schmalpha together. In the same presentation, I tried to explain-- Somebody had explained to me... I didn't originally know him as Bernie Madoff. I knew him as the Jewish T-bill. And in looking at his returns, said, "This is really frightening stuff. Why don't you wanna be involved with this guy?" I didn't know how it worked, but I knew that there was something really troubling. So I changed the name to BlackArts Capital because there's lot-- there's BlackRock, Blackstone, Black this, Black that. [sighs] And we tried to come up with a methodology which explained that the more uncertainty there is in a strategy that might go up and up and up, the more you have to average over both the risk and the uncertainty leading to smaller allocations. Not that you shouldn't allocate, but that you shouldn't allocate large amounts.
- Eric Weinstein Systems Architecture, Kabuki Capitalism, and the Economic Manhattan Project (YouTube Content)