“The Experts Keep Getting It Wrong. And The OddBalls Keep Getting It Right.” Is This Really True, or Is it Survivorship and Outcome Bias That Make You Think So?

Select Excerpts from WSJ article: “The Outsiders Who Saw Our Future” (full article below):

“In both America’s energy transformation and the financial crisis, it took a group of amateurs to see what was coming”

“Over the past five years of business history, two events have shocked and transformed the nation. In 2007 and 2008, the housing market crumbled and the financial system collapsed, causing trillions of dollars of losses.”

“What’s most surprising about both events is how few experts saw them coming—and that a group of unlikely outsiders somehow did. Federal Reserve chairmen Alan Greenspan and Ben Bernanke failed to foresee the financial meltdown. Top banking executives were stunned, and leading investors such as Bill Gross, Jim Chanos and George Soros didn’t fully anticipate the downturn.”

“Bucking conventional wisdom is always risky, and many would-be mavericks in finance and the energy industry have failed.”

 Comments From Mike Perry, former Chairman and CEO IndyMac Bank:
“The few investors who got it right betting against mortgages in 2006-2009 or wildcatters who succeeded in making a bundle in oil and gas from shale formations, are the winners; the survivors. This WSJ article is infected with survivorship and outcome bias. Out of the tens of thousands of people who invested in these two marketplaces, these handful of investors and wildcatters got it right; this time. Take a look at the two short YouTube videos I have attached just below from a young man (who English clearly is his second language) who does a pretty good job explaining both survivorship and outcome bias. One of the best examples of outcome bias was the famed management book ‘Good to Great’; all you need to know is that Fannie Mae was profiled as one of a handful of truly great companies, based solely on its historical performance at the time. I would also point out that John Paulson (who is profiled in this WSJ article and got it very right for his investors betting against mortgages in 2009) lost his investors a historic sum just two years later. Paulson’s two largest hedge funds lost 36% and 52%, respectively, in 20111. Also, see Bernanke’s brief comments from his FCIC interview below: ‘in this blogosphere we live in today, at any point there are people identifying 19 problems, crises..’. The point being, most will be wrong. The ones who are right, may miss the timing or magnitude materially. And the maybe one who is right, will get a WSJ article like this one written about them; how they and their vision/strategy/process/people are somehow special, when they may or may not be. Finally, I would point out that a publicly-traded bank’s management can’t speculate or be contrarian like the guys who bet against mortgages and wildcatters; ‘the oddballs’. Their regulators and shareholders expect them to ‘follow the expert, consensus opinion’ at all times or else.”

1 ”This will certainly go down as one of the largest losses in terms of dollars and percent in the history of hedge funds,” said Bradley Alford, chief investment officer at Alpha Capital Management, which invests client money with Paulson. “When you see John Paulson cut you in half in a matter of months, after 17 years of stellar performance, you have to wonder the risk that hedge funds take to attempt to stand out in crowd of 10,000+ others.” Reuters, January 2012

Relevant Excerpt From Fed Chairman Bernanke’s 2009 Interview with The U.S Financial Crisis Inquiry Commission:

Commissioner Thompson: “So no calamity of this magnitude occurs without there being some early signals that something’s going wrong. In the case of this calamity, what were the signals? Why did we…and had we acted on them, might we have averted the disaster?”

Mr. Bernanke: “Well, I don’t know, I have to think about that.”

Mr, Bernanke: “I think there were people…there were people saying…including people at the Fed but others as well…saying, in the year before the crisis, that risk was being underpriced, that spreads were very narrow, that markets seemed ebullient, that liquidity was, in some sense, excessive. There were…you know, the way I would put it is, I think there were people…not necessarily the same people…identifying various parts of the problem…But I think notwithstanding the claims of one or two people out there who are now sort of living on the fact that they, quote, “anticipated the crisis”, I would still say that the interaction of these things, the “perfect storm” aspect was so complicated and large, that I was certainly not aware, for what it’s worth…and it could be just my deficiency…but I was not aware of any kind of comprehensive warning……in this blogoshphere we live in now…at any given moment, there are people identifying 19 different problems, crises.”

Vice Chair Thomas: “And they may be right at some point.”

Mr. Bernanke: “And this is the thing, one of them is probably right, but you don’t know who in advance….I would be very skeptical…there are people like…you know, even…take somebody like Robert Shiller who is now pretty famous for identifying the stock market and the house bubbles; right? A great economist. I have great admiration for him. He’s a very serious guy. But he identified the stock market crash when the Dow was at 7,000. So it went a lot further after that. And he was pretty open-minded in 2002, 2003, whether there was a housing bubble or not…So people that, quote, identify a problem, but they don’t get the timing and magnitude right. So I welcome your…you know attempts to unravel this…So while I can point to a number of different things various people said, I don’t know of anybody who really anticipated the…”

Commissioner Thompson: “So there were no actionable signals?”

Mr. Bernanke: “…If we had been smarter or more systematic, we might have identified them? Possibly, yes. So I think rather than saying, you know…obviously some folks are going to come out looking bad or whatever based on what they saw or didn’t see. But I think instead of relying on the future on particularly perspicacious financial geniuses who identify these problems accurately in advance, I think we just need to have a more systemic government or whatever structure that will at least make an attempt to look at the possible problems…”

ESSAY

The Outsiders Who Saw Our Economic Future

In both America’s energy transformation and the financial crisis, it took a group of amateurs to see what was coming

By

GREGORY ZUCKERMAN
Updated Nov. 3, 2013 12:33 a.m. ET
A worker at a hydraulic fracturing and extraction operation in western Colorado on March 29.ASSOCIATED PRESS

The experts keep getting it wrong. And the oddballs keep getting it right.

Over the past five years of business history, two events have shocked and transformed the nation. In 2007 and 2008, the housing market crumbled and the financial system collapsed, causing trillions of dollars of losses. Around the same time, a few little-known wildcatters began pumping meaningful amounts of oil and gas from U.S. shale formations. A country that once was running out of energy now is on track to become the world’s leading producer.

What’s most surprising about both events is how few experts saw them coming—and that a group of unlikely outsiders somehow did. Federal Reserve chairmen Alan Greenspan and Ben Bernanke failed to foresee the financial meltdown. Top banking executives were stunned, and leading investors such as Bill Gross, Jim Chanos and George Soros didn’t fully anticipate the downturn.

WSJ reporter Gregory Zuckerman, author of ‘The Frackers’, discusses how early pioneers of the fracking industry were seen as outsiders and ‘wildcatters’ by the established oil industry.

The big winners were people like John Paulson, an expert in mergers who only began researching housing in 2006 and scored a record $20 billion for his hedge fund. Jeffrey Greene, a Los Angeles playboy who partied with Paris Hilton, made $500 million predicting housing troubles.

In 2006, Andrew Lahde was an out-of-work 35-year-old stuck in a cramped one-bedroom apartment; then he made tens of millions of dollars betting against subprime mortgages. So did Michael Burry, a doctor-turned-stock investor in northern California with Asperger’s syndrome.

Wall Street talks up the importance of being contrarian. But in 2007, most traders subscribed to the mantra that the Fed wouldn’t let housing crumble or that the boom would continue, while others couldn’t find a good way to short subprime mortgages. They left it for the amateurs to figure out.

Less well known, but no less dramatic, is the story of America’s energy transformation, which took the industry’s giants almost completely by surprise. In the early 1990s, an ambitious Chevron executive named Ray Galvin started a group to drill compressed, challenging formations of shale in the U.S. His team was mocked and undermined by dubious colleagues. Eventually, Chevron pulled the plug on the effort and shifted its resources abroad.

Exxon Mobil also failed to focus on this rock—even though its corporate headquarters in Irving, Texas, were directly above a huge shale formation that eventually would flow with gas. Later, it would pay $31 billion to buy a smaller shale pioneer.

“I would be less than honest if I were to say to you [that] we saw it all coming, because we did not, quite frankly,” Rex Tillerson, Exxon Mobil’s chairman and CEO said last year in an interview at the Council on Foreign Relations.

In 2003, Alan Greenspan warned that the nation’s gas fields were running dry and urged Congress to back costly facilities to import gas. Famed investors Warren Buffett and Henry Kravisinvested in a record-setting utility-company buyout in 2007, wagering that a dearth of U.S. natural gas would send prices higher. Instead, the U.S. has so much cheap natural gas today that it is set to export it. The country is also pumping 7.9 million barrels of oil a day, up more than 50% since 2006 and the most in nearly 25 years.

The resurgence in U.S. energy came from a group of brash wildcatters who discovered techniques to hydraulically fracture—or frack—and horizontally drill shale and other rock. Many of these men operated on the fringes of the oil industry, some without college degrees or much background in drilling, geology or engineering.

In the late 1990s, George Mitchell, the son of a Greek goatherder, ran a midsize Houston-based company with shrinking natural-gas production. His stock price was falling, the industry was on its back, the 79-year-old had been diagnosed with cancer and his wife was in the early stages of Alzheimer’s disease. In almost two decades of trying, his men had not been able to coax enough natural gas from Mitchell Energy‘s Texas shale fields. But in 1998, one of Mr. Mitchell’s engineers finally figured out how to properly fracture shale, stunning colleagues and larger competitors while launching the American energy revolution.

Harold Hamm grew up dirt-poor in a tiny town in Oklahoma. He began school around Christmas-time each year, once it became too cold to pick cotton, and he started his career raking out oil tanks. Over the past six years, Mr. Hamm and his company have discovered so much oil in North Dakota that he is now worth $14 billion. Aubrey McClendon and Tom Ward of Oklahoma were land-leasing specialists; they managed to build the nation’s second-largest gas producer by leading the charge into shale fields. Charif Souki, a Lebanese immigrant and former restaurateur who knew more about fajitas than fracking, today runs Cheniere Energy, a Houston-based company that is on track to become the first to export gas from the contiguous U.S.

Bucking conventional wisdom is always risky, and many would-be mavericks in finance and the energy industry have failed. But corporate caution and complacency have their costs too, and today’s emphasis on short-term performance means that executives are even less likely to take long-term risks, to anticipate the unexpected. For the next great business revolution, it would be smart to bet once again on stubborn, flamboyant dreamers.

—Mr. Zuckerman is a special writer at The Wall Street Journal and the author of “The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters,” to be published Nov. 5 by Portfolio/Penguin, and “The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History.”

Copyright 2013 Dow Jones & Company, Inc. All Rights ReservedThis copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visitwww.djreprints.com

http://online.wsj.com/news/articles/SB10001424052702303618904579169513659659306

Posted on November 8, 2013, in Postings. Bookmark the permalink. Leave a comment.

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