finem respice


Submitted by ep on Mon, 12/19/2011 - 15:12
yeeaaaaah... we won't get fooled again

Last week saw the release of a curious paper from authors toiling away from within the hallowed, marble-encased edifice of the Cambridge, Massachusetts based "New England Complex Systems Institute." The piece "Evidence of Market Manipulation in the Financial Crisis," bought to the attention of finem respice by the always engaging Alea, purports to be the first direct evidence of what the authors term a "bear raid." The piece goes on to insist that market transparency is presently insufficient to guard against market manipulation and closes with a call for more regulation to curtail short selling, via the "uptick rule" in particular. Even the most superficial analysis of the work exposes it as utter nonsense. A deeper look would seem to suggest that this paper, as well as The New England Complex Systems Institute itself, are the essence of corrupt, crony-science masquerading as legitimate study.

The New England Complex Systems Institute describes itself as: independent academic research and educational institution with students, postdoctoral fellows and faculty. In addition to the in-house research team, NECSI has co-faculty, students and affiliates from MIT, Harvard, Brandeis and other universities nationally and internationally.1

A quick look at data from OMB Watch makes it clear that the use of the word "independent" by the New England Complex Systems Institute (hereinafter "CSI:NE") is creative.

To say the least.

Records suggest that between 2000 and 2011 CSI:NE received $1.5 million in federal grants, $1.2 million in federal contracts, and $172,000 in stimulus money awarded under the The American Recovery and Reinvestment Act of 20092 for a total of over $2.9 million, $1.5 million of which looks like it was awarded between 2009-2011. The vast majority of these monies are listed by OMB Watch as falling under the sphere of Congressman Michael Everett Capuano's (D-MA) district, probably because the main offices of CSI:NE lay therein (read: in Cambridge).3 A little investigation suggests this fact is acutely relevant.

In recent years Professor Yaneer Bar-Yam, CSI:NE's founding president, has been anything but the sort of non-partisan, objective observer we should all hope that skeptical, critical-thinking scientists aspire to emulate. To the contrary, his ideological bent has taken on an overt and even flagrantly confrontational tone of the sort that all but precludes an impartial (or even mildly biased) observer from avoiding the conclusion that these spasms of advocacy seriously color the legitimacy of Herr Professor's work and that of CSI:NE, his captive think tank. But, even beyond his personal port tack, it seems clear that he has also regularly used CSI:NE and its work product to support his political and policy positions and advocate for them while buttressing his support with the trappings of CSI:NE generated "science." Such of the CSI:NE produced content as finem respice could actually stomach to review without resorting first to Dramamine and eventually Aprepitant seemed unified by qualities- a plethora of bite-sized "sound bitable" conclusions perfect for use behind some capitol podium, a wealth of caveated generalizations, convenient if predictably partisan policy recommendations, and even the occasional conspiracy minded accusation- that make it ideal fodder for unscrupulous legislators anxious to wield the "science-based" cudgel against their ideological enemies and, eventually, the American people and the world.

True, finem respice has often remarked on the unholy alliance of advocacy and science, but it is rare to find such flagrant examples of their recessive, hybrid lovechildren in the wild. In this vein our wayward hero's recent activities include:

  • Co-authoring with Robert Pozen a Wall Street Journal opinion piece supporting the "uptick rule," a position furthered primarily by reference to the early work which eventually resulted in the "bear raid" paper that is the central focus of this writing. Pozen, his co-author, formerly distinguished himself as the former Associate General Counsel for the SEC during the Carter administration, Secretary of Economic Affairs for then Governor of Massachusetts Mitt Romney and Chairman of MFS Investment Management, the oldest mutual fund company in the United States (and probably no fan of short sellers).4
  • Providing Congressman Barney Frank (D-MA) with a letter on CSI:NE letterhead to support Frank's efforts with the United States Securities and Exchange Commission to reinstate the rule:

    In view of the report we recently forwarded to you providing evidence for a massive bear raid on Citigroup at the beginning of the financial crisis, and the recent "flash crash" and other market gyrations, I am writing this letter to emphasize the ongoing risk to the financial system from unregulated short selling and the imperative to have the uptick rule reinstated.5

  • Providing an outline of effective features of regulatory agencies for a financial regulation roundtable held by Congressman Capuano and Congressman Barney Frank (D-MA). The two page piece heralds the Federal Reserve and the Centers for Disease Control and Prevention as examples of outstanding regulatory bodies to be emulated (in what finem respice is certain is merely coincidence, it turns out that a sizable slice of funds flowing to CSI:NE originate from the National Institutes of Health and the CDC and Bar-Yam is a "visiting scholar" at the Federal Reserve Bank of Boston) but is otherwise devoid of meaningful content aside sweeping generalizations such as:
  • ...the regulatory system must have motivation and mechanism that promotes the objectives of regulation: these translate into (1) Accountability and (2) A Culture of Learning (education, research, and information), and (3) Authority (power).6

  • Endorsing Congressman Frank for re-election in an emotive missive characterized by prose as entirely non-partisan as it is sage, fact-based, and devoid of hyperbole. To wit:
  • The worst financial crisis since the Great Depressions followed eight years of Republican control of government. After less than two years the Democrats are being criticized for not fixing all the problems. This is astounding. If anything, the turn around since the crisis has been more rapid than was expected. As a scientist studying the causes of the financial crisis, I affirm that Congressman Barney Frank's actions over the past two years have been critical to the recovery of the economy.

    Congressman Frank is a remarkably capable, insightful, and deeply caring representative of our district. He has played a central role in righting the ship of the country by taking on the "anything goes" attitude of Wall Street. His success in passing major legislation to regulate risk is key to economic growth. In contrast, the Republican's eliminated key regulations of the financial system.

    I strongly endorse Congressman Frank for reelection.7

  • Leveraging the reputation capital of CSI:NE together with his own good name to support the Occupy Wall Street movement:
  • I am impressed by the Occupy Wall Street (OWS) movement and its objectives. As the head of an institute whose work is to bring to light central issues at stake nationally and globally, I would like to express my support and help clarify the scientific basis of their demands.8

  • And authoring the "Scientific Guide for 'Complex Systems and Occupy Wall Street'":
  • In sum, I believe that the call for reduced influence of corporations by Occupy Wall Street is a statement of economic necessity in the context of poorly considered decisions by government under the influence of special interests. The Occupy Wall Street movement is developing its identity and considering potential courses of action. Our research shows this is a good time to constructively engage in social change.9

Professor Yaneer Bar-Yam
President: CSI:NE

Apparently, the Occupy Wall Street crowd, purportedly the enemy of all things crony, has failed to notice that the NSA, CIA, TSA, United States Department of the Navy, United States Air Force, United States Army, United States Department of Defense, Boeing, Lockheed-Martin, Raytheon and SAIC are among their new resident scholar's chief clients and patrons.10 But we digress.

In the meantime CSI:NE has authored papers on subjects as insightful as:

  • High food prices cause food riots.11

    And a few weeks later:

  • Ethanol and evil speculators cause increases in food prices.12

    (Ergo evil speculators and refiners are responsible for social unrest in Africa and the Mid-East, perhaps?)

But setting aside for a moment the appearance of the messenger, an ad hominem line of argument finem respice is wont to take unless, as here, the subject first basks about willingly and conspicuously in the public eye, attempts to use their position or reputation to engage in policy advocacy otherwise lacking in logical merit, or otherwise behaves in a manner suggestive of a corner-haunting prostitute in the more dangerous postal codes of the District of Columbia, the content of this "bear raid" analysis would be found fatally wanting even among the company of the most hardened of data back-fitting malfeasants- and finem respice offers this comparison having, for years, endured the unrelenting and saccharine suits of many a sell-side investment banker.

The mosaic of flaws and misrepresentations that CSI:NE has the gall to present as "analysis," along with the overwrought and dank rhetorical cement in which it is incarcerated, likely has the ultimate effect of outright deception for less discerning readers (or those members of the media who, after overindulging in multisyllabic prose, lack the personal industry to venture past the abstract). It would therefore seem prudent to undertake a point-by-point analysis of these flaws. As such, the always intrepid finem respice reader will find that endeavor, carefully enumerated with respect to fallacies and flaws and beginning with the abstract, below:

We provide direct evidence of market manipulation at the beginning of the financial crisis in November 2007.13

  1. Informal Fallacy: Low Redefinition.
  2. The authors apparently could not avoid grossly negligent errors in the very first sentence of their abstract.

    The term "direct evidence" is a specific term of art and is used here erroneously, either for effect or perhaps out of simple ignorance.

    "Direct evidence" is generally defined as evidence that supports the assertion without the need for an intervening inference. Here, the assertion appears to be "an instance of market manipulation took place at the beginning of the financial crisis in November 2007." It is unclear what definition of "market manipulation" is meant, but the relevant statute of the Securities Exchange Act of 1934 reads:

    Transactions Relating to the Purchase or Sale of a Security

    It shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange--


    To effect, alone or with one or more other persons, a series of transactions in any security registered on a national securities exchange or in connection with any security-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act) with respect to such security creating actual or apparent active trading in such security, or raising or depressing the price of such security, for the purpose of inducing the purchase or sale of such security by others.14

    It seems reasonable to assume that given the context here (the "uptick rule") this statutory definition would be the most relevant. And here the trouble begins. Specifically, notice that "market manipulation" has a scienter requirement, to wit:

    "...for the purpose of inducing the purchase or sale of such security by others."15

    It will be seen immediately that without inferring the "purpose of inducing the purchase or sale" "direct evidence" of "market manipulation" in this instance would mean evidence bearing directly on the state of mind of a market actor. None such is presented in the paper. In fact, and by the very admission of the authors, the market actors at issue are never identified.

    Then again, one supposes that the correct phraseology "We provide circumstantial evidence of market manipulation..." doesn't quite have the same ring to it in the all-important only-section-the-guys-at-MSNBC-will-read abstract. Surely, if challenged, CSI:NE will reply "well, we clarify that in the paper you know…. Hey! Look at the time!"

  3. Informal Fallacy: petitio principii.
  4. Because the authors never show (or even reasonably suggest) intent here the conclusion that makes up their first stepping stone "there was a bear raid" becomes circular. Their final conclusion about the need for resurrection the uptick rule then assumes this unproven premise.

    The abstract continues:

    The type of market manipulation, a “bear raid,” would have been prevented by a regulation that was repealed by the Securities and Exchange Commission in July 2007.16

  5. Unrepresentative Sample Fallacy: Hasty Generalization.
  6. Even assuming the existence of a market manipulation event, and even assuming this particular event would have been prevented by the regulation in place this line of argument falls prey to the Hasty Generalization fallacy.

    This specific market manipulation was a "bear raid." (And since the world's collective bear raid n=1, this is the only one).
    This specific market manipulation would have been prevented by X, ergo;
    All bear raids would have been prevented by X.

    The term "bear raid" is defined later in the abstract (it won't be the last time):

    The magnitude and coincidence of borrowing and returning of shares is evidence of a concerted effort to drive down Citigroup’s stock price and achieve a profit, i.e., a bear raid.17

  7. Informal Fallacy: Redefinition.
  8. Again, the term "bear raid" has shifted.

    While it is widely accepted that the causes of the crash that began later that year were weaknesses in the mortgage market and financial sector, the close proximity of the repeal to the market crash suggests that market manipulation may have played a role.18

  9. Formal Fallacy: Ambiguous Middle.
  10. The authors have quickly shifted from a discussion of the "crash" of a particular stock (Citigroup) to the "crash that began later that year". The effect is to shift to focus from the discrete (if lacking) evidence of the absence of an uptick rule's contribution to issues with Citi stock and conflate this with the entire financial crisis.

    In addition:

  11. Informal Fallacy: non causa pro causa: post hoc ergo propter hoc.
  12. Repeal of uptick rule was undertaken
    There was then: "the market crash," ergo;
    The repeal of the uptick rule played a role in the crash.

    The shameless use of this fallacy even once in a paper purporting to be even some semblance of scholarly work would normally be shocking, and yet, two sentences later:

    The timing of the bear raid, in autumn 2007, suggests that it may have contributed to the financial crisis.19

  13. Informal Fallacy: non causa pro causa: post hoc ergo propter hoc.
  14. A partial solar eclipse occurred on November 25, 2011.
    Barney Frank announced his retirement three days later, ergo;
    The partial solar eclipse may have contributed to the announcement of Barney Frank's retirement.

    If only.

    To find this, the most basic of fallacies familiar to any high school student of basic math/logic, exhibited twice in as many sentences should be just beyond comprehension. The authors have, after all, been working on this topic for in excess of three years.


  15. Formal Fallacy: quaternio terminorum.
  16. Even, arguendo, giving the full weight of legitimacy to the previous syllogism, we come to:

    The uptick rule's repeal allowed a bear raid.
    The bear raid contributed to the Citi crash, ergo;
    The uptick rule's repeal contributed to the financial crisis.

    Valid syllogisms have three terms.


    Yes, we understand you might not want to go about showing that there was a causal connection between your observations of Citi stock price and the financial crisis. Well, yes you probably would get away with that on cable television. No, I'm not so sure that would fly on network television though.

    Bear raids are an illegal market strategy in which investors manipulate stock prices by collectively selling borrowed shares.

  17. Informal Fallacy: petitio principii.
  18. "A kind of stock price market manipulation, a 'bear raid,' occurs when there is a market manipulation of stock prices by short sellers."

    There's a manipulation when there's a manipulation? Sure thing, chief.

  19. Informal Fallacy: Redefinition.
  20. Collective action ("collective selling" here) is not a formal definition of market manipulation. To wit:

    It shall be unlawful for any person... to effect, alone or with one or more other persons....20

    It is possible that the authors meant to refine their definition, but they still fail to include the proper scienter requirement. In fact, collective selling (or any selling at all) may (and probably will) have the effect of manipulating stock prices, but absent "the purposes of inducing the purchase or sale of such security by others..." this is not, on its own, illegal. One also wonders after the statute itself, given that if an investor badly needed to dump a large block of stock and put a ask of 200,000 shares in at a price $2.00, $0.04 below the bid-ask of $2.04, and then bought the 10,000 shares sitting on offer at $2.03, $2.02 and $2.01 to clear the price down to $2.00 and get hit for their $2.00 ask, is this illegal? Any serious player in the market knows that happens regularly. Even short of this, isn't putting a large sell order in $0.50 below the bid-ask a transaction effected "for the purpose of inducing the purchase… of such security by others"?

    What the hell is the point if you don't induce someone else to buy?

    But we digress.

    While bear raids are often blamed for market events, including financial crises, this paper is the first to demonstrate the existence of a specific bear raid.21

  21. Informal Fallacy: petitio principii.
  22. Oh, now it "demonstrates the existence" of a bear raid? The authors seem unable to properly define market manipulation which they claim bear raids are an illegal subset of. Leaping to assert that their paper "demonstrate[s] the existence of a specific bear raid" is an awfully large jump.

  23. Informal Fallacy: argumentum ad nauseam.
  24. But, perhaps if you say it enough different ways someone will buy it.


  25. Informal Fallacy: Amphibology.
  26. While the Prime Minister appeared early today for Question Time, fish swim in water.

    Ok, Dali.

    The sale of borrowed shares, called short selling, is a standard form of market trading. Short sellers sell borrowed shares, then buy them back later and return them to their owners. This practice yields profits when prices decline. In a bear raid, investors engage in short selling with the addition of market manipulation.22

  27. Informal Fallacy: Equivocation.
  28. The authors now appear to redefine or additionally define a "bear raid" as "...short selling with the addition of market manipulation." They continue:

    Instead of profiting from a natural decline in the fundamental value of a company stock, the executors of a bear raid themselves cause the price to decline.23

  29. Informal Fallacy: Black-or-White Fallacy.
  30. This argument confuses matters by attempting to make bear raid declines and natural fundamental declines (whatever those are) mutually exclusive. Of course all selling exerts downward pressure on prices making it impossible to define a "bear raid" as selling that exerts downward pressure on prices. Further, if the authors have somehow arrived at a method to determine the precise and perfect "fundamental value" of shares they are wasting their time sucking up to politicos for cronybucks. The argument therefore begs us to assume that natural declines can be distinguished from artificial declines when the entire proposition of the work depends on the authors making this case and identifying a specific example, triggering another:

  31. Informal Fallacy: petitio principii.
  32. In the aftermath of the 1928 market crash, Congress created the Security and Exchange Commission (SEC). Recognizing the dangers of short selling, Congress specifically required the SEC to regulate short selling.24

  33. Informal Fallacy: argumentum ad verecundiam.
  34. "Well, Congress and the SEC said so..."

    Oh, well, in that case....

    SEC claims that the uptick rule had no significant effect on market stability, even in absence of specific manipulation, have been refuted.25

  35. Informal Fallacy: petitio principii.
  36. Informal Fallacy: ipse dixit.
  37. The authors cite themselves and their own prior work on which this paper is based- and which finem respice is certain readers will find of similar quality- in support of this proposition.

    One also wonders how, in the span of just a paragraph or two, Congress and the SEC go from sage regulatory authority to ignorant agent of the status quo. Perhaps this depends on the authors' personal views of the legislative/SEC policy being examined in each instance?

    Our results implying a bear raid in November 2007 contradicts [sic] the assertion of market transparency.

    Our evidence points to a bear raid on the large financial services company Citigroup.26


    "Results contradict."
    "A result contradicts."

  38. Informal Fallacy: Equivocation.
  39. Ah, so which is it? Do you "imply" a bear raid? Does your evidence "point to" one, or are you presenting "direct evidence" of one, as stated in your media-centric abstract? The more one reads the thinner the evidence seems to get. Perhaps finem respice is just being pedantic here, but don't most scholarly works proceed in the reverse direction?

    Do you not know the difference? Or do you simply have no idea what your data and analysis actually show?

    Or, Aristotle forbid, have you engaged in a teensy-tiny bit of rhetoric to make sure that your abstract had the flash that you couldn't be so flagrant about in the body of the paper? (After all, all real scholars know you can cheat a bit in the abstract, right? That's not for real readers… that's for readers with less time and a lot more money on their hands… press, political operatives, sea cucumbers, and the like).

    However you cut it it is difficult not to come to the conclusion that CSI:NE is either lazy or simply fraudulent here.

    News events to which these events might normally be attributed cannot account for the difference between trading in borrowed shares and trading by owners of shares.27

  40. Informal Fallacy: One-Sidedness/Suppressed Evidence.
  41. One hopes that readers are shocked by the flagrant cherry picking that permitted these authors to apparently claim that news of the day cannot account for a sudden surge in short selling in Citigroup stock without inducing (say) long term institutional holders to sell their longs. Even the most simplistic examination of the facts of the day reveals such numerous and material possible counter-explanations for extensive short selling that explaining the authors' failure to discuss them in detail requires the assumption either of:

    Such manifest ignorance on the part of the authors as to suggest they should be prevented at all costs from operating heavy machinery near civilian populations. (Evidence tending to contradict this theory is presented below), or;

    The most blatant sort of academic and scholarly fraud.

    Consider this timeline of events28 just a month before November 1-7, when the events covered by this paper occur:

    October 1, 2007: UBS reveals fixed income and mortgage losses of $3.4 billion. Citigroup suggests it will make a profit despite $1.3 billion in similar losses and $2.6 billion in "extra credit costs." Citigroup also "confirmed" $1.4 billion in losses to private equity firms. "This is cringe-making for Citi's chief executive, Chuck Prince," said [BBC business editor] Mr. [Robert] Peston.29

    October 15, 2007: Citi posts a 57 percent decline in third-quarter profit, hurt by $6.5 billion of write-downs and losses in areas including subprime mortgages. Prince calls the performance "frankly surprising."30

    October 29, 2007: "While others such as Jimmy Cayne at Bear Stearns and Chuck Prince at Citi hang on for dear life, Merrill Lynch CEO Stan O'Neal has been forced to bite the bullet."31

    October 30, 2007: Stan O'Neal retires in the wake of a $7.9 billion dollar bad-debt write down contributing to a net loss of $29 billion for the quarter. "Its worst financial performance since 2001."32

    And, of course, how can one forget:

    October 31, 2007: CIBC World Markets analyst Meredith Whitney along with Carla Krawiec release a "Change in Recommendation" report titled "Is Citigroup's Dividend Safe? Downgrading Stock Due to Capital Concerns," a chart, graph, and spreadsheet heavy, 23 page tour-de-force launched with:

    Our thesis is simple. We believe over near term, C will need to raise over $30bn in capital through either asset sales, a dividend cut, a capital raise, or combination thereof. We believe such a catalyst will pressure the stock significantly lower and accordingly downgrade to SU from SP as of Oct 31.33

    The report was punctuated with damaging barbs supported by raw numbers. To wit:

    Based upon our thesis that over the near term C will be forced to sell assets, raise capital or cut its dividend to shore up its capital ratios, we believe the stock will be under significant pressure and could trade into the low $30s. We note that at the height of JPM’s recent troubles in 2002, the stock traded at 2.5x tangible book. Today, C trades at 3.7x its tangible book value of $12.77.34


    We believe downside for Citigroup shares could be in the mid-30s or 2.5x Citigroup’s tangible book value. Over the last seven years, JPM has generally traded at 2.5x tangible book value. Citigroup has traded at nearly 4x tangible book value over the same period. Meanwhile, JPM has posted superior revenue, cost efficiency, earnings growth and stock price growth compared to Citigroup.35

    But even in this environment, and as any reader who lived through those days will remember, finem respice has barely begun even to scratch the surface in describing the panicked atmosphere during those dark days, where bank after bank had been forced to reveal much greater losses than thought, somehow the authors cannot possibly contemplate alternatives to their theory that might explain a sudden spike in short interest in a company that financial publication after financial publication pointed to as an example of an "at risk" firm whose CEO might, any day now, be sacked, even the day after a scathing and apparently accurate report was released in the name of a major equity research shop? Or understand the difference between the sorts of longs that held Citi in 2007 and why they might hold on, even as the Citi craft plunged- cockpit on fire- through the clouds, all the way to the crash site?

    It becomes increasingly difficult to excuse this behavior via "no-heavy-machinery-for-you" style "ignorance." But, apparently they cannot help themselves:

    News events to which these events might normally be attributed cannot account for the difference between trading in borrowed shares and trading by owners of shares.36

  42. Questionable Premise.
  43. This appears to make the argument:

    Short and long investors trade news events in similar fashion.
    Short investors in this instance did not trade like long investors, ergo;
    Short investors in this instance were not trading news events.

    Of course, the premise "Short and long investors trade news events in similar fashion" is both critical to the argument, and weak.

    We will return here later, as the authors attempt to support this premise further into their argument, but first they delve into the byzantine realm of statistics:

    In Appendix B we analyze quantitatively the probability of the events on November 1 and November 7. Often probabilities are estimated using normal (Gaussian) distributions that underestimate the probability of extreme events (“black swans”) that are better represented by long-tailed distributions. We directly fitted the long tails of the distributions and estimated the probability of the events based upon these tails to be p = 2*10^-5 and 8*10^-9, respectively. Given 250 trading days in a typical year, it would take on average 200 years and 500 thousand years, respectively, to witness such events.37

    One is tempted to give the authors full marks for reading their Taleb, given that most of their reading public will likely be enthralled with pop-finance titles like "The Black Swan." But then one considers that one does not give a 10 year child old full marks for being housebroken and not getting into the trash so much anymore. "Yes, yes, good job at not using a Gaussian distribution. That's great work Billy, now go play in traffic with your sister so I can read in peace and learn what depths The Economist has finally sunk to."

    Unfortunately, this is simply not good enough for prime time. We should expect more from our scholars than displaying that they are (usually) housebroken on holiday Saturdays when the grandparents are visiting.

    Using long-tail fitting is helpful (and one could be heard to remark that the first instance of dramatic share borrowing on November 1 only seems by the authors' figures to rank enough "rarity" to be seen every 200 years, for whatever that is worth), but we can throw out the methodology used here almost out of hand without even considering their fitting method or the eventual long-tail distribution they came up with and how they might justify it. (Still, finem respice has its guesses here). This is because they have completely ignored the import of conditional analysis, and their statistical application as well as the prose that describes it belies a mass of ignorance of such quantity that its gravitational pull threatens to suck into its event horizon a sizable population of the prestigious US universities that surround Cambridge. (Not that this would necessarily be to the overall detriment of the country given the number of Harvard and MIT grads among the CSI:NE faculty).

  44. Informal Fallacy: Argument from Rarity.
  45. Looking alone at the winner of a large national lottery one does not (generally) prosecute the individual for fraud because of the extremely low probability ("My god, the odds are one in several tens of millions!") of her having the winning ticket. With those odds she must have been cheating, you understand.

  46. Informal Fallacy: Conditional Probability Fallacy.
  47. Likewise, the question here is not (or should not be) "given a large population of normal trading, what is the probability of this magnitude of short selling"? The question is: "given the current environment (any number of crisis states and exceptional market conditions that have already come to pass and cannot therefore be part of the "rarity" analysis) what is the probability of this magnitude of short selling?"

    By way of a theoretical thought experiment compare:

    The probability of one of the CSI:NE authors committing suicide.


    The probability of one of the CSI:NE authors committing suicide given a $5 million gambling debt, a severe drug and alcohol problem, an upcoming sentencing hearing for embezzlement charges related to several prominent childrens' charity funds, and imminent exposure by a blackmailer of a penchant for sexual proclivities considered deviant by the vast majority of the population.

    The authors attempt to salvage their grant money from clawbacks:

    Moreover, the probability of these two events occurring 6 days apart is p = 1*10^-12, corresponding to 4 billion years, comparable to the age of the Earth. Figure 3 shows that these events are outside the general behavior of the market.38

    And yet, though they want to treat them as distinct, non-interdependent events in this bit of fancy statistical analysis, the authors already know full well that these events were linked, having penned this just a half-page earlier:

    The short interest before the increase on November 1 and after November 7 are virtually identical, the larger decrease corresponding to an additional increase in short interest between these dates. The mirror image one-day anomalies in short interest change suggest that the two are linked.39

    Is anyone really this dense? Never mind, Congressman- finem respice retracts the question.

    Of course, what they should have at least been asking was "given the borrowing of 130 million shares on November 1, what is the probability of their return on November 7?"

    Well the probability of their eventual return (and therefore any related short positions being covered) likely looks something like the inverse probability of the default of the borrower times the probability the borrowed shares themselves will be lost by the DTCC in a messy bankruptcy or subject to some crazy counter-party or custodian dispute. Call it "MF Global risk," or something. But that number certainly isn't something*10^-anything once the damn things are borrowed.

    But then you kind of, sort of, have to generally, oh we don't know… understand what the fuck you are actually talking about to pick up on that nuance?

    Conditional on a massive and probably speculative borrow of Citi shares that are costing a pretty penny in securities lending fees, the return of those shares less than a week later is an event that you would expect to see only once in every many thousands or hundreds of thousands of years? Really? Seriously?

    We emphasize that our estimates of the probabilities of these events reflects the higher probabilities of extreme events in long-tailed distributions.40

    Oh, well I'm certain that always erudite finem respice readers feel much better now.

    By way of a theoretical thought experiment compare:

    The probability of one of the CSI:NE authors (let's call him "Yar-Bam") committing suicide given a $5 million gambling debt, a severe drug and alcohol problem, an upcoming sentencing hearing for embezzlement charges related to several prominent childrens' charity funds, and imminent exposure by a blackmailer of a penchant for sexual proclivities considered deviant by the vast majority of the population.


    The probability of a second CSI:NE author committing suicide within 7 days given the first CSI:NE author having committed suicide given a $5 million gambling debt, a severe drug and alcohol problem, an upcoming sentencing hearing for embezzlement charges related to several prominent childrens' charity funds and imminent exposure by a blackmailer of a penchant for sexual proclivities considered deviant by the vast majority of the population. (By the way it turns out that- just by pure coincidence, you understand- this second author is also Yar-Bam's spouse).

    "My god! The odds of two CSI:NE authors committing suicide in such a short span must be astronomical. (Oh, right. Make sure you use a fitted long-tail distribution in your analysis)."

    Meanwhile, someone needs to alert the risk departments in every securities lending department on the planet that it might be another six ice ages until they get their big borrows back. Since this seems to be a uniquely novel analysis, one is tempted once more to suggest to the people of CSI:NE that their talents are wasted outside of the financial risk management sector. Or at least wasted as other than CNBC commentators.

    Of course, one sees this mistake very often, which is how during the same period in 2007-2008 LIBOR-OIS spreads blew out in an 9.7 sigma event and the press was quick to mouth off about how this was shockingly rare and could only happen every gazillion years or so. Then when the same spread blew out in a 6.2 sigma event 11 months later everyone was back to mere thousands of years (apparently not bothering even to go the extra mile like CSI:NE and calculate the combined probability of a 6.2 and 9.7 sigma event in 11 months time. Slackers).

    In fact, whenever you see this sort of nonsense, that is, trying to explain the many thousands of years it would take to see a similar event in finance again, you pay yourself huge returns by completely discounting not only the statement itself, but also anything the author thereof has ever written or co-authored. Or read. Or has on their Amazon wish list. In fact, you can magnify your personal returns even further by avoiding even casual contact with any of the original author's potential sex partners owing to the risk of contracting syphilis.

    Alas, there are several pages in the instant report to go:

    Changes in investor behavior are often explained in terms of specific news items, without which it is expected that prices have no reason to change significantly. The press attributed the drop of Citigroup’s stock price on November 1 to an analyst’s report that morning. This report, by an analyst of the Canadian Imperial Bank of Commerce (CIBC), downgraded Citigroup to "sector underperform".41

  48. Informal Fallacy: One-Sidedness/Suppressed Evidence.
  49. "Oh, well that whole analyst thing. Whatshername. Whatever."

    Given the shocking dearth of jarring news events the authors deigned to acknowledge during the period of study, one almost wonders if the authors were even in the same galactic local group while all this was going on. Dismissing the Whitney report is a curious response. But it is necessary to discount the impact of this public disclosure in order to keep the argument that sinister external forces influenced Citigroup alive.

  50. Questionable Premise.
  51. The authors may not realize it, but they appear to have become advocates of Semi-Strong Efficient-Market Hypothesis. To wit:

    "Changes in investor behavior are often explained in terms of specific news items, without which it is expected that prices have no reason to change significantly." (Emphasis added).

    The authors seem to be suggesting that in the absence of public news prices have no reason to change. For any definition of "specific news" that does not include rumor or widespread publicly disseminated information this sounds a great deal like the "semi-strong" variant of efficient-market hypothesis, where all prices reflect all publicly available information. The authors compound (and then confuse) this understanding later. Absent some resort to justify this belief about the market, it is difficult to let this premise go unquestioned. But, alas, there are only 41 hours in the day….

    Any such news-based explanations of investor behavior on November 1 (similarly for November 7) would not account for the difference in behavior between short sellers and other investors. Under the assumptions of standard capital asset pricing models, all investors act to maximize expected future wealth, and should therefore respond similarly to news.42

    And here they cite, yes, Fama and Sharpe.

    We are certain the authors are on the verge of explaining how they can use as a model in which all actors respond similarly to news, except this group of manipulators, which somehow manages, even in the face of the semi-strong efficient-markets hypothesis, to dig out a return from a technical strategy. We are equally sure they can do so without slipping into a recursion error.

    Even so, let's re-examine their application of this syllogism (without revisiting Fama and Sharpe any more than we have to):

    All investors seek to maximize expected future wealth.
    Short sellers are investors, ergo;
    Short sellers seek to maximize expected future wealth.

    Looking good so far (if you buy the simplified premise).

    All investors seek to maximize expected future wealth.
    Long investors are investors, ergo;
    Long investors seek to maximize expected future wealth.

    Still ok.

    Long investors seek to maximize expected future wealth.
    Short investors seek to maximize expected future wealth, ergo;
    Long and short investors trade the same in response to news.

  52. Formal Fallacy: quaternio terminorum.
  53. Woops.

    The flaw here is conflating "seek to maximize expected future wealth" with "trade the same on news." Of course, what one does to maximize expected future wealth depends a great deal on the specifics of the situation. What are an investor's holding costs? Assets? Credit? Available margin? Return expectations? Risk tolerance? Of course, Fama and Sharpe can get away with a lot of assumption work here. The authors attempt to do this on the sly:

    Under the assumptions of standard capital asset pricing models, all investors act to maximize expected future wealth, and should therefore respond similarly to news.43

  54. Informal Fallacy: One-Sidedness/Suppressed Evidence.
  55. That's a pretty harsh simplification of the assumption set that makes up the standard capital asset pricing model, as anyone who has actually read Fama or Sharpe or Treynor would know. The contemporary take on assumptions for CAPM tends to look like:

    1. Past return standard deviation is a perfect substitute for future risk. (Oddly, the authors have already rejected this in favor of long-tails).
    2. Investors aim to maximize economic utilities.
    3. Investors are rational and risk-averse.
    4. Investors are broadly diversified across a range of investments.
    5. Investors are price takers, i.e., they cannot influence prices. (The authors dispute this as well).
    6. Investors can lend and borrow unlimited amounts under the risk free rate of interest.
    7. Investors trade without transaction or taxation costs.
    8. Investors deal with securities that are all highly divisible into small parcels.
    9. Investors assume all information is available at the same time to all investors.

    Even ignoring the outright contradictions in the authors' disparate and multiple world views as expressed in this paper, cherry picking this stuff to imply that a trader (or several) with limited margin, high holding costs (borrowed shares, remember) and a particularly short term investment horizon trades the same news in similar fashion to a large, long-term institutional holder (say, a mutual fund) betrays the most severely infantile understanding of markets, or quite blatant academic and scholarly fraud. At the most basic level, not everyone can suddenly borrow 130 million shares. Investor mandates or limits on collective investment vehicles can prevent large players from selling short when they might otherwise wish to. The list goes on and on, but finem respice is certain that CSI:NE, if so confronted will immediately proceed to jump up and down, pointing "We cited CAPM assumption rules! Right there, see? CAPM assumption rules!" as if this is some immunity spell invoked in times of scholarly distress.

    Surrounding arguments on this issue with junk-science and fallacy-riddled prose is highly suspect both as to legitimacy and motive. Given the apparent agency over policy exerted by CSI:NE it is perhaps best that those finem respice readers possessed of more delicate sensibilities evaluate the consequences implicit in the realization of the kind of absolute horseshit that apparently passes for "science-based" policy recommendation in their own quiet time and where strong narcotic sedatives are available.

    But still it continues:

    In the literature, analysis of the residual small differences in the behavior of short and long investors has been interpreted to indicate that short sellers have an informational advantage or that short sellers are able to anticipate lower future returns, rather than cause them. Still, these studies do not show that large differences in trading generally occur between short and long sellers. Thus, the existence of such a difference is indicative of specific trader action.44

  56. Formal Fallacy: Affirmative Conclusion from a Negative Premiss.
  57. Formal Fallacy: argumentum ad ignorantiam.
  58. Lack of evidence for a proposition ("studies do not show") does not prove the anti-proposition ("studies refute").

    Bush league.

    Our evidence points to a bear raid during a period of financial stress to which the Federal Reserve Bank responded in August 2007 by announcing that they would be “providing liquidity to facilitate the orderly function of markets” because "institutions may experience unusual funding needs because of dislocations in money and credit markets".45

  59. Formal Fallacy: Ambiguous Middle.
  60. Was it the period of stress or the "bear raid" to which the Federal Reserve was reacting? (The date suggests the former but the term is conflated).

    Bear raids may have long-term price impact if decision makers infer investor confidence from price movements and act on that basis. Citigroup CEO Charles Prince’s resignation on November 4 after an emergency board meeting may reflect such an effect.

  61. Informal Fallacy: non causa pro causa: post hoc ergo propter hoc.
  62. Informal Fallacy: One-Sidedness/Suppressed Evidence.
  63. Please. Really? Again?

    Dozens of financial journalists were speculating on the demise of Prince a full month before November 4 and this is the best the authors can come up with? After the fact therefore because of the fact?

    The magnitude and coincidence of short activity is evidence of a concerted effort to drive down Citigroup’s stock price and achieve a profit, i.e., a bear raid.46

  64. Questionable Premise.
  65. Informal Fallacy: Propositional Fallacy: Affirmation of the Consequent.
  66. A concerted effort to drive down Citigroup price and achieve a profit (a "bear raid") would cause magnitude of short activity.
    There was a magnitude of short activity.
    Therefore there was a concerted effort to drive down Citigroup price and achieve a profit.

    First: We are provided with no argument suggesting that this is what a "bear raid" would actually look like. The authors claim to have found the first one in the wild but other than suggesting it would involve "a lot of short selling" they have little to define the term.

    All squares are rectangles.
    Figure B is a rectangle, ergo;
    Figure B is a square.

    Bush league. President Bush league even.

It takes a special kind of sleezebag to hurl thinly veiled accusations of criminal conspiracy. Even if much of this content can be explained away by resort to excuses like sloppy practices, lost data, drunk-at-work interns (damn their eyes!), slavishly overworked graduate students, or the inadvertent, opium nod induced activation of the "paste" feature before final submission, the borderline criminal abuse of conspiracy rhetoric that follows (optimistically labeled "Tests and Technical Notes" in the appendices) should literally shock the senses. A sample thereof, that the authors shamelessly attempt to conceal in the guise of a "frequently asked questions" format, as if the reader were browsing the Segway marketing website, follows:

Is it possible that the analyst report downgrading Citigroup that morning was released in collusion with the bear raid?
We have no specific evidence, but such collusion would be consistent with strategies used by those who manipulate stocks.47

Really, it isn't beyond the pale to translate this as: "We don't specifically say that Meredith Whitney is a criminal, guilty of securities fraud, conspiracy to commit securities fraud, money laundering and is personally responsible for the crash of world markets and the decline of Hollywood production quality in feature length movies, but that's entirely consistent with our beyond-reproach science practices and typically cogent observations."

Is it possible that the large block trades on November 1 and 7 represented trading based upon information that was not yet available to the public on November 1?
Our evidence suggests that a single individual or group of individuals traded a large volume of borrowed shares on November 1 and November 7. If this represented potentially illegal insider trading, the traders would have avoided attracting attention. Neither the large trading volume nor the abrupt price drop on November 1 at the opening of the market appear to be consistent with a low-profile trading approach. The rapid price drop is also inconsistent with the expected behavior of insider traders, which is to maximize profits by selling gradually to avoid affecting prices until the negative news becomes public. Both the large volume of trading and the rapid drop are consistent with trading intended to affect prices, i.e. a bear raid. While the intentions of traders can only be determined from a more detailed inquiry once those traders are identified, the available information strongly supports a bear raid over the possibility of insider trading per se. It is possible that traders with insider information chose to help matters along by performing a bear raid at the same time as they were trading on insider information.48

A number of flaws specific to finance plague this analysis.

In the first instance, the authors apparently are unaware of the relationship between trading on "non-public information," trading on "material non-public information," "insider trading" and "illegal insider trading." Of course, the presence of an actor who had, without misappropriation of any kind, come across material non-public information that they then went dramatically short on would be deleterious to the authors' preferred narrative: A market manipulator in the wild.

Such a trader would not necessarily be committing any crime (for example, and this is not, of course, the only manner in which such trading would be legal, perhaps the trader was a member of Congress?)

But even this assumption is excessive given the release the day before of the Whitney report on Citigroup. The authors refer to this instance directly, but use language that is fatally ambiguous and that, regardless of intent, has the effect of distorting the timeline of the Whitney report:

The press attributed the drop of Citigroup’s stock price on November 1 to an analyst’s report that morning.49

Do the authors meant that the Whitney report was issued "that morning" (November 1), that the press attribution took place on November 1, that the stock price drop was on November 1, or some other or combination of these interpretations? It is not difficult, given this somewhat tortured construction, to come away with the impression that some obscure and barely relevant report came out at some point on Thursday during the day, while a major crash of Citi stock was already in progress, particularly if the reader is already looking for that narrative.

In fact, the Whitney report was released on Wednesday, October 31st, giving astute and on-the-ball PMs already nervous about the state of the larger "full-service" banks that entire evening and the next morning to read, absorb and formulate trading strategies for Thursday morning and afternoon trading. In addition, rumors were already afoot about Citi. The Wall Street Journal ran a daunting, and ultimately prescient, piece on Wednesday, October 31:

Wall Street has a lot riding on the financial industry's effort to ease frozen credit markets by creating an $80 billion rescue fund -- but no company more than Citigroup Inc.

Supporting these off-balance-sheet funds, known as structured investment vehicles or SIVs, is the heart of the rescue effort led by Citigroup, J.P. Morgan Chase & Co. and Bank of America Corp. Accounting groups have raised the question of whether Citigroup and other managers of the SIVs should account for the funds, many of which face potential losses, on their own balance sheets.50

What must seem remarkable to seasoned finance professionals unfortunate enough to find themselves slogging through the CSI:NE piece is the decision by CSI:NE to posit such a wild and extraordinary theory in the face of circumstances that not only make the assumption of a large, even historic, short position unsurprising, but would almost require one from some quarter.

Frankly, finem respice hopes that readers are revolted and depressed by what passes for research and "science" bought with the hard earned treasure of the United States taxpayer. It seems beyond tragedy for liquidity taken by the sovereign by force to be expended to produce such- admittedly scintillating- counsel as "regulatory authorities must have authority." Subjects of the United States (for it seems clear the United States no longer has "citizens") should be outraged that borderline fraud has found occasion to pass itself off as the product of rigorous and impartial analysis under the auspices of an organization with such quality control regimes as could send a legitimate manager into grand mal seizures. Moreover, that this "research" and "analysis" seems to serve as the pivot point around which it has become routine to spyrogyrate twisted policy initiatives is enough to induce projectile vomiting even among those possessed of the most iron constitutions.

It is time for Professor Bar-Yam to step down and permit new, outside leadership to work to restore the independence CSI:NE have blazoned right in the midst of their catchy tagline, as well as make an accounting of the sums already expended in the name of "independent research." That is, if anyone cares about a few million dollars anymore (much less the hundreds of millions that CSI:NE influenced regulations from the CDC, Fed, NIH and so on might entangle).

Finally, it would be remiss of finem respice not to point out both to regular readers and those persons related to CSI:NE that the Federal False Claims Act provides that:

...any person who—
(A) knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval;
(B) knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim;


is liable to the United States Government for a civil penalty of not less than $5,000 and not more than $10,000, as adjusted by the Federal Civil Penalties Inflation Adjustment Act of 1990 (28 § USC 2461), plus 3 times the amount of damages which the Government sustains because of the act of that person.51

Given the (lack of) quality of such of CSI:NE's work as finem respice has had the misfortune to encounter, perhaps it will come to pass that some fraction of CSI:NE's nearly $3.0 million in federal grants, contracts and recovery money was obtained under false pretenses.

Then again, it may well be that Barney Frank is convinced that he got more than his money's worth after all. Perhaps his (long overdue) memoirs will provide us with some hint. Against this possibility finem respice can only counsel her readers to keep a well stocked supply of Aprepitant at hand.

  1. 1. "About NECSI," New England Complex Systems Institute.
  2. 2. Public Law 111-5 (February 17, 2009).
  3. 3. See Generally:, OMB Watch.
  4. 4. Pozen, Robert C. and Bar-Yam, Yaneer, "There's a Better Way to Prevent 'Bear Raids'" The Wall Street Journal (November 18, 2008).
  5. 5. Bar-Yam, Yaneer, "Re: Reinstating the Uptick Rule to Protect National Markets as it Did for 70 Years," (.pdf file) Attached to Letter from Congressman Barney Frank and Congressman Ed Perlmutter to Securities and Exchange Commission Chairman Mary Schapiro (May 25, 2010).
  6. 6. Bar-Yam, Yaneer, "A Regulatory System for the Financial Sector from Complex Systems Science," (.pdf file).
  7. 7. Bar-Yam, Yaneer, Barney Frank for Congress Website.
  8. 8. Bar-Yam, Yaneer "Complex Systems and Occupy Wall Street," New England Complex Systems Institute (November 18, 2011).
  9. 9. Bar-Yam, Yaneer "Scientific Guide for 'Complex Systems and Occupy Wall Street'," New England Complex Systems Institute (December 5, 2011).
  10. 10. Bar-Yam Biography, New England Complex Systems Institute.
  11. 11. M. Lagi, K.Z. Bertrand, Y. Bar-Yam, "The Food Crises and Political Instability in North Africa and the Middle East," (.pdf file) New England Complex Systems Institute (August 10, 2011).
  12. 12. M. Lagi, Yavni Bar-Yam, K.Z. Bertrand, Yaneer Bar-Yam, "The Food Crises: A Quantitative Model of Food Prices Including Speculators and Ethanol Conversion" (.pdf file) New England Complex Systems Institute (September 21, 2011).
  13. 13. V. Misra, M. Lagi, Y. Bar-Yam, "Evidence of Market Manipulation in the Financial Crisis," (.pdf file) The New England Complex Systems Institute (December 13, 2011). (Hereinafter "Manipulation").
  14. 14. 15 USC § 78i (a)(2)
  15. 15. Ibid. (Emphasis added).
  16. 16. Manipulation at 1.
  17. 17. Manipulation at 1.
  18. 18. Manipulation at 2.
  19. 19. Manipulation at 2.
  20. 20. 15 USC § 78i (a)(2) (emphasis added).
  21. 21. Manipulation at 2.
  22. 22. Manipulation at 2.
  23. 23. Manipulation at 2.
  24. 24. Manipulation 2-3.
  25. 25. Manipulation at 3.
  26. 26. Manipulation at 3.
  27. 27. Manipulation at 3.
  28. 28. See Generally: "Credit Crisis Timeline," Credit Writedowns and "Timeline: Sub-Prime Losses," BBC News (May 18, 2008).
  29. 29. "Banks Reveal US Mortgage Losses," BBC News (October 1, 2007).
  30. 30. "Timeline: Citigroup Turmoil Seen Ending in Ceo Resignation," Reuters (November 4, 2007).
  31. 31. "Stan O'Neal's legacy to Merrill Lynch," Euromoney (October 29, 2007).
  32. 32. "Merrill Lynch Chief Leaves Firm," BBC News (October 30, 2007).
  33. 33. Whitney, Meredith, "Is Citigroup's Dividend Safe? Downgrading Stock Due to Capital Concerns," CIBC World Markets (October 31, 2007).
  34. 34. Ibid at 2.
  35. 35. Ibid at 13.
  36. 36. Manipulation at 3.
  37. 37. Manipulation at 4.
  38. 38. Manipulation 4-5.
  39. 39. Manipulation at 4.
  40. 40. Manipulation 4-5.
  41. 41. Manipulation at 5.
  42. 42. Manipulation at 5.
  43. 43. Manipulation at 5.
  44. 44. Manipulation at 6.
  45. 45. Manipulation at 6.
  46. 46. Manipulation at 1.
  47. 47. Manipulation at 15.
  48. 48. Manipulation at 16.
  49. 49. Manipulation at 5.
  50. 50. Sidel, Robin, "For Citi, Stakes Get Higher," The Wall Street Journal (October 31, 2007).
  51. 51. The Federal False Claims Act, 31 U.S.C. §§ 3729-3733 (2009).
[Art Credit: Unknown "Untilted," Photograph (Unknown), from the author's private collection.. It is tempting to brand out of hand the wayward band of pop-science and televised junk (or pop television and junk-science) led by the melodramatic David Caruso with the "Trofim Lysenko Award for Public Misunderstanding of Science" (not to be confused with "The Carl Sagan Award for Public Understanding of Science" presented by the Council of Scientific Society Presidents). But it seems Bar-Yam and his crew have something to say about that first.]

Entry Rating:
Your rating: None Average: 4.700 (20 votes)