Déjà vu All Over Again?

1. Déjà vu All Over Again?

2. Critical Thinking vs. Computing SynthesisAnalysis Cannot predict the future - Spreadsheet predicts future Cannot predict probability - Theory predicts probability Focus on unknown unknowns - Focus on the known Skeptical - Believer Observation to theory - Theory to practice Aim toward being broadly correct - Precisely wrong Accept randomness - Manufacture explanations Thinking - Computing

3. 1. Cannot Predict the Futurevs. Spreadsheets and Models Predict Future • 1637 Dutch Tulip Collapse • 1970s Energy Crisis • 1980s Latin American Bank Defaults • 1980s Junk Bonds, Michael Milken • 1980s S&L Crisis • 1990s Derivatives crisis • 1990s Emu bubble burst • 1999 Dot-Com Collapse • 2000 Long-Term Capital Management Implodes • 2008 Sub-prime Mortgage Debacle • Before 2015 Unexpected disaster

4. 2. Cannot Predict Probabilityvs.Theory Predicts Probability “Most negatives in housing are behind us.” Alan Greenspan, October 2006

5. 2. Cannot Predict Probabilityvs.Theory Predicts Probability “I don’t see (sub-prime mortgages) imposing a serious problem.” Treasury Secretary Henry Paulson, April 2007

6. 2. Cannot Predict Probabilityvs.Theory Predicts Probability “We see no serious broader spillover to banks from the sub-prime market.” Fed Chairman Ben Bernanke, October 2007

7. 2. Cannot Predict Probabilityvs.Theory Predicts Probability “The effective management of risk is one of the core strengths that has made Lehman Brothers so successful.” Still found on Lehman Brothers website one month after collapse.

8. Why Are All Projects Late and Over Budget? • 3. Focus on Unknown Unknownsvs. Focus on the Known • No evidence of problems • Evidence of no problems

9. 3. Focus on Unknown Unknownsvs. Focus on the Known • Risk Management - Mirage Hotel in Vegas • Hundreds of Millions on • Cheating Detection • Employee Monitoring • Probability and Diversification • Theft Protection • Four biggest losses: • Tiger attacks Siegfried or Roy • Contractor wires hotel with dynamite • Forms not turned in to IRS • Owner’s child kidnapped

10. 3. Focus on Unknown Unknownsvs. Focus on the Known Source: 2006 Report to the Nation on Occupational and Fraud Abuse by the Association of Certified Fraud Examiners (ACFE)

11. 4. Skepticvs.Believer • Doubting takes mental effort • Opening a barbeque restaurant • Left-brain makes up the reason • Context • Zap left-brain — see objects with less prejudice • L-dopa, dopamine and Parkinson’s disease • $200,000 • Lowers skepticism • Left brain sees patterns

12. 4. Skepticvs.Believer • Silicon Valley engineering problem • Boone Pickens

13. 5. Observation to Theoryvs. Theory to Practice • Coin flips heads 50 times in a row--what are the odds tails comes up next? • Ideology = Tails is due • Scientific probability theory = 50/50 • Critical Thinking = Crooked coin

14. 6. Aim Toward Being Broadly Correctvs.Precisely Wrong • Index investing • Sector investing • Things that go up fast come down fast

15. 7. Accept randomnessvs. Manufacture explanation • Underestimate the role of luck in life • Overestimate it in games of chance • Think we can measure it in decision-making • We are better at explaining than understanding

16. 7. Accept randomnessvs. Manufacture explanation • Left brain = 1000 words • Right brain = picture • Split brain people • Left brain refuses to see randomness • Respect what happened • Ignore what might have happened

17. Super Bowl IndicatorAFL = Bear NFL = Bull • 1967 – 1997 28/31

18. 8. Thinkingvs. Computing • The energy conferences • Dot-com’s new world

19. Applications • Recognize and appreciate randomness, uncertainty and ambiguity. • Develop a more realistic understanding of the inability to quantify and measure risk. • Think! Don’t compute. • Reconsider the use of leverage • Recognize the risk of thinking you know…what you don’t know. • Pursue ventures with limited risk/cost and tremendous upside potential. • END