Back in 1998, the world of finance learned a very painful lesson: Models break and markets aren’t efficient. And with the rise of Donald Trump from sideshow to presumptive Republican nominee, politics has learned the same lesson. Long-Term Capital Management was a hedge fund staffed by several
Nobel Prize winners that possessed a supposedly unmatched grasp on how
markets work. The firm had the most sophisticated methods for exploiting
any and all inefficiencies, millions and millions of times over. And it
blew up.Spectacularly.
Chronicled at length in Roger Lowenstein’s brilliant book “When Genius Failed,” the short version of LTCM’s blowup is that a series of misplaced bets that certain interest rates would converge over time — because they always had in the past — went against the firm until they were out billions of dollars.
LTCM’s core conceit was that it believed markets were efficient and any inefficiencies would be corrected in due course. They were wrong.
Trump’s efficient market
Trump’s presidential campaign began with a surreal press conference inside Trump Tower in Manhattan. His “supporters” were reportedly paid actors and much of the spectacle was a farce.
And so Trump was not only written off as a marginal and unserious
candidate because he himself is so unserious, but also because no
outsider candidate with no establishment support and using only his
money to fund his campaign could, the theory goes, win a nomination.
In politics there’s an axiom that says “the party decides.” This idea
that vague, entrenched powerful interests — not the voters — determine
an election’s outcome is the political field’s efficient-market
hypothesis.
And it was essentially this idea that underwrote months of Trump
commentary that effectively followed the simple line that this can’t
happen because the party won’t allow it. The voters and the media can
have their fun (look at Bernie Sanders), but eventually reality sets in
and the practical candidates that Very Serious People believe are best
for the job will be put to the voters.
And yet here we are, not a year later, with Trump as the presumptive Republican presidential nominee.
REUTERS/Jonathan Ernst
Buoying themselves against this market ideology of deciding parties
were not only the traditional pundit class but also the newly crowned
top dogs of the political commentariat: the data hounds.
In 2008, Nate Silver rose to fame by correctly calling the election
in favor of outsider Barack Obama, a junior senator who overcame the
establishment in defeating Hillary Clinton but also topped the face of
the GOP, revered Sen. John McCain.
In 2012, Silver again nailed the election — which was never really
that close — that so many believed to be a toss-up between Obama and GOP
establishment choice Mitt Romney.
But this time around Silver failed.
On Wednesday, Silver wrote:
“To me, the most surprising part of Trump’s nomination — which is to
say, the part I think I got wrongest — is that Trump won the nomination
despite having all types of deviations from conservative orthodoxy.”
Nate Cohn at The New York Times also drew similar conclusions in a reflection on what data-based predictions about the Republican contest got wrong.
Which are both ways of saying that it seems the party itself failed —
the market failed to self-correct its inefficiency, in other words —
and thus the arguments undergirded by a belief in a coherent party
structure inevitably fell apart.
There was simply no there there.
Models
The statistician George Box once wrote, “Essentially, all models are wrong, but some are useful.”
This is true.
The failure to predict of Trump’s rise to the nomination, then, is
not the fault of the work done by folks like Silver, but a manifestation
of the hubris involved in trusting the party over what was happening on
the ground. Trump dominated Republican polls for months, but his place
in the race as a self-funded outsider who was clearly not the choice of
The Party seemed entirely untenable.
The incoming data was doubted all the way. The model broke.
In a great tweetstorm Wednesday,
former Wall Street trader Chris Arnade — who was among the slick,
model-wielding upstarts to hit finance in the 1990s — broke down the
problem with models, with beliefs, and why Trump’s imminent nomination
is, really, a pie in the face for everybody.
The success of Silver in 2008 and 2012 at the time appeared to be the
triumph of math over feeling or inspiration. The classic political
pundit could — still can! — anecdotally outline their case for or
against a certain candidate. Silver instead brought the data to back up
his view. And he was very right.
APNate Silver.
But where a Silver-style model eventually broke down this cycle was in doing what all models do: using the past to predict the future.
And this is ultimately why Box’s quote endures. All models — even
those that are useful and correct for long stretches — will eventually
reach a point at which the current inputs no longer yield results that
look anything like the past. The model’s guiding light goes dark. The
model breaks.
Arnade argued Wednesday that this affirms the need for on-the-ground
reporting, meeting voters in real life, getting a feel for just how
serious the Trump thing is by talking to people who take it seriously.
Maybe this is the answer. Maybe not.
But Arnade’s point is that using the model as a backstop to affirm
your priors — that Trump can’t win because he’s not the party’s choice,
that he’s too unserious, too racist, too inconsistent, too everything — is exactly the point at which the model begins to fail.
Long-Term Capital Management thought all arbitrage opportunities
would eventually revert to some efficient equilibria. Then they incurred
a revision of belief, and then they were out of business.
Sad!
Markets, in general, are pretty efficient.
But they are not absolutely so. There’s an old John Maynard
Keynes quote that says markets can remain irrational longer than you
remain solvent. Trump rendered the Republican Party insolvent.
Business Insider’s Henry Blodget wrote Wednesday that Democrats who are so confident that our next president will be Clinton should be a bit more humble.
And what I think his post really drives at is that to believe Trump
can’t beat Clinton would be to once again trust the model, trust the
market. This position would require you to believe, just like the GOP
did for the last year or so, that the party would decide, that the
sensible decision would be made, and the theory against which you
balanced your world would not fall apart into nothing.
Before 2016’s actual voting began, Trump’s surprisingly strong poll numbers were somewhat dismissed because, well, they were early.
And then, finally, Trump lost Iowa. Peak Trump! The model was going to be right!
REUTERS/Charles MostollerTed Cruz.
But
this was and remains Donald Trump. His campaign of schoolyard-style
insults exploited what my colleague Allan Smith has called Trump’s
biggest strength: finding someone’s weakness quickly and hammering on
it.
So Iowa winner Ted Cruz became “Lyin’ Ted.” A multi-decade Bush political dynasty was destroyed with two unforgettable words: “low energy.” Marco Rubio, the preferred establishment choice for the GOP nomination, became “Little Marco.” John Kasich was “1 for 38 Kasich,” which isn’t even that catchy: It’s merely true.
Cruz, as Josh Barro noted on Tuesday, ostensibly admitted that he was finally done deceiving voters after he knew he wouldn’t win their support.
Jeb Bush? He’s actually pretty low energy. Which is fine, but it’s also true.
Marco Rubio, at 5-foot-10, isn’t short at all, just shorter than Trump, who’s 6-2.
John Kasich did, in fact, win only one state.
But with these schoolyard insults — which, again, were mostly
statements of slightly inconvenient facts — Trump galvanized his base
against his opponents, against the party he hoped to represent, and
against the truth we all took to be self-evident about modern
presidential politics.
He upended the party and the “truths” that come along with a
political establishment using its heft to nudge voters toward the
candidate that has been vetted, supported, put in position to succeed.
Trump broke the model, and now he’s one vote from the White House.
