Friday, November 21, 2014

The Money Culture

I recently reread another Michael Lewis book, his 1991 collection of magazine articles, "The Money Culture". While I generally like Lewis as a writer I didn't much care for this book. The pieces are dated and for the most part not all that great to begin with. Give this book a pass.

Tuesday, November 18, 2014

Procedure Codes

Back in March I went to the dentist for a routine cleaning. A week or two later I was reimbursed by my dental insurance (after my dentist submitted the claim directly). I noticed that as usual the insurance paid most but not all of the bill but otherwise paid little attention. I went back to the dentist in October for another routine cleaning. This time I paid a bit more attention when my reimbursement check arrived (because coincidentally dental insurance reimbursement rates had recently come up in conversation) and noticed it was more than the earlier check. My first thought was that my insurance company must have raised its reimbursement rates. This was a small part of the explanation but examining the respective explanation of benefits statements showed that most of the difference was because in March I had been reimbursed for procedure code D0190 (screening of a patient) whereas in October I was reimbursed for procedure code D0120 (periodic oral evaluation) which my insurance covers for a larger amount. (In both cases I also was reimbursed for procedure code D1110 (adult cleaning)). So my next thought was that my dentist had coded my claim suboptimally (from the point of view of maximizing insurance reimbursement) but my March bill showed the D0120 code and when I went into the dental office a couple of weeks ago with my bill and the insurance statement of benefits they insisted the insurance company would have received exactly what was on my bill. But they also offered to try and straighten things out. And Monday I duly received an additional reimbursement check from my insurance company.

So what happened? This is a bit puzzling as it seems everything should have been handled by computer with little room for human error given that the original entry into the system was done correctly as it appears it was. It seems unlikely that MetLife is randomly recoding procedures (to reduce reimbursements) and hoping nobody notices. I suppose a short lived computer software bug is the likeliest explanation but who knows. In any case when receiving explanations of medical benefits it seems it can pay to take a moment to compare the procedure codes to those on your bill from your provider.

Saturday, November 15, 2014

Flash Boys

As I mentioned in my previous post I recently read "Flash Boys" a 2014 book by Michael Lewis. Most of this book is about the creation of IEX, a recently formed dark pool (private stock exchange) which claims to be fairer to its clients than other stock trading forums.  A couple of chapters are devoted to the case of Sergey Aleynikov a computer programmer for Goldman Sachs who was criminally charged for allegedly stealing computer code after he quit to take another job.  His federal conviction was overturned on appeal but he still faces New York State charges.  These chapters have little to do with the rest of the book.

The founders of IEX have apparently constructed a narrative in which the previously existing US stock markets were rigged and corrupt inducing the outraged founders to create IEX to clean things up.  Lewis appears to have bought into this entirely and his book reflects this.  As I said in my review of Lewis's earlier book, "The Big Short":

There is a bit of a danger with an entertaining writer like Lewis that you will give undue credence to his point of view simply because he is such a good story teller. Lewis has been criticized along these lines but for the most part I think his books get the big picture (if not every detail) correct.

Lewis remains entertaining but in this book I don't believe he has gotten the big picture correct.  He doesn't seem to realize that if you try to buy or sell a large amount of a stock you will move the price against you (up if you trying to buy, down if you are trying to sell).  This is just how markets work by balancing supply and demand and doesn't mean they are corrupt or rigged.  But Lewis seems to think there is something nefarious about this process. 

On page 109 Lewis writes:

... After the market was computerized and decimalized, in 2000, spreads in the market had narrowed--that much was true.  Part of that narrowing would have happened anyway, with the automation of the stock market, which make it easier to trade stocks priced in decimals rather than in fractions. Part of that narrowing was an illusion: What appeared to be the spread was not actually the spread.  The minute you went to buy or sell at the stated market price, the price moved.  ...   

First decimalization narrowed spreads because as part of decimalization the tick size was reduced from .0625 (1/16) to .01 (not because decimal fractions have some inherent superiority to binary fractions).   It became apparent that the larger tick size had been keeping spreads artificially high and they narrowed when it became possible for them to do so.  Second the smaller tick size (and resulting narrower spreads) made it possible to observe stock prices to greater precision.  Which made it possible to observe smaller changes in stock prices.  In particular it became easier to observe the price changes induced by a moderate sized order which a larger tick size might have obscured.  This doesn't mean the narrower spread isn't real, it is quite real for small scale traders like most individual investors including me.

On page 114 Lewis writes:

... The algos had names like Ambush and Nighthawk and Raider and Dark Attack and Sumo.  Citi had one called Dagger, Deutsche Bank had Slicer and Credit Suisse had one named Guerilla, ... , Their very names made Rich Gates wary; he also didn't like how loudly the brokers selling them told him they'd come to protect him.  Protect him from what?  Why did he need protection? From whom did he need to be protected? ...

Although Lewis doesn't bother to explain it appears these programs mostly just disguise large orders by splitting them into smaller orders (enabling a better average price to be obtained).  As for from whom Gates needed to protected, apparently he needed to be protected from himself, from revealing his intent to buy or sell a large block of stock before he had to and thereby getting a worse price.

No doubt there are many ways US stock markets could be improved, the big players are all seeking private advantage.  But this unbalanced book while entertaining is not in my view a reliable guide to the issues.

Thursday, November 13, 2014

Stock Prices

I recently read "Flash Boys", a 2014 book by Michael Lewis about stock trading.  I intend to review it but for now just wish to discuss one point, the issue of what a "fair" price for a stock trade is.  Consider the market for IBM stock.  Suppose for example the market bid and offer prices are $159.99 and $160.01 (per share).  So there are people offering to sell shares for $160.01 and others offering to buy shares for $159.99.  So it seems plausible that a fair price is $160.  And if you should happen pay $160.01 or receive $159.99 the penny a share profit to a market maker providing liquidity doesn't seem outrageous to me. 

But this analysis only makes sense if the amount of stock you are buying or selling isn't enough to move the price significantly.  Suppose there are a billion shares of IBM stock outstanding and the elasticity of demand is 1 for IBM stock (this is just an illustrative example, the actual values will vary).   Then a small order like one thousand shares can be expected to move the price by one part in a million (since one thousand is one part in a million of one billion) or $.000160.  Since this is small compared $.01 it won't materially affect a market maker's profit.  But a large order like a million shares will move the price by one thousand time as much or $.16.  This is enough to turn an anticipated $.01 per share profit into a $.15 per share loss if  a market maker should be so unwise as to sell a million shares at $160.01 (or buy a million shares at $159.99). 

So what is a fair price for a large order?  It seems to me that it is the midpoint between the before and after prices.  Or $160.08 if you are buying, $159.92 if you are selling.  If you could obtain better prices than this then you could profit by repeatedly buying (driving up the price) and then selling (at a higher price) a large block of shares.  And you should be able to obtain near to this price just by splitting up your order and feeding it into the market slowly buying (or selling) at gradually increasing (or decreasing) prices.    

Much of the behavior of high frequency traders that Lewis complains about in this book just seem to be attempts of market makers to protect themselves from being blindsided by large orders.  Without endorsing every specific tactic this doesn't seem unreasonable in general.  And it benefits small investors (like myself) as the alternative is larger bid ask spreads (like for example $159.90 bid, $160.10 asked). 

Sunday, November 9, 2014

My Vast Fortune

My local library had another Andrew Tobias book, his 1997 "My Vast Fortune", which I also checked out and reread.  I have mixed feelings about this book.  When Tobias keeps a light touch I find him an entertaining writer.  But when he gets all earnest and serious I find him less entertaining and sometimes actively annoying.  Much of this book humorously  chronicles Tobias's financial triumphs and misadventures and I generally liked that part.  But a big part of the book is devoted to Tobias's ill-fated crusade for no fault auto insurance which culminated in a 1996 California proposition which lost overwhelmingly.  He goes on at tedious length about the purported benefits of a no fault system and the perfidy of those, Ralph Nader foremost, who opposed it.  Even granting his case it is hard to understand why he thought logic and reason would count for much in a political fight and eventually his outraged sense of betrayal becomes a bit hard to take.

I also was a bit annoyed by Tobias's position that liberal programs like free legal services for the poor are fine ideas but they just need to be administered with a little discretion so as not to inconvenience people like Tobias.  I have no problem believing a case brought against Tobias by a former tenant was baseless but Tobias's proposal that legal services "settle" the case by having Tobias denote money to charity was ridiculous.    

I noticed a curious inconsistency between this book and "The Only Other Investment Guide You'll Ever Need".  In the earlier book Tobias recounted (p. 168-169) his investment in a research and development venture that was bought out by Johnson & Johnson doubling his money but leaving him (and some of the other limited partners) dissatisfied both with their return (they felt under the terms of their investment they should have tripled their money) and with the lawyer they had hired to sue to enforce their contract (who appeared to have lost interest).  But in this book he reports (p. 33) tripling his money in this deal.  So one is left wondering what happened.  Did his lawyer sudden spring to life and obtain a better deal or what?  I suppose it's probably just a mistake (possibly caused by confusion between a profit of double your investment and doubling your investment) though.    

So in summary I found this book too flawed to recommend but I did find some of it entertaining.

Saturday, November 8, 2014

The Only Other Investment Guide You'll Ever Need

Having recently reread "Money Angles" by Andrew Tobias I decided to see what other books of his were in my local library. His book "The Only Investment Guide You'll Ever Need" was supposed to be there but apparently has been lost or stolen. But I checked out and reread the 1987 sequel "The Only Other Investment Guide You'll Ever Need". Although it is similar in some respects to "Money Angles" I didn't like it as much. One problem is the book comes across as more badly dated because it offers more of the kind of specific advice that depends on the details of things like current tax laws and many such details have changed. For example the book mentions at one point (p. 225) a tax on mutual fund advisory fees (which were to be included in income). But this tax on "phantom income" proved so unpopular it was repealed before it ever actually took effect.  Also I have read enough personal finance books that another version of fairly standard advice is not very interesting to me. 

I didn't hate the book, it does have some of the same sort of amusing stories I liked in "Money Angles".  And some of the advice is still good.  But if you are looking for a guide to personal finance I think you would do better with a more recent less dated book.    

Tuesday, November 4, 2014

Election Day 2014

I voted Tuesday on my way to work. This was easy as my polling place is conveniently located just off my usual route and there was no line. I didn't find the electronic voting machines being were used very confidence inspiring (as regards my vote being correctly recorded and counted) but I suppose this is partly a function of unfamiliarity.

I am registered as unaffiliated but like most independents tend to lean one way, in my case towards the Republicans. So I was pretty happy with the results especially the (apparent) defeat of the loathsome Martha Coakley in the Massachusetts Governor's race. It will be interesting (although of course almost totally meaningless) to see how the financial markets react Wednesday.