Two of a Kind
What the Neapolitan Novels can teach us about risk: What Doesn’t Matter; What Matters in Cyber; eBanking; Defense See-Saw; Vaccine Soft Power; Geopolitical Unrest
Unlike stories, real life, when it has passed, inclines toward obscurity, not clarity.
— Elena Ferrante, The Story of the Lost Child
Risk Developments this letter:
What Doesn’t Matter
What Matters in Cyber
eBanking
Defense See-Saw
Vaccine Soft Power
Geopolitical Unrest
Dialectical Risk
The best selling, pseudonymous, author of the Neapolitan Novels begins her famous quartet with an ominous phone call. The main character, Elena, picks up the receiver and is not surprised to hear that her estranged best friend, Lila, has gone missing. The quartet of books has many characters, plot twists, romances and betrayals, but unlike previous letters of The Refractor it is not worth summarizing this story for two reasons. First, I cannot do it justice, and second, it is not really important. All that matters is the bilateral relationship between Elena and Lila. In risk, as it relates to finance, technology and geopolitics, it is often the case that the bilateral relationship overwhelms everything else.
Elena and Lila are best friends, antagonists, twins and rivals. Both born to poor families in the slums of Naples, they share a common aptitude for education and ambitions to escape poverty. Despite these commonalities, their lives play out dramatically differently due to small, but important differences in character. Lila is hot headed, creative, strident, beautiful and incredibly smart. Elena is diligent, obedient, agreeable, homely and studious.
Throughout their lives a pattern develops, as exemplified by the most important anecdote in the whole quartet, from the first book, “My Brilliant Friend.” As young girls, Elena and Lila play with dolls, and in a seemingly random and cruel act, Lila tosses Elena’s doll down a hole into the basement of the neighborhood boogeyman and loan shark, Don Achille. In retribution, Elena does the same to Lila’s doll. Lila defiantly knocks on the loan shark’s door and demands their dolls back, but instead he pays them a small sum they use to buy a book. Elena goes on to become an academic success, attending university, and eventually becoming a published author.
Three important facts about this anecdote stand out. First, it is a dialogue between Elena and Lila. Second, it is an allegory for the Hymn of Demeter, where Persephone causes the seasons by traveling to the underworld. Finally, it is a story of taking money from a loan shark.
Dialogue is how one can integrate the shadow, as we have discussed before. On the international stage this often plays out as rivals achieving success by copying their rivals. How did the U.S. beat the Soviet Union? With massive government space and defense programs, a growing welfare system, falling inequality and strong unions. How is China challenging the U.S. today? With market oriented reforms, capitalist economic targets and private sector technological innovation. The more Elena imitates Lila, the more successful she becomes, but at the price of alienating her friend, turning her into a rival.
The Hymn of Demeter is both a bildungsroman and a metaphor for creation. Death and tragedy precipitate rebirth the same way investment and experimentation are required for innovation. Riskless R&D is an accounting exercise for tax purposes, but real experimentation has uncertain outcomes. It is no wonder that Lila is a fount of entrepreneurship from authoring stories to creating shoe lines and programming computers. Her actions appear brash and reckless, but often have a calculated upside.
Lastly, there is Don Achille, the loan shark. Don Achille is a former fascist and represents both Italian facism and the financial sector. After his death, Lila is faced with the choice between marrying a fascist or a mafioso. She chooses the fascist’s son to secure the capital her family’s growing shoe business requires. There is much more to discuss regarding Italian domestic politics, but let me turn to the more relevant risk topic, counterparty risk. In taking money for the lost doll, Lila makes a deal with the devil that sets her life on a path to marry Don Achille’s son and Elena’s on a path towards academic and cultural success. Lila’s failed marriage does not absolve her karmic debt. It is only when Elena and Lila are fully grown, and pregnant at the same time with daughters, how the final repayment of the doll debt will happen.
The Neapolitan Novels are many things, but ultimately it is a story about becoming. Actualization happens through communion with the other, with exceptional uncertainty and oftentimes a heavy price. Dialogue, calculated risks and counterparties are everywhere.
Risk Developments
What Doesn’t Matter
I’ve held off on writing about GameStop, mostly because I didn’t have much to add to the conversation, which already has great pieces like this one by Alex Williams, among others, but also because it doesn’t matter. Some people got rich and others did not is not newsworthy. Another topic I’ve held off on has been Special Purpose Acquisition Corporations (SPACs), which Byrne Hobart calls “a call option on hype”. Fads come and go.
In college I took a class on financial panics (it was fall 2008, and timing couldn’t have been better, i.e. worse). We started with fundamentals of company valuation. “Why do stock prices even exist?” is an underrated question. Our professor had three answers. The first was the book value of a company. The second was the net present value of all future cash flows. The third was the expectation of being able to sell it to somebody else at a higher price in the future. This maps nicely to Minsky’s three stages of a bubble.
GameStop began as a dialogue between book value (short sellers) and future cash flows (longs) that spiraled into greater fool territory. One reason this happens is nihilism. If you’re a short at heart, but see that longs are winning, you start to think nothing matters and stock prices are just bets that there’s an inexhaustible supply of stupid people. One thing the internet is really good at is providing a constant stream of stupidity, so this thesis is appealing.
Eventually, this kind of thinking comes up against some real constraints. The commission free stock broker app, Robinhood, came up against some real restraints and fumbled the public relations of pausing buying orders to shore up their balance sheet as the Depository and Trading Clearing Corporation (DTCC) requested more collateral. This forced Robinhood to raise money at an eye watering 30% discount to whatever they IPO at.
What matters here is not the hype, the fad or the fool. What matters is the counterparty risk. This goes for SPACs as much as it does in Robinhood’s case.
What Matters in Cyber
Lots of things in cybersecurity appear to matter, but don’t. One place this has been even more true is cyber insurance, but as losses mount and premiums rise, that’s starting to change. The Vice President of eRisk (eAnything is such a great throwback) at a smaller property and casualty insurer is pushing back, saying “One thing that brokers have sometimes struggled with in the past is articulating what the rate savings will be if companies engage in effective risk management.” To snowclone a famous political slogan, it’s the incentives, stupid.
Here’s another thing that matters, corporate boards. Gartner is predicting a jump in percentage of boards with cybersecurity committees, from 10% to 40% of corporate boards by 2025. Boards and incentives have real costs. They take scarce time and money away from other pressing problems companies face, but there is no innovation without risk. As Lila and Persephone prove, the first step is looking death squarely in the eye.
Some things are designed to look like they are coming to grips with an unpleasant truth, without having to go down to the depths. New York Department of Financial Services released a Cyber Insurance Risk Framework, today which as far as I can tell consists of three best practices: don’t pay ransomware, measure the insured’s risk rigorously and take into account aggregation risk. Yes, sure that’s all correct. It is not, however, very helpful. The difficulty is not in knowing what to do, but how to do it. Other places to look out for cyber theater are public private partnerships, like this one between Mastercard and Dubai.
eBanking
While Mastercard is doing cyber in Dubai, Visa announced yet another neobank partnership that ticks a number of buzzboxes. One way to try to distinguish whether something is real dialogue or just a bait and switch is to closely observe the language. Nobody in retail banking calls it “eBanking” anymore. Insurance is still stuck in the world of “eRisk,” but the cutting edge of fintech is light years ahead having already moved on from “digital banking” to “neobanks.”
Meanwhile, the big banks are still getting their digital banking feet under them. JPMorgan is launching a digital bank in the U.K. Bank of America is setting lofty goals for its digital banking platform. Even the feds are getting in on the act, as enthusiasm builds for real-time payments service FedNow. The Biden administration, long friendly with the banking sector, is looking to at two different candidates to head the OCC. The pick is falling along the classic Democratic fault line between woke (Mehrsa Baradaran) and tech (Michael Barr). Both are friendly with WallStreet. Either way, the bet is on digital banking, not the eBanking of the past, or the disruptive banking of neobanks.
Defense See-Saw
In other Biden administration news, the back and forth of the UAE/Saudi 23 billion dollar F-35 deal has been fun to watch. First, Trump signed a deal for 50 F-35’s and 18 drones in his last days in office. Biden froze the deal. Now the UAE ambassador is saying it’s back on? Dialogue is paramount in diplomacy, so it’s no surprise that changing conversation partners results in some back and forth without much substantial change.
Elsewhere in defense, Boeing reports record annual loss and General Dynamics missed earnings, but troubled helicopter manufacturer, Textron, is finally back on track. When your biggest customer decides whether you can sell to other customers, your counterparty risk is high and dialogue is of the utmost importance. The defense sector has been known for steady cash flows and long-term profits throughout the neoliberal era. Now that the political volatility genie has been let out of the bottle, don’t expect a change in administration to get everything back to normal overnight.
Vaccine Soft Power
While the defense sector is off to a bumpy start under Biden, pharma has taken the lead in geostrategic importance. The administration has left the top job unfilled at FDA, but the private sector in the U.S. has proven adept. Check out this interview with Noubar Afeyan, co-founder of Moderna and prolific inventor. The joint German-American Pfizer vaccine also makes use of mRNA, which can be developed in just a matter of days. Finally the promise of software is coming to biotech.
On the other hand, manufacturing mRNA vaccines can be a challenge. The two best known alternatives, Johnson & Johnson’s one dose vaccine and the Russian Vaccine are adenovirus vaccines. In a rare soft power win for Russia, the vaccine, which they began rolling out last summer was vindicated in the respected medical journal, the Lancet.
Last August I linked to a piece with Dr. Fauci’s skepticism of the Russia vaccine. He is still right that proving a vaccine works and creating a vaccine are two separate problems, but knowing what we know now about how fast mRNA can be developed and how effective the adenovirus vaccines can be, what calculated risks should we be taking in the future? Who should we be choosing as our partner in dialogue and rival? How can we avoid the mistakes of this pandemic?
Geopolitical Unrest
Here’s a public health cliche, “When America sneezes, the world gets a cold.” It’s as though the recent embarrassment on Capitol Hill has spread from farmers in India to dissidents in Russia to the military in Myanmar. Here’s a map of coronavirus lockdown protests worldwide. The world’s in dialogue, enabled by social media where conversations ricochet around the world at the speed of bits. Back and forth sooner or later leads to a crisis. That pivotal moment is the time to take stock of who your counterparties are.
Gratitude
Big thanks to Byrne Hobart, Alex Williams, Vinit Shah and Roger Farley for your thoughts and encouragement.