Bookstaber's "A Demon of Our Own Design"

by: SoundView Technology Group

By Kris Tuttle

Kris Tuttle submits: The book by Bookstaber won’t provide much additional information if you are already familiar with most of the major leverage-driven derivative trading events in recent history. However, Bookstaber provides a very readable overview as someone who was there but one step removed from the inner circles.

Towards the end of the book he makes an interesting point. Starting with Godel, Heisenberg and Lorenz (bravo!), he moves into a discussion of biological methods for dealing with risks that are unknowable. What comes out is a powerful reminder that the right designs for dealing with 'known' risks often come at the direct expense of being able to deal with 'unknown' risks. This helps to explain why one set of regulations often leads to another different crisis, followed by a new set of regulations, and so on.

Lastly, there’s a good quote about research we have to include here for future use.

There is no reason to think this exercise of tearing apart the accountants’ aggregation (10Q’s and the like) and then trying to re-aggregate it into a meaningful form can be successful. And it certainly is not the ideal. The ideal is not to take something that is pieced together incorrectly and then redesign it; the ideal is to start with the raw materials, the actual transactions themselves, and build from there. For example, beyond the standard accounting numbers, statistics that might be helpful for companies with non-tangible assets are the cost of acquiring new customers and the retention rate for those customers - think of the insight these would have provided into America Online (NYSE:AOL) in its years of burgeoning growth - sales backlog, contracts received versus proposals made, training expenditure per employee, revenue from new products compared with revenue from old productions, the proportion of business that is done with existing customers, and the time it takes for a new product to recover its development cost.
(A Demon of our own Design
, Richard Bookstaber, p. 139.)

Bookstaber may not realize that most fundamental equity research looks at precisely these sorts of things, but it’s still not the rule and sometimes people who know better forget.