When Quality Doesn’t Matter

Friday, September 3rd, 2010

Back when the Web was young, Paul Graham demonstrated a new algorithm to Yahoo’s Jerry Yang, one that ranked search results by user behavior and differentiated between clicks and clicks leading to purchases.  Yang didn’t seem to care, and this confused Graham:

I was showing him technology that extracted the maximum value from search traffic, and he didn’t care? I couldn’t tell whether I was explaining it badly, or he was just very poker faced.

I didn’t realize the answer till later, after I went to work at Yahoo. It was neither of my guesses. The reason Yahoo didn’t care about a technique that extracted the full value of traffic was that advertisers were already overpaying for it. If they merely extracted the actual value, they’d have made less.

This, Eric Falkenstain notes, is just one example of when quality doesn’t matter:

There are many stories about real-estate brokers setting up shop in the early aughts, not caring about whether homebuyers would actually pay their mortgage because it did not matter. This was a signal that rot was rampant. Basically, if quality doesn’t matter, and there’s free entry, there’s a bubble.

When people have positions that don’t do what they say they do, and make a lot of money, there are myriad bad effects. Once when I was a risk manager, I remember showing a swaps book trader a more efficient way for him to hedge his portfolio. As I had to calculate his value-at-risk I had all the data to demonstrate conclusively my superior algorithm. He found this annoying. As a market maker, his Sharpe was already well above 10, so decreasing his value-at-risk by 20% did not really matter. Like Graham’s encounter, I discovered it was all marketing.

The problem with this situation is that when you really understand the game, you have to never talk about it, which is easiest to do if you really don’t understand it. So, the best brokers or brokers-who-call-themselves-traders are blithely ignorant, because they don’t generate ‘tells’ that make everyone engaging in the game uncomfortable. When they talk about trade ideas that are totally unfounded, they can’t be convincing if aware of its lack of statistical evidence, or how their qualifications make everything said meaningless (this could lead to a retracement). Once you swallow the red pill, you can’t go back to enjoying the Matrix.

Similarly in the corporate borg, especially in places like the new Office of Minority and Women Inclusion that is now mandated to be part of each of our 30(!) financial regulatory bodies. As true discrimination is about as rare as a Klan rally, this is all just a sop to the Indian-like ethnic group spoils system the US is becoming (are there really any bankers who hate minorities enough to forgo extra profits?). So, the Chief Diversity officer’s real role is not to rid financial discrimination, but rather to spout cliches about diversity, and put a pretext on the patronage daisy-chain that led to the 2008 housing crisis. However, if you really understood this, you would go crazy, so earnest dolts plague the aristocracy because the dupes actually believe their job is about what it says it’s about.


  1. Borepatch says:

    Of course, this sort of behavior puts them terribly at risk to a competitor who does know the weakness. Look at Google’s market value, vs. Yahoo’s.

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