AP Chemistry Practice Tests

Update: I've added a link to the 2018 free-response questions.

As you may already know, the AP Chemistry test changed in 2014. It's now more like a college final exam than a high school test, and you can't study for it as you'd prepare for SAT Chemistry, which largely tests memorization.

The questions have become more conceptual, and there's a large focus on lab chemistry. They remind me of the SAT's Critical Reading section: if you're not extremely careful, you'll misread the something without realizing it.

These changes aren't fully reflected in the prep books, not even the 2017 Princeton Review book I recently looked at. Of the students who took the AP exam, only 12.6% received a 5 in 2018, as opposed to 18.2% in 2013.

The good news is that you can train yourself to be one of the top 9% who gets a perfect score. I recommend taking released exams and free-response questions two months before the AP test. Prepare a list of questions you'd like to review in each tutoring session.

If you need more practice material, do the hardest problems at the end of every chapter of your AP Chemistry textbook. Treat them like free-response questions: write out a paragraph-long explanation for explaining how you arrived at each answer. Since your book won't have free-response-style answers in the back, ask your tutor to check your explanations for completeness.

Practice Tests

Here are some official practice questions. Start at page 117 of the booklet, which is PDF page 126.
AP Chemistry sample multiple-choice questions and answers

The College Board has also released the free-response questions from actual AP exams:
2014 Free-response questions and answers
2015 Free-response questions and answers
2016 Free-response questions and answers
2017 Free-response questions and answers
2018 Free-response questions and answers

AP Chemistry is my favorite subject to tutor. If I didn't like the chemistry, I wouldn't have bothered to get two degrees in it! Contact me if you'd like to schedule a session.

Read More

ACT Practice Tests

Here are six official ACT practice tests.

2018-19 ACT Practice Test

2016-17 ACT Practice Test (This is the test Compass Prep usually uses as a diagnostic tool.)

2014-15 ACT Practice Test

2011-12 ACT Practice Test

2008-09 ACT Practice Test

2005-06 ACT Practice Test

Since the ACT has slowly changed over time, start with the most recent version and work your way down the list.

I strongly suggest printing the tests out onto real paper. It's almost impossible to take notes, cross off answer choices, or double-check your bubbling unless you're working on paper!

If you need more practice tests, you can buy the Official ACT Prep Guide.

Have fun!

Read More

Free Web Site Help AND a Free Tutoring Session

On January 28, the Contra Costa Small Business Development Center is offering a free three-hour seminar about building a Web site through Wordpress.

In the interest of helping students build an online presence, I'm offering a free tutoring session to any current or new student who attends. The link below has the seminar's location and time.

Web Site Building Basics: Building and Publishing Your Own Web Site

After the seminar, please contact me about tutoring and include the words "Web site building seminar." I'd be happy to help you with test prep, math, or chemistry. Alternatively, you can use the free session to learn how to use your new Web site to market yourself to colleges and potential employers.

Read More

On Big Companies and Free Practice Tests

Big test prep companies offer free practice tests because it's a great way for them to make money.

They pay marketers, proctors, graders, administrative staff, bondholders, and shareholders - not to mention real estate costs - so you can get a score for free.

In exchange, you've become what salesmen call a warm lead: someone who's demonstrated interest in their product.

There's nothing wrong with this as long as you understand how the process works. Test prep companies offer practice tests, which are valuable to you, so they can get your attention, which is valuable to them.

They pay for this by charging $125-250 an hour for tutoring, ten sessions at a time, paid up front. Their tutors typically make $25-40 an hour, and the difference ($100/hour or more) is used to pay administrative costs and provide investors with a profit.

The breakeven point between teaching at a public school and working as an independent tutor is around $90/hour. Tutors who accept less than half of that amount typically have SAT scores of around 1400-1500. Those are good scores, but if you're paying $150/hour, your score target is probably already at or higher than 1500.

This is not going to change, as these tutors aren't being exploited. Test prep companies have large expenses every month that aren't going to go away if there's a recession. Most workers, including tutors, accept lower pay in order to have their employers shoulder that burden.

If you have time, it's best to take responsibility for your own education. Practice taking the SAT and ACT yourself, then compare the two scores. You can then choose SAT or ACT prep books and study on your own.

If you need a tutor, you have lots of options, including highly qualified independent tutors like myself. Go in with your eyes open, and you'll make a great choice.

Read More

UC Schools Have Become More Selective

It's gotten harder to get into University of California schools: not just for your friends who were seniors last year, but for everyone.

I've included data below for the high school graduating classes of 2017 and 2018 with the information for UC Berkeley and UCLA highlighted.

While GPA ranges across the board have increased only slightly, test scores are consistently higher, and the percentage of applicants admitted has consistently moved lower from 2017 to 2018.

UC Data: Class of 2017

UC Data: Class of 2018

Audrey Slaughter was kind enough to share a Compass Prep article with me that breaks down ACT and SAT test score data from the past few years.

Compass finds that median scores haven't changed much, but more students are have been scoring at the high end of the range (1400-1600):

At the most competitive colleges, high test scores can be viewed as “necessary but not sufficient.” It is extremely difficult to gain admission to Stanford with a low SAT score, but getting a great score is far from a guarantee of admission. The net effect of the growth at the top ranges is to make a high score more essential but less sufficient.

After the dust settles each April, we often hear that “this was the worst year ever.” For 2018, that assessment feels fair. ACT and SAT scores at colleges have trended up over time, but it’s not simply higher scores that create anxiety — it’s also the added unpredictability. The combination of increased applicant numbers at competitive colleges and a higher percentage of top scores magnify the uncertainty that students experience.

So How Do I Get In?

In the end, grades, test scores, and a college degree itself are only imperfect measures of what really matters: your dedication, creativity, and life goals. Schools like Stanford know that, and they're looking for much more than just great numbers on your application.

Does your life thus far show that you have the potential to win a Nobel Prize or found your own company? That's what schools are looking for. Those are the things that get an alma mater noticed.

As a nation, we're obsessing more and more about the scoring well on the things that measure success without necessarily getting better at achieving success itself.

Test scores and grades matter because those are the things we've chosen to measure - but don't forget to live a life of dedication and meaning. It's that life that will get you involved in amazing extracurriculars and help you write essays that will get noticed.

Yes, UC schools have become more selective. Become the kind of person they would like to select.

Read More

The Four Best Places to Find a Tutor

Update: I've added a link to Northgate High School's peer tutoring program.

Are you looking for a tutor? Our capitalistic economy provides a dizzying array of educational options, and part of my job is to help you sort through them, even if you end up working with someone else as a result.

Why would I purposefully direct you to tutor who's a better fit for you? Most of my business comes from word of mouth, and I believe that following the Golden Rule and giving to others will benefit me indirectly. (Check out this animation about win-win scenarios.) What's best for you is often what's best for me.

Full-time tutors start at $45/hour, and tutors with perfect SAT and ACT scores are $180-600/hour. Use the guide below to evaluate your options.

Peer Tutors

Most schools offer free or low-cost peer tutoring. I used to work as one of those tutors when I was in eighth grade. That's the lowest-end option and is suitable for help with homework, since those tutors are likely to be most familiar with the local curriculum.

If you go this route, you'll probably want to do sessions multiple times a week to stay caught up in school.

Using peer tutoring to get A's in math and English is an excellent way to prepare for the SAT and ACT and will reduce the number of sessions you'll need with a test prep specialist.

Similarly, you can get a peer tutor multiple times per week for an AP class and wait until March to hire a test prep specialist to help you prepare for the corresponding SAT Subject Test and AP exam.

You can find your school's peer tutoring page by searching Google for your school's name plus the word tutoring.

Northgate High School's peer tutoring program meets in the Multimedia Center.

I also have students with perfect SAT/ACT Math and Calculus BC scores who currently work as private tutors. They're good options at the high end of the peer tutoring spectrum.

Tutoring Companies

Medium-sized companies (JC Education, Lafayette Academy, Zenith Tutoring) and big companies (Kaplan, Princeton Review, Tried and True Tutoring, Compass Prep) charge two to five times what they pay out to tutors. They offer tutoring in the range of $45-250 an hour.

You'll be getting a lower-paid tutor, but the service is convenient, as those companies are one-stop shops for help in all subjects, including college admissions counseling.

In general, the larger the company, the more standardized its product will be. I personally go to huge corporations for commoditized services where I want predictability: gasoline (World Oil), book delivery (Amazon), and health food (Odwalla). Standardization is less of a benefit in situations where you have to learn a skill like swing dancing, writing, or math.

Mid-Tier Independent Subject Tutors

You can also hire independent educators through Web sites like Thumbtack and Wyzant, and you'll also find some advertising on NextDoor. You'll probably get more for your money than if you go through a big company.

A credentialed teacher who can tutor in most school subjects will run you about $70/hour, depending on the area you live in.

$70/hour is theoretically a bit low in California: the average high school teacher makes $75,000 a year. In order to be incentivized to tutor full-time, which is 20 hours a week of tutoring with 20 hours of driving and prep, the teacher needs to make around $75/hour AFTER paying business expenses and the extra taxes involved in being self-employed. That could end up being more like $90/hour gross of expenses, but I use $70/hour as an average because that's what I tend to observe in the market.

Of course, there are great tutors who charge less than $70/hour, just as there are great teachers who make less than $75,000 a year. (Un-unionized private school teachers - I used to be one - come to mind.) Just be aware that in general, you get what you pay for, and if you want something great at a relatively low rate, you have to be willing to evaluate a number of tutors to find the diamond in the rough.

Top-Tier Test Prep Specialists

Finally, there are independent specialists, each of whom focuses on one academic area and does it very well.

For example, I have a master's degree in chemistry from Stanford and perfect scores on most standardized tests, so I tutor mainly SAT/ACT, Math Level 2, calculus, and AP Chemistry. Audrey Slaughter specializes in college admissions counseling and spends a large portion of each year visiting college campuses and keeping up-to-date with changes in her field.

Specialized tutoring runs up to $600/hour and works best to address specific needs rather than as a long-term solution to raise grades. You may want to consider hiring a peer tutor to come multiple times per week and then supplement with a specialist two months before the AP test or four months before the SAT.

Tutors with perfect SAT and ACT scores are relatively rare, as they could be working at Google or founding startups instead of spending their weekends with high school students. They're usually high-value educators with multiple qualifications.

My own tutoring service compares favorably with other top-tier options. If you'd like to have ACT score gains of 5-10 points, SAT score gains of 180-350 points, or perfect scores on Subject Tests and AP tests, please contact me so I can help you create a study plan.

Read More

Boomerang (Michael Lewis)

This week, we'll look at Boomerang by Michael Lewis. As usual, I've included representative quotes from the book along with finance-related lessons (in blue) that we can apply to markets today.

Lewis visits Europe to consider the aftermath of the 2008 financial crisis on Iceland, Greece, Ireland, and Germany.

Each of these countries took enormous financial risks it didn't understand. In each case, there were people who saw what was going on. Their voices were ignored until after the market began to collapse.

Iceland: The Carry Trade

For the past few years, some large number of Icelanders engaged in the same disastrous speculation. With local interest rates at 15.5 percent and the krona rising, they decided the smart thing to do, when they wanted to buy something they couldn't afford, was to borrow not kronur but yen and Swiss francs. They paid 3 percent interest on the yen and in the bargain made a bundle on the currency trade, as the krona kept rising. (p. 8)

Borrowing at a low interest rate and buying an asset that is expected to provide a higher return is known as the carry trade. It's a profitable strategy for traders who get in early. In this case, as other traders piled in - borrowing yen and buying the krona - the krona rose in value, providing those early traders with both positive carry (the difference between what they paid to borrow yen and what they made lending the krona) and the appreciation of the krona itself.

It must have seemed like a no-brainer: buy these ever more valuable houses and cars with money you are, in effect, paid to borrow. But, in October, after the krona collapsed, the yen and Swiss francs they must repay became many times more expensive. Now many Icelanders - especially young Icelanders - own $500,000 houses with $1.5 million mortgages, and $35,000 Range Rovers with $100,000 in loans against them. To the Range Rover problem there are two immediate solutions. One is to put it on a boat, ship it to Europe, and try to sell it for a currency that still has value. The other is to set it on fire and collect the insurance: Boom! (p. 9)

At some point, the carry trade runs too far, creating mispricings that will eventually be reversed. In this case, the krona became overvalued and the yen undervalued. Traders needed to exit their positions, buying yen and selling the assets they had bought, but some weren't able to because the assets they bought weren't liquid enough. If you borrow yen in the short term and buy long-term bonds to get a higher interest rate (or worse, buy houses and cars), you're counting on finding a willing buyer to eventually take that position off your hands.

That was the biggest American financial lesson the Icelanders took to heart: the importance of buying as many assets as possible with borrowed money, as asset prices only rose. By 2007, Icelanders owned roughly fifty times more foreign assets than they had in 2002. They bought private jets and third homes, in London and Copenhagen. They paid vast sums of money for services no one in Iceland had theretofore ever imagined wanting. "A guy had a birthday party, and he flew in Elton John for a million dollars to sing two songs," the head of the Left-Green Movement, Steingrimur Sigfusson, tells me with fresh incredulity. "And apparently not very well." They bought stakes in businesses they knew nothing about and told the people running them what to do - just like real American investment bankers! (p. 15)

Since the entire world's assets were rising - thanks in part to people like these Icelandic lunatics paying crazy prices for them - they appeared to be making money. Yet another hedge fund manager explained Icelandic banking to me this way: you have a dog, and I have a cat. We agree that each is worth a billion dollars. You sell me the dog for a billion, and I sell you the cat for a billion. Now we are no longer pet owners but Icelandic banks, with a billion dollars in new assets. "They created fake capital by trading assets amongst themselves at inflated values." (pp. 16-17)

The Danske Bank report alerted hedge funds in London to an opportunity: shorting Iceland. They investigated and found this incredible web of cronyism: bankers buying stuff from one another at inflated prices, borrowing tens of billions of dollars and relending it to the members of their little Icelandic tribe, who then used it to buy up a messy pile of foreign assets. "Like any new kid on the block," says Theo Phanos, of Trafalgar Asset Mangers, in London, "they were picked off by various people who sold them the lowest-quality assets - second-tier airlines, sub-scale retailers. They were in all the worst LBOs." (pp. 19-20)

You didn't need to be Icelandic to join the cult of the Icelandic banker. German banks put $21 billion into the Icelandic banks. The Netherlands gave them $305 million, and Sweden kicked in $400 million. UK investors, lured by the eye-popping 14 percent annual returns, forked over $30 billion - $28 billion from companies and individuals and the rest from pension funds, hospitals, universities, and other public institutions. Oxford University alone lost $50 million. (p. 23)

As a bull market ages, the deals that are done tend be less conservative, and the people participating in those deals tend to be less sophisticated.

Greece: A Subprime Government

In 2001, Greece entered the European Monetary Union, swapped the drachma for the euro, and acquired for its debt an implicit European (read German) guarantee. Greeks could now borrow long-term funds at roughly the same rate as Germans - not 18 percent but 5 percent. To remain the in euro zone, they were meant, in theory, to maintain budget deficits below 3 percent of GDP; in practice, all they had to do was cook the books to show that they were hitting the targets. Here, in 2001, entered Goldman Sachs, which engaged in a series of apparently legal but nonetheless repellent deals designed to hide the Greek government's true level of indebtedness. For these trades Goldman Sachs - which, in effect, handed Greece a $1 billion loan - carved out a reported $300 million in fees. The machine that enabled Greece to borrow and spend at will was analogous to the machine created to launder the credit of the American subprime borrower - and the role of the American investment banker in the machine was the same. The investment bankers also taught the Greek government how to securitize future receipts from the national lottery, highway tolls, airport landing fees, and even funds granted to the country by the European Union. Any future stream of income that could be identified was sold for cash up front and spent. As anyone with a brain must have known, the Greeks would be able to disguise their true financial state for only as long as (a) lenders assumed that a loan to Greece was as good as guaranteed by the European Union (read Germany), and (b) no one outside of Greece paid very much attention. Inside Greece there was no market for whistle-blowing, as basically everyone was in on the racket. (pp. 82-83)

Greece bundled up and sold off tomorrow's income in order to have cash today. That would have made sense if they had invested the money in assets that would have provided a higher return and allowed them to pay the money back. Instead, they spent the money - after having paid fat fees to do the borrowing.

Ireland: An Even Bigger Housing Bubble

Kelly saw house prices rising madly, and heard young men in Irish finance to whom he had recently taught economics try to explain why the boom didn't trouble them. And the sight and sound of them troubled him. "Around the middle of 2006 all these former students of ours started to appear on TV!" he says. "They were now all bank economists and they were nice guys and all that. And they all were saying the same thing: 'We're going to have a soft landing.' "

The statement struck him as absurd on the face of it: real estate bubbles never end with soft landings. A bubble is inflated by nothing firmer than people's expectations. The moment people cease to believe that house prices will rise forever, they will notice what a terrible long-term investment real estate has become, and flee the market, and the market will crash. It was in the nature of real estate booms to end in crashes - just as it was perhaps in Morgan Kelly's nature to assume that if his former students were cast on Irish TV playing the financial experts, something was amiss. "I just started Googling things," he says.

Googling things, Kelly learned that more than a fifth of the Irish workforce was now employed building houses. The Irish construction industry had swollen to become nearly a quarter of Irish GDP - compared to less than 10 percent or so in a normal economy - and Ireland was building half as many new houses a year as the United Kingdom, which had fifteen times as many people to house. He learned that since 1994 the average price for a Dublin home had risen more than 500 percent. In parts of Dublin rents had fallen to less than 1 percent of the purchase price; that is, you could rent a million-dollar home for less than $833 a month. The investment returns on Irish land were ridiculously low: it made no sense for capital to flow into Ireland to develop more of it. Irish home prices implied an economic growth rate that would leave Ireland, in twenty-five years, three times as rich as the United States. ("A price-earnings ratio above Google's," as Kelly put it.) Where would this growth come from? Since 2000, Irish exports had stalled and the economy had become consumed with building houses and offices and hotels. "Competitiveness didn't matter," says Kelly. "From now on we were going to get rich building houses for each other." (pp. 90-1)

Their real estate boom had the flavor of a family lie: it was sustainable so long as it went unquestioned and it went unquestioned so long as it appeared sustainable. After all, once the value of Irish real estate came untethered from rents, there was no value for it that couldn't be justified.... 

"There is an iron law of house prices... the more house prices rise relative to income and rents, they more they will subsequently fall." (pp. 91-2)

As it happened, Kelly had predicted the future with uncanny accuracy, but to believe what he was saying, you had to accept that Ireland was not some weird exception in human financial history. "It had no impact," Kelly says. "The response was general amusement. It was what will these crazy eggheads come up with next? sort of stuff." (p. 93)

Kelly wrote his second newspaper article, more or less predicting the collapse of the Irish banks. He pointed out that in the last decade the Irish banks and economy had fundamentally changed. In 1997 the Irish banks were funded entirely by Irish deposits. By 2005 they were getting most of their money from abroad. The small German savers who ultimately supplied the Irish banks with deposits to re-lend in Ireland could take their money back with the click of a computer mouse. Since 2000, lending to construction and real estate had risen from 8 percent of Irish bank lending (the European norm) to 28 percent. One hundred billion euros - or basically the sum total of all Irish bank deposits - had been handed over to Irish commercial property developers. By 2007, Irish banks were lending 40 percent more to property developers alone than they had to to the entire Irish population seven years earlier....

This time Kelly sent his piece to a newspaper with a far bigger circulation, the Irish Independent. The Independent's editor wrote back to say he found the article offensive and wouldn't publish it. Kelly next turned to the Sunday Business Post, but the editor just sat on the piece. The journalists were following the bankers' lead and conflating a positive outlook on real estate prices with a love for country and a commitment to Team Ireland. ("They'd all use the same phrase, 'You're either for us or against us,' " says a prominent Irish bank analyst in Dublin.) (pp. 94-5)

As a bubble inflates, there are always people who point out how irrational the market's behavior is, and they're almost always ignored. In practice, it's hard to tell if they're wrong or simply calling the end of the bubble too early. 

Objective quantitative approaches may help here: are valuations currently high relative to history, relative to other asset classes, and relative to other countries? Have trend-following indicators begun to suggest that the bubble may be popping?

A banking system is an act of faith: it survives only for as long as people believe it will. Two weeks earlier the collapse of Lehman Brothers had cast doubt on banks everywhere. Ireland's banks had not been managed to withstand doubt; they had been managed to exploit blind faith. Now the Irish people finally caught a glimpse of the guy meant to be guarding them: the crazy uncle had been sprung from the family cellar. Here he was, on their televisions, insisting that the Irish banks' problems had nothing whatsoever to do with the loans they'd made... when anyone with eyes could see, in the vacant skyscrapers and empty housing estates around them, evidence of bank loans that were not merely bad but insane. (p. 98)

It would have been difficult for Merrill Lynch's investment bankers not to know, on some level, that, in a reckless market, the Irish banks acted with a recklessness all their own. But in the six-page memo to Brian Lenihan - for which the Irish taxpayer forked over to Merrill Lynch 7 million euros - they kept whatever reservations they might have had to themselves. "All of the Irish banks are profitable and well-capitalized," wrote Merrill Lynch advisers. (p. 112)

"At the time they were all saying the same thing," an Irish bank analyst tells me. "We don't have any subprime." What they meant was that they had avoided lending to American subprime borrowers; what they neglected to mention was that, in the general frenzy, all of Ireland had become subprime. Otherwise sound Irish borrowers had been rendered unsound by the size of the loans they had taken out to buy inflated Irish property. That had been the strangest consequence of the Irish bubble: to throw a nation that had finally clawed its way out of centuries of indentured servitude back into indentured servitude. (p. 113)

Experts aren't always right. Do your own research, and turn off the financial news.

Germany: It's Risk-Free. Right?

The curious thing about the eruption of cheap and indiscriminate lending of money between 2002 and 2008 was the different effects it had from country to country. Every developed country was subjected to more or less the same temptation, but no two countries responded in precisely the same way. Much of Europe had borrowed money to buy stuff it couldn't honestly afford. In effect, lots of non-Germans had used Germany's credit rating to indulge their material desires. The Germans were the exception. Given the chance to take something for nothing, the German people simply ignored the offer. "There was no credit boom in Germany.... Real estate prices were completely flat. There was no borrowing for consumption. Because this behavior is totally unacceptable in Germany. This is deeply in German genes. It is perhaps a leftover of the collective memory of the Great Depression and the hyperinflation of the 1920s." The German government was equally prudent because, he went on, "there is a consensus among the different parties about this: if you're not adhering to fiscal responsibility you have no chance in elections, because the people are that way."

In the moment of temptation, Germany became something like a mirror image to Iceland and Ireland and Greece - and the United States. Other countries used foreign money to fuel various forms of insanity. The Germans, through their bankers, used their own money to enable foreigners to behave insanely....

They lent money to American subprime borrowers, to Irish real estate barons, to Icelandic banking tycoons, to do things to German would ever do. The German losses are still being totaled up, but at last count, they stand at $21 billion in the Icelandic banks, $100 billion in Irish banks, $60 billion in various U.S. subprime-backed bonds, and some yet-to-be-determined amount in Greek bonds. (pp. 145-6)

He'd created the bank when the market was paying higher returns to bondholders: Rhineland Funding was paid well for the risk it was taking. By the middle of 2005, with the financial markets refusing to see a cloud in the sky, the price of risk had collapsed: the returns on the bonds backed by American consumer loans had collapsed. Rothig says he went to his superiors and argued that, as they were being paid a lot less to take the risk of these bonds, IKB should look elsewhere for profits. "But they had a profit target and they wanted to meet it. To make the same profit with a lower risk spread they simply had to buy more," he says. The management, he adds, did not want to hear his message. "I showed them the market was turning," he says. "I was taking the candy away... instead of giving it. So I became the enemy." When he left, others left with him, and the investment staff was reduced, but the investment activity boomed. "One-half the number of people with one-third the experience made twice the number of investments," he says. "They were ordered to buy...."

As long as the bonds offered up by the Wall Street firms abided by the rules specified by IKB's experts, they got hoovered into the Rhineland Funding portfolio without further inspection. Yet the bonds were becoming radically more risky, because the loans that underpinned them were becoming crazier and crazier. After he left, Rothig explains, IKB had only five investment officers, each in his late twenties, with a couple of years' experience: these were the people on the other end of the bets being handcrafted by Goldman Sachs for its own proprietary trading book, and by other big Wall Street firms for extremely clever hedge funds that wanted to bet against the market for subprime bonds. The IKB portfolio went from $10 billion in 2005 to $20 billion in 2007, Rothig says, "and it would have gotten bigger if they had had more time to buy. They were still buying when the market crashed. They were on their way to thirty billion dollars."

By the middle of 2007 every Wall Street firm, not just Goldman Sachs, realized that the subprime market was collapsing, and tried frantically to get out of their positions. The last buyers in the entire world, several people on Wall Street have told me, were willfully oblivious Germans. That is, the only thing that stopped IKB from losing even more than $15 billion on U.S. subprime loans was that the market ceased to function. Nothing that happened - no fact, no piece of data - was going to alter their approach to investing money. 

On the surface IKB's German bond traders resembled the reckless traders who made similarly stupid bets for Citigroup and Merrill Lynch and Morgan Stanley. Beneath it, they were playing an entirely different game. The American bond traders may have sunk their firms by turning a blind eye to the risks in the subprime bond market, but they made a fortune for themselves in the bargain, and have for the most part never been called to account. They were paid to put their firms in jeopardy, and so it is hard to know whether they did it intentionally or not. The German bond traders, on the other hand, had been paid roughly one hundred thousand dollars a year, with, at most, another fifty-thousand-dollar bonus. In general, German bankers were paid peanuts to run the risk that sank their banks, which strongly suggests that they really didn't know what they were doing. (pp. 160-2)

The Germans were blind to the possibility that the Americans were playing the game by something other than the official rules. The Germans took the rules at their face value: they looked into the history of triple-A-rated bonds and accepted the official story that triple-A-rated bonds were completely risk-free....

Perhaps because they were some enamored of the official rules of finance, the Germans proved especially vulnerable to a false idea the rules encouraged: that there is such a thing as a riskless asset. After all, a triple-A rating was supposed to mean "riskless asset." There is no such thing as a riskless asset. The reason an asset pays a return is that it carries risk. But the idea of the riskless asset, which peaked about late 2006, overran the investment world, and the Germans fell for it the hardest. I'd heard about this, too, from people on Wall Street who had dealt with German bond buyers. "You have to go back to the German mentality," one of them had told me. "They said, 'I've ticked all the boxes. There is no risk.' It was form over substance...." 

IKB had to be rescued by a state-owned bank on July 28, 2007. Against capital of roughly $4 billion, it had lost more than $15 billion. As it collapsed, the German media wanted to know how many U.S. subprime bonds these German banks had gobbled up. IKB's CEO, Stefan Ortseifen, said publicly that IKB owned almost no subprime bonds at all - which is why he's now charged with misleading investors. "He was telling the truth," says Rothig. "He didn't think he owned any subprime. They weren't able to give any correct numbers of the amounts of subprime they had because they didn't know. The IKB monitoring systems did not make a distinction between subprime and prime mortgages. And that's why it happened." Back in 2005, Rothig says, he proposed to build a system to track more precisely what loans were behind the complex bonds they were buying from Wall Street firms, but IKB's management didn't want to spend the money. "I told them, You have a portfolio of twenty billion dollars, you are making two hundred million dollars a year, and you are denying me six point five million. But they didn't want to do it." (pp. 163-5)

People can be spectacularly wrong. It's a particularly bad sign when they can't make well-thought-out arguments for their views and ignore contradictory evidence.

At some point, you'll be tempted to capitulate and change your views because it feels like you're the only one in the world who's willing to stand against the crowd. As we've seen, it's good to question your beliefs and consider new evidence, but that evidence is probably not going to come from experts who are all trading in the consensus direction. Do your own research whenever possible.

ISBN 978-0-393-08181-7
Lewis, Michael. Boomerang: Travels in the New Third World. Norton, 2011.

Read More