Nassim Nicholas Taleb on fragility, centralization, and capitalism

[Magox]

I was reading an interview today with Reason and Nassim Taleb, author of the Black Swan, he was one of the few to predict with precision the banking crisis that we went through. I think a few of you may find this interview fascinating.

 

 

A finance professor at New York University and a research scholar at Oxford, Taleb drew wide attention after the 2007 publication of The Black Swan: The Impact of the Highly Improbable, which warned that our institutions and risk models are not designed to account for rare and catastrophic events. Among other things, the book presciently cautioned that oversized and unaccountable banks using flawed investment models could trigger a financial crisis. He also warned that the government-sanctioned housing finance agencies, Fannie Mae and Freddie Mac, were sitting on a “barrel of dynamite.” One year after The Black Swan was published, Taleb’s predictions came to pass.

 

On debt

 

 

reason: Paul Krugman, one of your great friends or nemeses, just recently wrote that these trillion-dollar deficits don’t matter.

Taleb: All these economists, let’s put it this way: Risk is not their thing.

Debt leads to fragility. We’ve discovered since the Babylonians that debt has systemic consequences whereas equity doesn’t. Let’s say that you have two brothers. One of them borrowed and they both had predictions about the future—forecasts. One brother borrows. The other issues equity. The one who borrows will go bust if he makes a mistake. The one who issues equity will fluctuate but will be able to survive a forecast error.

reason: But is it also true that the brother with equity can never really have that big payday?

Taleb: For him! But overall the system is well distributed. There’s an accounting equality. Debt traditionally has blown up systems and has been very good for governments to wage war. I’m not against credit. I’m against leverage.

reason: So you give me a loan and I say I’m going to pay you back and that gives me the ability to get something in the short run that will help me produce more in the long run. That’s OK?

Taleb: Banking started [like this]: You’re going to Aleppo, Syria, and Florence and you’re going to send me some silk. You trust me, and my correspondent in Aleppo would pay you the minute I get my silk—that kind of transaction. That’s called letter of credit, where you have debt conditional on some commercial transaction being completed. And it also allows people to finance some inventory, provided the buyer is a committed buyer. That kind of facilitation of commerce is how it all started—the letter of credit—and it developed very well.

Before that we had debt in society and it led to blowups in Babylon, and then they had to have debt jubilees. Then of course the Hebrews also had debt jubilees. And of course, they say neither a borrower nor a lender be. The Romans didn’t like debt. The Greeks didn’t like debt, except for a few intellectuals. Intellectuals for some reason, like Mr. Krugman, like debt.

Later on debt came back to Europe with the Reformation and it was mostly to finance wars. The industrial revolution was not financed by debt. California was not financed by debt; it was financed by equity. So debt is not necessary. You can use it for emergencies. Catholic societies—Aquinas was against debt and his statements were stronger than the Islamic fatwa against debt.

We have learned through history that debt in the form of leverage can blow things up. Debt fragilizes. Now what we have had in this economy is a growth of debt mostly financed indirectly by governments. Because if you blow up, we’re going to be behind you.

 

 

 

On Too Big to Fail

 

 

reason: So this is the problem of too big to fail, which went from being a worry to being inscribed in official policy?

 

Taleb: Exactly. When you’re a banker and you have the upside but no downside, what are you going to do? Create the maximum number of loans that don’t blow up often, and collect your bonuses.

 

You’re paying for his downside. This, to me, is not capitalism. It is a misunderstanding of basic rules. Skin in the game started with Hammurabi, led later on to eye-for-eye, and led to the Golden Rule.

 

 

I completely agree, I was talking about this the other day, that one of the things corporations should do is create a "skin in the game" culture of compensation packages, that accounts for risk management in bonus, CEO pay. Clawback's would be something that would qualify as a "skin in the game" approach.

 

 

reason: You talk about decentralization. One of the most fascinating things in the global economy in the last 50 years—you could argue over the past 1,000 years—is that in many ways it’s becoming more and more decentralized. Certain types of knowledge are more decentralized than ever before. Economies compete in a way that they didn’t before; countries can no longer force investors to keep their money in a particular currency, in a particular geographic location. Even as we’re facing a global crisis, is globalization generally a good thing?

Taleb: It is if you know how to handle it—if you let firms fail.

There is something called the island effect. In nature, an island will have a higher number of species per square meter than a continent; it’s actually proportional to the square of the area. We’ve lost the island effect. Now you have Google dominating the whole planet. It’s not a problem. The thing is that if we stop letting these firms fail when they become ill, they can get large enough to dominate government. Now, computer firms I’m not worried about.

 

I was talking with GG about this in one of the recent threads, one of the reasons why I was opposed to the Bank Bailout was because of the moral hazard issue.

 

 

reason: Why aren’t you worried about computer firms?

Taleb: Because it’s a competitive environment. Google is a product of a competitive environment.

reason: So we can see the end of Google on the horizon.

Taleb: We can see the end of Google, and it doesn’t make a difference. It makes no difference for you and I. If Google fails tomorrow, there will be something else, don’t worry. The government won’t save them. And I don’t think they’ll fail, for that reason: They know the government won’t save them. But you can have some centralization/concentration. That’s not the problem.

The problem we have had in almost all Western countries is that nominally they say they are decentralizing, but effectively they’ve [given] more and more power to the central government. You want decisions to be spread out. Government debt is a result of centralization, and typically the cause of more centralization. It’s a very bad circle.

 

 

 

Taleb: To make big mistakes and to be wiped out; this is the island effect at work. What we have had in this country is the progressive rise of central government. Particularly, deficits are the work of central government. [scottish philosopher David] Hume figured it out. He said: Small states and city-states, they love commerce. And large governments love war. And that’s what justifies large government—war. There is no justification for large government other than war. And they’re not good at it.

reason: You say that you’re not a libertarian, but a lot of this overlaps with what’s considered libertarianism. So why aren’t you a libertarian?

Taleb: I’m a risk-based person. My libertarianism would be not demotic libertarianism—the philosophical libertarianism that freedom comes as a first good—so much as I want errors to be multiplied.

reason: So it’s a kind of John Stuart Mill. You like the idea of experiments in living.

Taleb: Exactly. Errors need to be multiplied. That’s it. I’m more of a left-wing conservative, if you want.

reason: Ayn Rand called libertarians right-wing hippies.

Taleb: There you go. So left-wing conservatives—that would map exactly. In a way, I’m conservationist. I want to not break things that have been around for a long time, things that have their own logic. [successes] come from tinkering, not from some radical transformation of things.

reason: It’s curious that you are so popular in the business market, because business books will end each chapter with bullets points about what this chapter was about.

Taleb: The minute I’m bored writing I stop. Particularly with The Black Swan, [the idea was to] make sure that no content of any section can be discovered without surprising the reader somewhere. Textbooks bore you. Critics hate it because they want to skim books. People who read will not hate it. I’m an empiricist. If I sell 3 million copies of a book writing in some way, I’m not going to be lectured about style. Of course the critics come in and they tell you it’s a mess. The Black Swan sold more probably in a day than they sold in a lifetime.

reason: But you’re not going to say that the market is always right, and that 50 million Elvis fans can’t be wrong?

Taleb: No. My point is that someone who just arrived in a limo does not take lectures on finance from someone who just took the subway. That’s the idea. You can take ideas, maybe, but you don’t take instructions about how to write a book. So if you want to write a book, either take instructions from the Harry Potter lady or take instructions from Seneca, who survived 2,000 years. But definitely not from some academic at Cambridge who sold 2,200 copies.

My idea of living is taking risks for causes. The more I do, the more I feel good about myself.

 

 

http://reason.com/archives/2013/03/24/how-debt-ruins-systems/4

[Dean Cain]

I f'ing love me some Taleb from a standpoint that he adhere's to a core ideology & doesn't stray.

 

[Magox]

I f'ing love me some Taleb from a standpoint that he adhere's to a core ideology & doesn't stray.

 

I know what you're doing, but just for ***** and giggles, explain.