Wednesday, April 8, 2009

Being Nassim Nicholas Taleb X

In yesterday's Financial Times Nassim Nicholas Taleb gives "Ten Principles of a Black Swan-Proof World." Here they are:

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an incentive" bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning. Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to "restore confidence." Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Maybe Nassim Nicholas Taleb should be advising the President.

6 comments:

DB said...

Wonderful list. Many similar issues have been spoken before, unfortunately only the choir is listening. The question I started asking 6 years ago is "Where is the money?" Why is the nation and almost every American in debt? Where's the money? The monoply game played on Wall Street doesn't concern us. They put each other out of business and then reward themselves for doing that. They cut corners, fire American workers by the thousands and outsource the labor, they destroy collective bargaining, hire temp workers so they don't have to take care of them, all under the label of Maximizing Shareholder Value. And who are the major shareholders? The same guys who are doing this. In the real Monopoly game, if you lose your property your broke and out of the game. In the Wall Street version you don't have to worry. You pack up your enormous salary, take your bloated bonus and move to Majorca. We are not involved in that game. Every time President Bush said the economy is improving I wanted to throw shoes at him. Not because he was wrong. Of course he was wrong, that was self evident. But because too many people believed him, like those who signed up for an impossible mortgage. It was totally irreesponsible of him. The first thing the new administration should do is find the money, and I think, I hope they are doing it. DB

dave wheeler said...

Judith,

Exceptional! The most meaningful to me "Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. "

This should apply not only to the financial crisis but to all government agencies and public policy and programs from child care to public education. Remake the system before it remakes itself...yes indeed.

Judith Ellis said...

Great points, DB! Thank you. Regarding the choir, some of us are pushing for a greater audience for this brilliant thinker who himself was a successful trader. In fact, the company for which he advises, Universa Investment, LLC made returns last year of some 110 percent while while the Standard and Poors index lost 39 percent during the same time period. (You will love it, DB, that he is also a philosopher. Have you read The Black Swan? Great book!) We want to see him in Washington advising the President and insisting on change on Wall Street.

Taleb believes in fundamental change, not window dressing for the next crisis and the garnering of billions in fees that the taxpayer finance for Wall Street guys. (By the way, He and Roubini are both in favor of clawbacks.) This is defintely a game. We have seen the same plays repeatedly. There is nothing new about the plays or the rules of this game; the players have even remained the same. We know them.

Recently, Taleb was in Washington for the Wall Street Journal's Future of Finance conference. Read about it here. While there, Taleb did not stay for the gathering to "kiss Summer's ring," according to Marion Manaker, author of "Mr. Smith Goes to Washington."

I laughed aloud when I read this. It seems so much like him!

Judith Ellis said...

"Finally, this crisis cannot be fixed with makeshift repairs..."

Dave - I really hope that Taleb's words are so. But is really require not letting up on these guys. It seems that very little is actually changing fundamentally. Geithner's plan seems very much akin to the others of the past.

This mark to market concerns me. It allows banks to essentially double dip and destroy the initiative of small investors. Banks can set prices for creating this mess and sell to investors at market rates they set.

I really like your broadening of these ideas as the basis for every government agency. I could not agree more with you. This is real change that I can believe in--FOR SURE!

Thanks, Dave! As always, I appreciate your comments. I also so appreciate your very fundamental sense of change starting from the bottom up instead of top down. This matters.

steveroni said...

Judith! Just stopped in to say "Hi" and read some of the interesting stuff you post.

Ain't forgot ya, Opera-Girl. Just got all tied up with what I do. No, I don't sell rope!

-steve-a-roni (Naples, FL)

Judith Ellis said...

steve-a-roni, Hey! Yeah, it's good to know that you haven't forgotten me. I remember you! Do pop in again whenever time allows. I'm glad you find the posts interesting.