Taleb: Principles of a new, robust economy

10 principles for a Black Swan-proof world

By Nassim Nicholas Taleb

April 7, 2009  | Financial Times

 

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.

 

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage.  A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

 

In other words, a place more resistant to black swans.

 

The writer is a veteran trader, a distinguished professor at New York University's Polytechnic Institute and the author of The Black Swan: The Impact of the Highly Improbable

Sirota: 'Too big to fail' means too big to be private

Or, as Nassim Taleb said, if it might have to be bailed out tomorrow, nationalize it today.  As Sirota explains, there is free-market thinking behind this prescription.  It's about keeping a clean separation between what is government's, and what is the private sector's, without all this quasi-national bailout baloney and airs of "protecting capitalism" with no-strings government financing.

If It's 'Too Big To Fail,' Then It's Too Big To Be Private

By David Sirota

March 3, 2009

 

I appeared yesterday at the top of Neil Cavuto's Fox News show to discuss the potential for financial industry nationalization. You can watch the clip here. I tried to use the opportunity to float a fairly simple - and old-fashioned - concept: If something is "too big to fail," then it's too big to be in private hands.

The term "too big to fail" is a euphemism for any institution that is so important to the entire nation's most basic well being, that society cannot let that institution fail. This is why one of the foundational principles of civilized society has always been nationalization - ie. government control - of the institutions that are "too big to fail": institutions like the military, whose failure would mean a basic loss of national security; law enforcement, whose failure would mean a basic loss of civil order; and infrastructure construction, whose failure would mean the crumbling of commerce. The government, as the most powerful representative of society as a whole, runs these institutions/services because they are too important to be allowed to fail.

 

Unfortunately, the hard-right and center-right ideologues who ran the government for the last 30 years gutted the basic laws and enforcement mechanisms (financial regulations, anti-trust prosecutions, etc.) that prevented a myriad of financial institutions from becoming "too big to fail."

 

The American Insurance Group is the best example of this - a company that, as the New York Times notes, essentially based its business on a risky scheme to sell insurance to other corporations against colossal housing market failure. This allowed huge banks and investment houses to effectively offload their own absurdly risky housing investments by "insuring" those investments against loss with AIG - a shuffling of paper and deep-frying of books that let those banks leverage themselves even more, sans regulation. When the housing bubble burst and the banks called in their insurance, AIG was asked to pay up, and it couldn't, because it never expected to have to back up its insurance policies. But because AIG was so big - because it had so singularly cornered the market on such insurance and had essentially become the insurer of last resort - it couldn't eventually pay up, its failure would result in a cataclysmic ripple effect of defaults.

 

So now everyone is focused on the short-term question: Should we temporarily nationalize AIG and the biggest banks, or should we keep forcing taxpayers to get all the downsides of nationalization (ie. throwing money at the companies) without any of the upsides (i.e. ownership of the companies, power to throw out management, etc.)? Obviously, I'd say the former, but I'd go a step further: When it comes to an AIG - a company that is effectively ensuring the rest of the economy against loss - we shouldn't temporarily nationalize it, we should permanently nationalize it, or at least its core functions.

 

As I wrote in an earlier post, we shouldn't be afraid of permanent nationalization, because it is - thankfully - already all around us. Indeed, in some sectors of the economy, we have embraced nationalization thanks to an era where our government at least considered the possibility that if a function or service or entity is too big to fail, it is too big to be private.

 

That era's government believed a minimum retirement benefit and health insurance for the elderly is a "too big to fail" kind of function - too important to be subjected to the whims of the private marketplace. So we now have government-run Social Security and Medicare. That era's government also created the Pension Benefit Guaranty Corporation, which nationalized the catastrophic insurance of pension plans. It forces corporations to pay premiums that underwrite a fund that pays out the pensions of companies that go bankrupt. The government deemed that function - catastrophic pension insurance - as a "too big to fail" kind of function, understanding that if the service was in private for-profit hands, there would be a risk of that private venture overleveraging itself, and then failing when it needed to pay out retirement benefits to millions of Americans.

 

Now, clearly, it's time to resurrect the principle that if something is too big to fail, it's too big to be private. We can resurrect that principle both through far tougher regulation that prevents individual private institutions from ever becoming so singularly important to our nation,* and by nationalizing the few core functions and services that are probably best left to the government as insurer of last resort. In the former category, that means much stronger financial regulation, and in the latter category it means some kind of nationalization of basic market insurance (and, I might add, health insurance).

 

If ever there was a time that the country was ready for this kind of back-to-what-made-us-great argument, that time is now.

 

* A key point here is the word singular: There is some safety in diversification and numbers - for instance, if a crucial function of the economy is handled by multiple businesses, then the failure of one of those businesses should (theoretically) pose much less danger to the overall economy than if that business was so singularly or monopolistically crucial as in the case of AIG.

Roubini & Taleb bitch slap CNBC cheerleaders

It's pathetic how hard CNBC tries to spin Roubini and Taleb's statements, and how hard they look for "glimmerings of hope."

One of the bubbly newsbabes even posited that since people are finally desperate enough to listen to Roubini and Taleb, that the market must have finally hit bottom.  (Meaning, it's going to start going up).  Taleb would have nothing of it.  He said the system needs to be completely changed, change our culture, and live with less debt.  And most important, Taleb said banks need to change their incentive systems, which encourage bankers to take on hidden risk in pursuit of short-term bonuses:  "Wall Street can no longer operate like before."  And: "Those who one day may need to be bailed out need to be nationalized now."  The CNBC panel, which is used to kissing Wall Street's behind, was going nuts.

Roubini also favors government nationalizing the insolvent banks and then re-selling them.  He said, "Cash is king," and he's not invested in the market.  "We need more sustainable [economic] growth based on real investment in human and physical capital," not an economy based on unproductive housing or dot-com bubbles.


Nouriel Roubini and Nassim Taleb Spreading Doom & Gloom on CNBC
February 9, 2009 | CNBC

URL: http://www.cnbc.com/id/15840232?video=1027496846&play=1.