on 7 Apr 2009, Nassim Taleb published the following in the Financial Times.
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.
Below is my commentary on his observations. I welcome your feedback as this is great debate.
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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.
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.
I think this speaks to the cat and mouse game that private enterprise plays under the guise of the state. effectively multiple governance layers exist across the organizations irrespective of size, but the government to date has used both stick and carrot approach, where self regulatory organizations. i.e. enterprises policing themselves through best practices, etc, work with existing laws and regulations on the books passed by government entities who also enforce them.
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.
Agreed to a point. Partial bailouts and nationalization is a messy sport. This debate began with point 1. Who is too big to fail? Whats the threshold? What to do with multiple failures? The real story, there was no plan. The panic and chaos ensuing from bankruptcy of Lehman started this whole mess. Aside from the auto industry, we dont have a cross industrystory here. It's the Financial Services Industry that needed an action plan. TARP has failed.
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.
This implies there are enough willing and able "smart people" to replace "not so smart people". This strategy didn't work so well in Iraq, when the government and the Army were disbanded in favor of untrained and inexperienced. We know now how well that worked.
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.
Agreed. Huge disparity in compensation at the C-level vs. lower echelons. It is already part of the agenda in the Obama administration: compensation reform.
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.
I translate the above as, let's simplify debt products. The nature of the Financial Services industry, specifically the trading business/brokerage is all about creating new instruments and ways to trade them. At that point, the government is invited to learn about these instruments and generally has played side lines or catch up game until something breaks, someone gets too greedy, etc. So what's new, right? You can't outlaw creativity or greed.
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.
As I said above, complexity is inherent in the business model designed to outdo the competition, or to exploit loopholes in trading, timing, etc.. which point the finger back at regulation. Are regulators not as smart as bankers? You bet. Regulators write laws, bankers make ways to play by them as long as they make money.
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.
Irrespective whether you have been voted into office or hired to create regulation as part of a government entity, you are a politician. The difference is degree of spotlight. Shrugging off rumours doesnt win elections, or persuade the public to stand behind those that create policy. As mass populace is uneducated about the complexity of what insiders do, ie..wall street, so does the public need reassuring sound bites like "restore confidence" as they watch their 401K disappear the way of the Dodo.
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.
Agreed. Too much leverage has caused the current crisis.
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).
This goes to fundamental question of how do you create wealth, for the purpose of sound retirement. At the core of this, 99% of investors are not professionals nor educated enough to understand investment theory. Retirement planning with the advent of mutual funds (thank you Fidelity and Mass Financial) have allowed millions to seek excess returns through investing their money in the markets (across all asset classes). The Nirvana is creating a model that allows limited downside risk as well as limiting returns enough to meet retirement goals. That already exists in modern asset allocation theory. Question is, what reform do 401k plans and the like, as well as the "experts" that support them need to create more transparent investment vehicles that wont bring the house down.
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.
Agreed. The Capitalism 2.0 needs to bring the best of the past and the present. The propensity of the failed is dragging us down.
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