Taleb’s Recipe

No, unlike the previous post, this has nothing to do about food. It is about Nassim Nicholas Taleb’s recent op-ed in the Financial Times where he gives his “recipe” for saving the global financial system. Two of my favourite bloggers Arnold Kling and Felix Salmon have responded to it, but I didn’t like either so I thought I should post my response as well.

I borrowed The Black Swan from Aadisht sometime in late 2007. I tried starting to read it several times but never got past Taleb’s childhood stories of his hometown Amioun. I took a couple of months to get past the first 50 pages, I think. And then it was easy reading. I loved the sub-plots. I broadly bought into the main plot. By the time I had finished reading the book, I wanted to ask Taleb to accept me as his sisya. I  bought and read Fooled By Randomness, and liked that too. And then decided to read The Black Swan yet again. It was only a couple of months back that I finally returned the latter book to Aadisht (in the meantime he had bought two other copies of it, and read it).

Till very recently, I would read up any article of Taleb’s that I could find. I wrote to him a couple of times with my CP, and he even responded. I infact wrote to him about “Positive Black Swans and the World of Romance” and he responded with a “Thanks Karthik, Ciao, Nassim”. I had become a worshipper.

However, now I think he’s kinda lost it. I don’t think he intends to write another book and so he has nicely settled down to peddling his last theory (black swan). In response to a recent post on studs and fighters, Kunal had said, “He that is good with a hammer tends to think everything is a nail.”. The same disease affects Taleb I think, as he goes around the world trying to force-fit his black swan model to every conceivable problem.

And then I have a problem with people like Taleb and Satyajit Das, and actually with all those ibankers who are asking for bailouts. These guys made full use of capitalism, and made heaps of money, when things were good. And now that their money has been made, they call for government intervention, and socialism. Taleb and Das are different from the other wall streeters because they are calling for full-scale government intervention, unless the other bankers who are only calling for a bailout!

Now that the elaborate intro is done, let us get to the point. Taleb’s essay consists of ten points. The headings are italicized and there’s a detailed explanation. For purpose of brevity I’m putting only the headings here, and writing my comments after each of them. Go to the FT site to read the full points that Taleb has written.

1. What is fragile should break early while it is still small.

I agree with this. And my take is that competitors need to keep each other in check. For example, if this round of bailouts were not to happen and the biggies were let to fall, no one would grow so big in the future, and even if they did, they would make sure that they were insulated enough from one another. This round of bailouts will make the next crisis (whenever it will happen) worse.

2. No socialisation of losses and privatisation of gains.

Agree with this.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.

Taleb has clearly not learnt his own lessons (fooled by randomness). I might have crashed the school bus once, but it may not be my mistake. the one data point of one bus crash should not be used to decide my career as a driver. One should look at how the driver drove before the crash to determine whether he gets a second chance. Blanket banning of people involved will not help.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks.

It’s all about structuring. Taleb was a trader and he forgets about structuring. As long as incentives of the employee and the employer are reasonably well aligned, there is no problem with an incentive bonus. The problem in ibanking was that too much emphasis was placed on short-term performance of employees. It’s tragic that the fall of the financial system has brought to an end what was an excellent compensation system (in principle, mind you; not the way it was practised) – where each person was paid fairly based on his/her contribution.

5. Counter-balance complexity with simplicity.

I think the simplest way would be to leave things to the market. Government intervention would lead to a new form of complexity, and in the overall scheme of things increase complexity rather than decrease it. None of the stuff that Taleb has mentioned is easily implementable.

6. Do not give children sticks of dynamite, even if they come with a warning .

Again Taleb prescribes mai-baap sarkaar. Does he realize that if governments had always had tight control over the markets, the markets wouldn’t have crashed on October 19 1987, and he wouldn’t have made any money? (Taleb has reportedly made 97% of his life’s earnings out of this one event). What is “complex derivatives”? And how can you ban it? If you ban it, it’ll go to the black market. You are better off collecting hefty security transaction tax.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”.

I agree

8. Do not give an addict more drugs if he has withdrawal pains.

Agree once again. We need to structurally change things to get to saner leverage than what was practised 1-2 years back. Regulations should be simple and principles-based, minimizing chance for regulatory arbitrage. Remember that the purpose of creation of most “complex derivatives” in the last 25 years is regulatory arbitrage.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement.

Bullshit. The point on markets not containing information, that is.

10. Make an omelette with the broken eggs.

None of this makes any kind of practical sense. It’s just an old man ranting. Thanks, guru (pun intended).

6 thoughts on “Taleb’s Recipe”

  1. “I might have crashed the school bus once, but it may not be my mistake.”

    He is not talking about crashing the bus, but driving it blindfolded. Surely, that has to be their mistake? There were people warning about this for years. But the insiders continued with it as if there is nothing wrong. Either they are stupid or they didn’t care. All he is saying is, don’t expect them to get us out of this mess. Don’t trust their judgment again.

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  2. “there is no problem with an incentive bonus”.

    Yes, but where is the disincentive? You take huge amounts of risk to show short-term profits, collect your bonuses, but when those risks materialise, what will you lose? Worst case your job, but you have already made your millions and you may not even lose your job, because your bank will be bailed out and you are paid more to get us out of the mess you created. Maybe best way to compensate is to put a large part of the incentive bonus on a 20-30 year fund. If you take the right decisions, you will end up with a huge retirement fund. If you don’t, if the investments you made blew up a decade later, then you retire penniless. And if that fund turns negative beyond a limit, you will have to declare bankruptcy and spend the rest of your life in a government guesthouse for financial offenders.

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    skimpy Reply:

    you didn’t read carefully. i said that the general concept of incentive-basd pay is good. i think i mentioned that the way it was implemented in investment banks was plain wrong, and messed up which is why it failed

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  3. I think you have misunderstood the ‘full scale government intervention’ when you imply that it’s even more profitable to bankers than a bailout.

    With a bailout you basically give them a few billion free with not much in return.

    With a full scale intervention, you take over the bank itself and give them nothing. So it’s not a good thing for the bankers.

    And the reason why people call for this is the fact that some of the banks are in fact bankrupt. (eg. Citi) Instead of giving them a few billion so that they hobble along for a few more months before going bankrupt anyway, why not accept the fact that they are bankrupt and instead of throwing any more money down the drain, just take them over by the government to enforce an orderly bankruptcy proces..

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    skimpy Reply:

    i understand full scale govt intervention. i completely agree that it’s definitely superior to this bailout business – which is plain cheating.

    my take is that no intervention is superior to full scale government intervention. even if a government takes over a bank, it’s only the people inside the bank that get screwed and not the counterparties. counterparties deserve to get screwed for doing so much business with such a messed up bank.

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  4. The guys after having made their number and calling for government intervention is same as NRI to US being democrats at entry and voting Republican once they are millionaire green card holders.

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