When the Secretary of the Treasury admits that the financial system has failed, as he did in his Congressional testimony yesterday, you would assume that the country is in for a sweeping overhaul of Wall Street and the banking establishment. But that hardly seems the case with what we’ve seen proposed. Part of the problem seems to be where the Obama administration is getting its advice: from the same characters who built the over-leveraged, under-capitalized mess.

Case in point, the Wall Street Journal held its Future of Finance Intitiative in Washington, DC earlier this week to contribute principles to the reform debate. On the whole, the assembled group went for incremental adjustments over wholesale reform. The lone voice of radical reform was Nassim Taleb, but he couldn’t stay past the opening night festivities. Here’s what he would have told the conference the next day:

First, he says, we have to unmask the charlatans of risk like Myron Scholes. To Taleb, Scholes is the Great Oz in this Emerald City because his work on options and derivatives allowed the whole of the financial system to adopt poorly understood products-like the ones that brought AIG down-that hide risk. To Taleb, Scholes’ academic work, which enabled the widespread use of complex derivatives, was like “giving children dynamite.”

“This guy should be in a retirement home doing Sudoku,” Taleb says. “His funds have blown up twice. He shouldn’t be allowed in Washington to lecture anyone on risk.”

With complex derivatives unmasked and, in Taleb’s vision of the future, outlawed, the next step is to create a more robust version of capitalism. Taleb calls it Capitalism 2.0. Robustness begins with a dismantling of debt. Leverage was the gas that inflated the financial system until it was too big, too fragile, and too volatile.

Taleb’s solution? It’s fairly simple. Get rid of the leverage. That’s the problem with the PPIP, it uses leverage to try to cure the problems of over-leverage.

We cannot have both debt leverage and a hyper-efficient system—the volatility is just too great. What Taleb explains—which no one else does—is that efficiency is already a form of leverage. A highly efficient system removes slack and magnifies small changes. Think of the efficient system as a high-performance aircraft. Each minute of steering input creates a rapid and violent shift of course, speed, or altitude. The system itself is souped up even before you add the debt. Once you do, the pilot is equally jacked up and twitchy, creating an explosive combination. Now imagine that fighter jet trying to fly in a 1,000-plane formation, and you get an idea of the world financial system in the 21st century.

We can’t erase the technology that created the planes, so we’ll have to make sure we fly sober, maybe even with an onboard computer that dampens the controls. That means getting rid of the debt. It’s that simple.

Source:

Mr. Taleb Goes to Washington

A Black Swan Meets Some Ugly Ducklings
by MARION K. MANEKER
The Big Money; March 26, 2009

http://www.thebigmoney.com/articles/judgments/2009/03/26/mr-taleb-goes-washington

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

34 Responses to “Mr. Taleb Goes to Washington”

  1. Nice piece.

    Taleb is a Truthteller, thus, he must be ignored by those in power.

  2. Barry Ritholtz Says: March 27th, 2009 at 8:09 am

    Nice piece.

    Taleb is a Truthteller, thus, he must be ignored by those in power.
    ~~

    some things say it all, and, thereby, should be re-read..

  3. danm says:

    Makes sense but I wonder which one they’ll choose:

    - Quit cold turkey
    - Hair of the dog

  4. flipspiceland says:

    The problem with simplicity, as common sensical as it is, is that it’s transparent and a vast number of people can’t honestly earn a living, can’t make lots of money unless they complicate things.

    In chaos there is great profit. My ignorance is other people’s profit.

    And that’s whether it be about plumbing, taxes, electricity, government contracts, estate law, CDS, CDOs, Glass-Steagal, Uptick rules, etc ad nauseum.

    Our so-called justice system is really a convoluted LEGAL system to make money for lawyers, judges, and others who benefit from the jerry rigging of systems. Accountancy is made complex to enhance accounting careers, Taxes are made labyrinthine to pad tax attorneys and and CPAs bank accounts. With every bit of reduction in the complexity of things, someone loses the ability to make a lucrative living.

    Therefore, I wouldn’t hold out any hope of a change in how things get done. As soon as soon as someone in government hears about an attempt to simplify, they use the opportunity to create even more complexity.

  5. danm says:

    The problem with simplicity, as common sensical as it is, is that it’s transparent and a vast number of people can’t honestly earn a living
    ——–
    Cut down on all non-essentials in your life… watch the great depression n times magnified.

  6. wally says:

    Change? Not with Banker Obama in charge.

  7. danm says:

    My forecast:

    Mother Nature, the law of gavity and entropy will prevail.

  8. danm says:

    As for entropy:

    Did you notice that it takes so much longer to clean up than to make the mess… and this one was 3 decades in the making… Oopps!

  9. AlexInNC says:

    Am I wrong to ask why Taleb/Roubini aren’t being interviewed on the Hill the same way Markopolos was?

  10. danm says:

    And as for cleaning up… we were brought up to clean up our own messes. I don’t see this changing any time soon, even less at the top!

  11. call me ahab says:

    danm Says:

    “Cut down on all non-essentials in your life… watch the great depression n times magnified.”

    exactly- leverage is what created the economy we have- by ratcheting it down a notch in how we live the economy must contract- that is what Washington doesn’t want.

  12. Transor Z says:

    km4 posted this link last night. Simon Johnson’s article “Triumph of the Oligarchs” in the Atlantic. Excellent IMO.

    http://www.theatlantic.com/doc/print/200905/imf-advice

  13. danm says:

    And as for cleaning up… we were brought up to clean up our own messes. I don’t see this changing any time soon, even less at the top!
    ————–
    Actually, I might be wrong here. The middle class is taught this… the upper crust usually has others doing their dirty work so it is unnatural to have them up there cleaning up this mess!

  14. Foghorn Longhorn says:

    Is it just me or is anybody else feeling a -500 mph wind blowing in?

  15. Foghorn,

    you’re not alone, though, it may be a +500 mph wind that blows..

    implosion/explosion–a coin toss, really..

  16. snapshot says:

    Thank you Transor – I posted that on the previous thread…”The Quiet Coup.”
    It printed out at 11 pages. I didn’t want to miss a thing.

    pg. 8 – “Even leaving aside a fairness to taxpayers, the government’s velvet-glove approach with the banks is deeply troubling, for one simple reason: it is inadequate to change the behavior of a financial sector accustomed to doing business on its own terms, at a time when that behavior must change.”

  17. Foghorn Longhorn says:

    http://finance.yahoo.com/insurance/article/106813/Signs-of-Stress-Fraud-on-Roadside;_ylt=Av1mfwHu0b6qok7SbgvLGgy7YWsA

    ,i>”The economy is stretching people to the breaking point and some of them are willing to risk criminal conviction,” said James Quiggle, a spokesman for the Coalition Against Insurance Fraud, an industry-backed group. “They look at this as their own personal stimulus package.”

    Tow yards in Las Vegas are filled with the blackened hulls of Mercedes sedans and Cadillac Escalades. The wrecks were pulled from desert hills and city streets by the department’s eight-member auto-theft unit, which responds to calls around the clock. Over one weekend this month, Mr. Menzie investigated eight car fires in 36 hours.

    “This is a money town,” says Lt. Robert Duvall, who reorganized the auto-theft unit to include insurance arson fraud. “Where else can you lose a paycheck in a night?”

    The cops hunt suspected arsonists by SUV and helicopter, trying to identify registered owners as quickly as possible. “We see people with singed eyebrows and hands,” said Sgt. Will Hutchings, Mr. Menzie’s boss. “Some of them still smell like gas.”

    The trend began to surface in 2007 when gas prices spiked and the number of auto arson claims jumped. In 2008 claims climbed nationally by 6%, said Dick Luedke, a spokesman for State Farm Insurance. In hotspots like Indiana, Michigan and New York the numbers rose 13% to 18%.

    Oh, the delicious irony.
    On a side note, look for an increase in arson, home and businesses at fire sale prices, indeed.

  18. maynardGkeynes says:

    This is who Obama listens to — why didn’t they didn’t include Bernie Madoff and Sir Alan Stanford I’ll never know.

    Obama Seeks JPMorgan, Goldman, Citigroup Support on Bank Plan – Bloomberg.com

    http://www.bloomberg.com/apps/news?pid=20601087&sid=aLhW6WphVhAk&refer=home

  19. wally says:

    Here’s Obama on the auto industry:
    “Obama says automakers need ‘drastic changes’”

    I wish we were hearing that same thing directed toward the banks – especially since their failure has been vastly more costly than the auto industry failure – but we do not. It is the assumption that we should pay the future of our children to restore banks to business as usual, with some window-dressing ‘regulation’ which they would soon buy off.

  20. Moss says:

    Change the damn tax laws so that interest expense is not a deductible item or at least start the process of bringing down the max that can be deducted. Index it perhaps to some sensible counter balance.

    Increase margin requirements and go back to a sensible limit for the banksters capital requirements.

    Incent savings by increasing the amount of interest income that is excluded from tax. Again index it.

    The financial system reminds very much of the enery sector. Incumbent players resist change.
    Why is it we have no sensible energy policy? Big Oil, and now bankrupt Detroit fought it tooth and nail.

    Fuck them.

  21. some_guy_in_a_cube says:

    Taleb’s message – which has enriched me both intellectually and financially – will fall mostly on deaf ears. It is a conceit of most people that they think they have control over their environment. This helps them sleep at night, I suppose. I am resigned to the fact that this is too human to overcome.

    Expect the unexpected.

  22. danm says:

    some_guy_in_a_cube:

    Exactly. We can analyze this to death but I think this is too big for us to fix. It will just evolve into something else.

    My spouse and I have had long conversations about this and we put a very large % on the scenario where we could lose everything. It might sound strange but accepting this has meant sleeping better at night.

  23. Foghorn Longhorn says:

    some_guy_in_a_cube Says:

    Expect the unexpected.

    My late grandparents, who went through The Great Depression ver. 1.0,
    each gave a bit of sound advice, which seems apropos here.
    From granny,
    “Watch their hips, not their lips.”
    From gramps,
    “Son, the stock market is nothing but a giant casino, treat it accordingly.”

    It’s worked well for me, your mileage may vary.

  24. Why rescue a system that got us here in the first place? Viable economic systems allow, even encourage, the destruction of inefficient actors. The real systemic risk is not the economic realignment that could and should take place. The real systemic risk is that we have grown so rich and complacent and unwilling to imagine a future without the same oligarchs and same enterprises and same inefficiencies that got us here until we destroy, through the inefficient allocation of capital attendant to systemic rescues, the very system that we purport to wish saving.

    The action of government has been to attempt to perserve a system that failed us. The only conclusion I can fathom as to why is that the government cares very little about the real risk of systemic failure that inheres with inefficient capital allocations, but quite a lot about the risk that allowing failures to proceed as they should (and ultimately, inevitably, will) would create a new system where they and the economic oligarchy have less importance than before.

  25. wally says:

    Why rescue a system that got us here in the first place?

    Because that system owns the government… it should be obvious. How else do you get other people’s money conscripted and handed to you as a reward for your failure? If you own government, you own coercive power.

  26. Mannwich says:

    The Simon Johnson article in The Atlantic posted by several commenters here lays out why we’re rescuing/trying to preserve the current system. It’s to preserve the oligarchs’ wealth and power. There’s really nothing more to say. He gets to the heart of it.

  27. some_guy_in_a_cube says:

    danm wrote: We can analyze this to death but I think this is too big for us to fix. It will just evolve into something else.

    Yes indeed.

    Like everyone else, I was taught to have confidence in how much I know. But it’s actually liberating (and rewarding) to accept that in the grand scheme of things, what I and anyone else knows combined doesn’t amount to a hill of beans.

  28. Greg0658 says:

    “Quit cold turkey” the problem with cold turkey .. the gangster banksters hold the account cash and will rule the world as things tumble ……. without a planned shutdown / reformulation

    flipspiceland says at 8:16 am “The problem with simplicity …..” that is so so so on the mark

    “as for cleaning up” there is a zinc processing supersite not far from here transfered from Corp to Corp via mergers each passing the buck and putting off the cleanup

    “to preserve the oligarchs’ wealth and power” its more than that – how many people have the plantation to provide for themselves .. nearly none .. so the ship must not sink …. who in America will support true Nationalization .. few (unless …)

  29. I have thought similar thoughts before (especially in regards to taxes) but I never quite put it all together like this. Very well stated flipspiceland…

    “flipspiceland Says:
    March 27th, 2009 at 8:16 am

    The problem with simplicity, as common sensical as it is, is that it’s transparent and a vast number of people can’t honestly earn a living, can’t make lots of money unless they complicate things.

    In chaos there is great profit. My ignorance is other people’s profit.

    And that’s whether it be about plumbing, taxes, electricity, government contracts, estate law, CDS, CDOs, Glass-Steagal, Uptick rules, etc ad nauseum.

    Our so-called justice system is really a convoluted LEGAL system to make money for lawyers, judges, and others who benefit from the jerry rigging of systems. Accountancy is made complex to enhance accounting careers, Taxes are made labyrinthine to pad tax attorneys and and CPAs bank accounts. With every bit of reduction in the complexity of things, someone loses the ability to make a lucrative living.

    Therefore, I wouldn’t hold out any hope of a change in how things get done. As soon as soon as someone in government hears about an attempt to simplify, they use the opportunity to create even more complexity.”

  30. “With every bit of reduction in the complexity of things, someone loses the ability to make a lucrative living.”–OBR

    the flip-side to that is: “With every bit of reduction in the complexity of things, someone Gains another additional piece of the Liberty that this Schema has ripped from their Lives.”

    lucrative, is an apt, given the popular tarring of lucre, word choice.

    See: lu·cre (lkr)
    n.
    Money or profits.

    ——————————————————————————–

    [Middle English, from Latin lucrum; see lau- in Indo-European roots.]
    Word History: When William Tyndale translated aiskhron kerdos, “shameful gain” (Titus 1:11), as filthy lucre in his edition of the Bible, he was tarring the word lucre for the rest of its existence. But we cannot lay the pejorative sense of lucre completely at Tyndale’s door. He was merely a link, albeit a strong one, in a process that had begun long before with respect to the ancestor of our word, the Latin word lucrum, “material gain, profit.” This process was probably controlled by the inevitable conjunction of profit, especially monetary profit, with evils such as greed. In Latin lucrum also meant “avarice,” and in Middle English lucre, besides meaning “monetary gain, profit,” meant “illicit gain.” Furthermore, many of the contexts in which the neutral sense of the word appeared were not wholly neutral, as in “It is a wofull thyng . . . ffor lucre of goode . . . A man to fals his othe [it is a sad thing for a man to betray his oath for monetary gain].” Tyndale thus merely helped the process along when he gave us the phrase filthy lucre.

    The American Heritage® Dictionary of the English Language, Fourth Edition copyright ©2000 by Houghton Mifflin Company. Updated in 2003. Published by Houghton Mifflin Company. All rights reserved.

    ——————————————————————————–
    lucre [loo-ker]
    Noun
    Usually facetious money or wealth: filthy lucre [Latin lucrum gain]
    Collins Essential English Dictionary 2nd Edition 2006 © HarperCollins Publishers 2004, 2006
    http://www.thefreedictionary.com/lucre
    http://www.thefreedictionary.com/lucrative

  31. farmera1 says:

    I am bummmmmmed.

    Often it is not good to know too much, understand what is happening and not be in a position to do anything about it. Often it is better to watch American Idol, spend as much as you have at Walmart and hate all those people that are different than you and just go on your way. I have one rental house on a farm. Those people that rent do not worry about things like Greenspan, AIG, Bear etc, in fact they could care less. Their worries center on meeting this months rent and this months electric bills. Worries, yes and just as big to them at least in the short term. But they don’t even try to understand the banksters running this country. Not their problem, they think, they don’t put their money in banks, that is their solution. Understanding can be a bad thing, especially when we are powerless to do anything about it.

    I just got dinged with a huge unexpected, unfair IMHO tax bill do to a technicality, see the economy in trouble, jobs disappearing and the true problems aren’t being addressed. Like I said I’m bummed.

  32. farmera,

    take it easy. one cannot know too much, one can only, in relation to what he knows, do too little..

    if the ‘answers’ aren’t, readily, apparent, then one needs to learn more, not self-lobotomize..

    btw, to pay that Tax Bill, you may want to look into getting an Ag Exemption so you can grow Industrial Hemp..
    http://clusty.com/search?input-form=clusty-simple&v%3Asources=webplus&query=growing+hemp+in+the+U.S.

  33. vv111y says:

    Who is left in Wall St. that is clean?

    Is there any firm or bank who can be considered ethical?

    Is there any firm or bank that you could do business with – financing, IPO – that you can

    1) trust
    2) accept that they too will benefit from your hard work

    For 2, it is too repulsive and frankly too dangerous for all our futures to work with the big banks in a way that they become even more wealthy.

    It is a good idea to start collecting such information about who’s who, about reputation.
    I’ll be asking around and why not start here.
    Thanks.

  34. vv111y says:

    I’m not sure if somebody has said it yet – to be clear

    The toxic assets are not just the securities, the toxic assets are also the people and the culture.

    The toxic bonds & derivatives are just the produce.