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The inimitable Nassim Nicholas Taleb with colleague Mark Spitznagel offer up what, in tone and substance, is now the classic style of punditry in the current crisis in Tuesday's Financial Times: absolute demands for transformational action couched in granitic certainty despite a situation they admit is replete with uncertainty. Taleb and Spitznagel are arguing -- though that's really too soft a characterization -- that the world, or at least the part that's suffering, must immediately and unilaterally initiate a massive debt-for-equity swap.
"The only solution is the immediate, forcible and systematic conversion of debt to equity," they write. "There is no other option." Here's their argument. Debt is bad; it treacherously hides underlying problems. Equity is good; it reacts sensitively to changing market sentiments. Trading debt for equity would turn banks from "hopers" (hiding risk) to "doers" (initiators of economic activity). Governments are exacerbating the crisis by piling up public debt. This will produce either deflation or hyperinflation. Governments are advised by economists who adhere to "standard models," which of course are abysmally wrong. The Internet has changed the economy to such an extent that "invoking the pre-Internet Great Depression as guidance for current affairs is irresponsible." The pair want to construct an economic system that does not try to eliminate bubbles or other black swan events, but to become more robustly accepting of them. I will let economists answer these charges in their own way, although even I can foresee enormous and destabilizing issues in establishing a predominately equity monoculture. More importantly, there's the political, social and legal impracticalities of this scheme. This isn't like Paul Krugman demanding a bigger stimulus or the folks at the Baseline Scenario arguing to break up the banks. This is like saying that governments have to extend a practice that only really occurs in the extremities of restructuring or bankruptcy (their implication, of course, is that the global economy is basically bankrupt) and apply it to every debt vehicle from home mortgages to derivatives. That "forcible" conversion would override large chunks of the current legal and regulatory systems, making Obama's intervention in the auto bankruptcies look gentle. You wouldn't have to worry about banks being doers or hopers because they would essentially be irrelevant: Their core business is lending, which is debt. Everyone would instead be exposed to markets every waking day; do you think we'll pay even more obsessive attention to the Dow if all our mortgage and credit card debt became equity based? What if we don't want to (or can't) live that way? Besides, while it's true that equity is more transparent, it's as vulnerable --or more so -- to bubbles than debt, which has the advantage (a disadvantage to Taleb and Spitznagel) of being longer term. Exchanging debt for equity in a massive way would be like ingesting large amounts of speed to stay awake so nothing bad happens to you when you're asleep. And it would only work if everyone lived that way. As they say, "There is no other option." The FT column like earlier Taleb eruptions sometimes reads like a joke. But it does capture a tendency shared by lots of opinonizing from the financial and economic crowd. Despite the widespread acknowledgment that nearly everyone missed the disaster, and haven't been so hot in predicting its twists and turns, the pundits have forged on with ever-greater certainty and, in cases like this, with ever-greater distance from the activities, demands and limitations of the real world. Like these prescriptions, politics is somehow so corrupt, so enmeshed in the genesis of the crisis that it has to be superseded entirely. Only the initiated know. Attention must be paid. Sweeping actions must begin today. Everyone who has ever been wrong must shut up. Economics has a secret key, which only adepts possess. To justify their prescriptions, the diagnosis grows more and more dire, more and more systemic. This is not just a policy change; human nature itself must change. From here, it is a short path to the dark woods of paranoia. And it is, of course, chilling. Fortunately, there is a real world out there that has shown a propensity to resist utopian prescriptions. True, it's staggering along right now. It's quite clear we need to rid ourselves of some debt, figure out how to wriggle out from massive government spending, rebalance the global system. But that doesn't mean massively swapping debt for equity will solve all these difficult and complex economic and political issues. Suddenly a world that can't agree on matters of stimulus, trade imbalances, regulation of hedge funds, or, for that matter, cuisines, footwear and a ruling deity doesn't seem such a bad idea. Real-world imperfection feels a lot more livable than Taleb's forcible, no-option universal solution. - Robert Teitelman See Taleb's column in the FT Robert Teitelman is the editor in chief of The Deal.
CategoriesComments
From: joe Stafura,
Taleb is a very smart guy who is part of the movement to stop doing the same thing over and over and wondering why it doesn't work, unless you are Goldman Sachs. The future is really Internet driven and many people still don't understand the difference this is making now and the larger shifts in the future. As far as making the bank irrelevant, that is another good idea, they are far too relevant now, approaching 20% GDP when a healthy economy would only incur 5-8%. Remember the GDP measures every dollar without judgement as "good", whereas bank and insurance fees are really parasitic to economic growth.
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July 14, 2009 2:33 PM
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deMarigny / DITMo Strategies / AMERICADE (14July2009)
deMarigny: Taleb Almost Has Solution Right
In today's article: "Taleb offers a universal solution to our ills" (Published July 14, 2009 at 10:46 AM "THE DEAL")
Prof. Taleb, author of "The Black Swan," a book about the likelihood of outlier events otherwise believed to be improbable, profers a solution to the current debt and liquidity malaise. He says to make a mandatory conversion of all public and bank debt to equity for what I infer solves an "agency" dilemma or moral hazard.
First, I perceived back in Summer 2007 in articles posted on Albourne Village that the growth of the C.O. market with its corresponding fraudalent price discovery structure and boundless creation of synthetics already doomed the banks and would result in money center bank nationalization and subsequently result in the creation of a world currency displacing the USD and the Fed.
Taleb has his own views of predicting Black Swans, but as a student of Financial Risk (GARP) I recognize two things:
1 - Risk itself is PATH DEPENDENT
2 - Parametric measures are useless in predicting Black Swans
Parametrics use third and fourth moments to evaluate the multitude and magnitude of outliers (i.e. Kurtosis and Skew) and many use other measures like VaR and multiples of maximum drawdown, but it all relies on a respresentation from a data series. That is like using Carbon Dating to date something from the geological record - "That dog just don't hunt." Alternatively, non-parametrics may better model for "Black Swans."
To get back to the point of today's Taleb article posted on "TheDeal.com" about forcing a conversion of all debt to equity: Taleb is ABSOLUTELY CORRECT about forced conversion out of the debt. That IS the only answer. However, the forced conversion cannot be to EQUITY, as equity is just structured form of debt, and vica versa. The answer is a FORCED CONVERSION of the USD to a World Currency that is not under the auspices of a sovereign government's congress or monetary policy - rather put under an independent Basel-headed consortium of Central Bankers and Risk Managers that supersedes sovereign central banks to oversee a new World Currency Unit (WCU).
This is the solution Taleb would eventually get to using his reasoning, and it is a better alternative than to empower the Fed as the super-regulator integrated in Treasury. I believe there will be a forced conversion of the USD into a World Currency possibly as early as latter 2011 using Taylor's laws. I do not believe there will be massive inflation nor deflation to that time, but that the USD will simply be displaced in one fell swoop by design.
In the meantime, U.S. growth is being sacrificed at the cost of stability (and sovereignty) so sideways strategies will continue to be in vogue. For institutions, they should look to managers who can execute equity "OVERLAY" strategies as the move away from CTAs commences from lack of direction and volatility.
Peter J. deMarigny / DITMo Strategies / AMERICADE