Posted by: jackslife | April 9, 2009

Black Swans and the Too Big to Fail

Rod has a post up right now with an excerpt from a Financial Times article by Nassim Nicholas Taleb that echoes some of what I’ve been saying about businesses that are “too big to fail”.  Here are the points that Rod calls out –

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.

For those not familiar with Black Swans or Taleb.

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Responses

  1. How about relying not only on regulations, but also considering Paul Volcker’s advice from experience: being too big is itself a problem that can and should be remedied? I’ve just posted on it at http://euandus3.wordpress.com/2009/10/25/bigger-banks-too-big-to-fail/

    You might want to read the article I read: http://www.msnbc.msn.com/id/33477077/ns/business-the_new_york_times/

    • I agree completely. I do think that the bigness is itself a problem. I would be in favor of steps that would keep banks from getting “too big to fail”, and would break up banks that are already at that point. I would much prefer that we revert to a more regional banking system as much as possible. In general the regional banks seem to have fared much better than the national ones.


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