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Nassim Taleb: His Solution To Solve The Crisis Won't Work
By Jeff Harding
I am a big fan of Nassim Nicholas Taleb, author of Black Swan and Fooled By Randomness. He is an independent thinker and he has enlightened us on some basic epistemological issues about investment risk. He seems to embrace the Hayekian-Misean concepts of the fallacies of explaining human behavior through mathematics. He has popularized Benoit Mandelbrot's discovery of fractal geometry and its application to investment analysis. Really interesting, fundamental stuff.
I hate to criticize someone I highly admire, but I think he is way off the mark with his solution for solving the economic crisis.
Here is his latest video where he explains his ideas. It's short and interesting. Please view it and then, see my commentary, below.
Taleb has discussed this idea before. Here is his exposition in a previous article on the same topic:
The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers. The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.
His general analysis of the causes of the crisis is dead-on. I couldn't say it any better. He does have a tendency to see the world through black swan glasses, but then I suffer from the same syndrome when it comes to Austrian economic theory.
But ... You can't solve the crisis by converting debt to equity. And this is where we part.
1.) Banks are saddled with home mortgage debt (which he calls "toxic"), but the numbers are ahead of him: foreclosures are continuing at a high rate, and bank loan loss reserves are at an all-time high as they raise more equity. This problem will be solved before any efforts to convert debt to equity will occur. Also, Federal regulators are making it impossible for banks to renegotiate bad loans. They are requiring them to write down loans, come up with more equity, and tighten lending standards. By the time the politicians get around to changing the rules, the loans will be long written off.
2.) Much of the debt is on homes that have no equity left. Recent studies have shown that about 25% of homeowners ditch their homes, not because of their inability to pay, but because of negative equity in their home. With prices still falling, it would not be practical for banks to do this. Banks need to get this debt off their books. Why wait 5 years for this stuff to recover?
3.) Many of the loans are held by investment trusts, not banks. Much of the debt in this country has been securitized, and their trust structures don’t allow for such renegotiations.
4.) The shadow foreclosure market (those behind in payments is estimated to be up to 1.5 million homes, on top of the 1.2 million that are in foreclosure. With prices continuing to fall, why keep capital tied up in a wasting asset? Yes, I realize that the housing market is starting to recover, but bottoming out is different than a robust housing market.
5.) The big issue now is not just home mortgages but commercial mortgages. That market is huge and is hitting the economy right now. Would having them convert this debt to equity solve the banks' problem? The reason these properties are in trouble is that the dynamics of the economy have changed. Much of this market is overbuilt and won't come back. Keeping these investments alive won't change their inevitable failure.
6.) The quickest road to recovery is to allow debt to be written down/off and recapitalize banks, not permit banks to become investors with their failed borrowers. The sooner capital is diverted from failed investments to new profitable ventures, the sooner the recovery.
The cure prescribed by Dr. Taleb would only delay a recovery. As we've discussed before, the real problem is in not allowing debt to be eliminated. You can't by fiat declare what was once debt to now be equity. There are substantial and important economic distinctions between the two. The Japanese tried that and failed, resulting in 19 years of economic stagnation. Whether you call debt "equity" or just leave it on the books waiting for things to improve has no economic difference. Certainly, such capitalization of debt can't be treated as capital for purposes of Tier 1 equity requirements. So, what good does it do? None.
What harm will it do? Much.
This is a complicated topic, and, sadly, I don't think Taleb has done it justice.
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taleb is a poseur and a piece of cowdung - he wouldn't know math or stats if it hit him in the face. how many math filled examples in the black swan? what is his investing record? his successful years total how many? 100x better a promoter than investment advisor. mandlerot? chaos theory? ha. sucker. he's destined for the giveaway book rack.
love this site by the way, a austrian home run slightly overrun by goldbugs at 1100 gold lol.
Actually, Janet Tavakoli could perhaps be in the best position to comment on Taleb's remarks. Because, to a certain extent the promise of structured finance was to manage risk. But, what we see for MBS CDOs, the real money was made up front. As either feeding the securitization machine (bad loans), or in fees for creating the AAA rated MBS, so it could be sold without the true recognition of risk (potential loss).
Why I mention Janet is the fact that, the crisis was essentially a misuse or, if you will, abuse of a potentially useful approach to risk, and how this underlying speculative asset class was insured (CDS) and hence interlinked across the banking industry. Planting the seeds of systemic risk.
So will the banker's ever be responsible, or self regulating, in the use of structured finance? Does the FED recognize that derivatives have eclipsed the FED's ability to effectively manipulate the economic cycle? That is, if you do not regulate or control derivatives, you cannot control monetary policy. The old FED tool box and theories, no longer applies.
So what if the problem is really the undisciplined use of structured finance? Not the promise of derivatives, but a manifestation of uncontrolled abuse. Subverted for short term profit, but through leverage and misuse, the new definition of systemic banking risk.
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What I see with MBS CDO is that its evolution has produced a vehicle that exhibits asymmetric risk with price.
When the base asset class (real estate) is increasing in price, due to the FEDs bubble-isms, then risk is somehow containable and believable in conveyance from seller to buyer, even producing a AAA rating. But, when the asset class price trends down, there is no easy way to establish underlying value, in a range acceptable for an investor.
The translation is just too complex, for a buyer to commit. So we see a trend to extrapolate worse case price into the established market behavior resulting in a very low price estimate. Meaning, the seller will have to take a potentially amplified loss if the transaction is done in the open market with real price discovery.
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The debt to equity proposal is interesting, but does not acknowledge the reality of the underlying problem of recovery from an over priced asset, in terms of a loan agreement like a Mortgage, which is collateralized by the asset itself.
Ultimately, the question is one of loss, and how it will be recognized on the banks books through default and foreclosure. The problem is that any loss that is recognized will contribute to the banks insolvency, and thus must be avoided until the collateral's price recovers. If ever.
If the mortgage is bundled MBS, there is the possibility of a leveraged loss, that in CY2010, will move on balance sheet due to accounting rule changes.
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The question is who will take the loss and when. If price continues to fall, then finding buyers or being adequately capitalized will become more difficult. As part of the asymmetric risk, its manifestation is one of extreme price sensitivity. Where banks will move from solvent to insolvent over a few percentage point drop at a loss transition point (default recognition) in their loan portfolios. This drop could easily happen over a weeks time in distressed markets.
Anyway Janet would be in a better position to judge if unregulated structured finance will fulfill its promise of risk mitigation.
Mark Beck
Well what a lot of comments..
I think only one of them really got the point. Converting debt in to some sort of equity does allow people to live in their homes or have credit cards or what have you. The alternative is massive social unrest, here it leave math theory and economics for the most part.
The jobless "recovery" has an aspect to it that relates to equity and debt. There are a lot of jobs that did not need to exist and businesses that were unnecessary. But after the fall the people still exist. We are headed into an era where outsourcing and automation and downsizing through technology will upset most neat economic models.
The not so Black Swan of the highly probable is that converting debt to equity is a loss but not so great as creating revolutionary conditions for nothing. It is very predictable that living people want to live normaly.
By not facilitating such reform we play into the hands of those who think "the worse the better" you know the Comrade Stalins of this world. Are we toying with something that bad? You bet your life!
I don't see anyother way but a debt w/off of massive proportions. The question is can it be merely isolated to US interests. This disturbance is a bowl of congealed spaghetti. No sauce either for color. When?? is another question. Inflation is also a non-starter.
Whether solved with math, calc or trig, the human element is unavoidable.
I'm not sure what Mr. Taleb is advocating when he is talking about a debt for equity swap but a debt for equity swap is pretty much what foreclosure is, i.e. the mortgage is converted into ownership of the property mostly resulting in the bank selling it in auction.
This mortgage foreclosure is not really the problem since its necessary in the event of a loan becoming delinquent. The problem is what to do next. The optimal solution is obviously to retain the previous homeowner now as a tenant paying a much lower rent than the previous mortgage payment. That would be a plan worth pursuing.
If I bought a car a long time ago and didn't intend to buy a new one until it died of old age, I don't see why that is necessarily a bad way to own a car. It might be smarter to own a car that way than to upgrade every two years. So Taleb's criticism is not necessarily a very strong one. Cash for Clunkers served a good purpose. Improved air quality and gave a shot to the economy. It also likely helped poor folks more than the well off. You can always find something wrong with anything, but this is sort of a cheap shot in my view. --Mark A. Goldman
Not sure how this is better than debt re-negotiation in court. Seems like he is trying to work around the inevitable end, as a chunk of distressed mortgages have little/no equity.
Maybe I'm missing something salient in his proposal. The day has been nuts.
If you own a gas guzzling car it doesn't mean that you did anything wrong. It might just mean that you purchased a care a long time ago and hasn't upgraded, wating until the car is ready to die. That might have been a very wise way to own a car. The cash for clunkers is a good idea because it gets money flowing again and also helps improve air quality. Of course there are those who fit Taleb's description but I don't think it's a strong argument.
I never agree with Hayekians, so I thought I had to comment because I do in this case (basically, I think)
The thing I want to say and keep saying to lawmakers is: "It's the collateral, stupid!".
Money lent on overvalued collateral is dead money. This is the unavoidable truth.
The owners of that debt have to take the haircut. Naturally they are struggling like heck not to. Too bad for them. Converting debt to equity is a nice idea, but the fundamental truth is that you can't reward people in equity for making $800K loans on $200K houses. They gave huge quantities of other people's money away to get commissions and fees. It was a crooked business.
Absent the possibility of clawing back the excess money transferred to the underserving homeowner and banker during the bubble, the only people who can take the hit are the idiots who loaned the money and the only way to do that is to hit the "reset" button on loan principal across the board. If that causes arbitrary losses, so did the bubble cause arbitrary gains.
The "debt" we are talking about here is assets on the balance sheet of the banks. Messing around with the assets do not sound like a good idea. Why not making equity with the stuff you find on the other side of the balance sheet? The easiest cure for TBTF is to have a mandatory convertion of debt (the banks' obligations) to equity (ordinary shares) when their capital falls below a preset limit. The convertion could either be proportional for all or ased on maturity or some other criteria. Those who lend banks money would take on the risk not covered by the present equity. Then the banks would have to pay for lack of transparancy, excessive risk taking and bad management.
The USA is prosecuting a path which it would never allow any lessor. A bankrupt would be pressed into dissolution so that creditors could at least quickly recover what value remained. Creditors would never submit to additional value diminishment by complicit pretending that a super-insolvent debtor is whole, and what more, prospering.
By cash flow analysis throughout the true books of the USA, it is apparent that debt-for-equity, forbearance, indulgent accounting, free money, debasement, risk asset pumps by gov't itself--simple aren't enough (even given length of time) to bring a profitable return.
No amount of restructuring nor arbitrary value resets of the underlying accounting units can make this whole. As has been noticed again and again, the parts cannot exceed the sum whole. And since the alliance (gov't, CB, Treasury, Wall Street) have stripped and consumed far beyond their inputs, some other entity must BEAR THE LOSS.
It has been decreed: That entity is dollar holders, US taxpayers, creditors to the US gov't, and banks playacting that they aren't public utilities with capped growth abilities.
Only foreign collusion and fear of the US military might stops creditors from seeking the breakup and action of the debtor.
We are in the economic doldrums. Here is where the creditors are attempting some kind of workout to extract what value they can. But once that agreement breaks down...
Of course you cannot convert BAD debt into equity. That's pretty fundamental... it is called 'extend and pretend' and a lot of banks are now trying it. But sooner, later or somewhere between it takes money to buy whiskey.
Seems like plenty of you need to either read or reread Taleb before posting further opinions on the man's writtings/ideas. And it wouldn't hurt you to read your comments before actually post them...some are simply pointless others simply senseless and many poorly edited.
I'm not chungaga or chuganmamma or whatever!
If we asume that the 2.5 million properties in or nearing forclosure are insured why not burn them down, then the insurance companies get their money back by raising premiums on those of us who don't burn down our house (mine is concrete with a concrete roof) . Then you have 2.5 million new homebuyers to whom we could extend first time homebuyer credits, end of problem
also see talking heads, speaking in tongues
http://www.youtube.com/watch?v=xNnAvTTaJjM&feature=fvw
See Bastiat, The Broken Window Fallacy.
Taleb's idea is not likely to work. Loans are an asset on the balance sheet of the bank. If you convert the loan to equity it is still an asset on the balalnce sheet of the bank.
This might work well for the homeowner but it does not solve the problem that the banks have. They end up with an asset that can still go down in value and have to write off the loss on the loan. You still end up with a screwed up balance sheet @ the bank.
KEEP IN MIND I AM OF THE OPINION THAT BANKS ARE IN THE BUSINESS OF INTERMEDIATION. THEY BORROW LOW AND LEND HIGHER, ALSO OFFERRING DRAFT SERVICES. YES THEY DO MORE TRADING STUFF TOO, PROBABLY MORE THAN THEY SHOULD.
The only solution is to transform debt into equity across all sectors, in an organised and systematic way. SO FAR SO GOOD.
Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. NO, THEY SHOULD OFFER LOWER INTEREST RATES UNTIL THE HOMEOWNER CAN CATCH UP, ON A CASE BY CASE BASIS SO NO ONE THINKS THEY CAN GET AWAY AND NOT PAY THEIR DEBTS WITHOUT SOME REPURCUSSION. 12% INTEREST IS TOO HIGH BUT THERE NEEDS TO BE SOME BETTER BALANCE, IF SOMEONE CANNOT AFFORD 6-7% THEN SELL THE HOME AND MOVE ON. THIS IS TRUE OF COMMERCIAL TOO, A BIT MORE COMPLICATED THOUGH.
Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. FORECLOSURE CAN BE QUICK BUT NOT A BAD IDEA, SEE COMMENTS ABOVE.
Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. PROBABLY TRUE.
Hidden risks become visible; hopers become doers. SOMETIMES AN ABERRATION OCCURS. IF YOU CAN WAIT IT OUT WITHOUT LOSING TOO MUCH TIME YOU DID GOOD.
Because any solution whose approach is either gradual or immediate entails the DEATH of the financial system as we know it; and because that throws every buy-button pump monkey, broker, analyst, specul-investor onto the hard street where they cannot make an honest living, the USA has adopted an alternative plan.
That plan is: LIE TO OURSELVES, and by corollary, everyone else.
the usa lies when it believes--
(a) it can become rich as lawyers, doctors, accountants, stock pickers, wage arbitrageurs, exploiters of value differences via sophisticated mathematical models of the globe at large, middle managers, paper pushers, and retail markup dry good liquidators.
(b) it can exploit the rest of the world for labour and commodity inputs, while it concentrates on design, marketing, and financial manipulation to preserve its lionshare gain in production and value pyramid.
(c) It can continue to fund (privately and publically)retirements of a demographically inverted-pear shaped society that is pushing out the mortality curve while retiring earlier, and do so relying on models that assume an investment return consistently over the natural base growth rate.
(d) the military will continue to prosecute foreign wars without legitimacy or mandate, and that its manpower will act with integrity in immoral state conduct. There will never again be a battleship potemkin event, certainly not in the USA military.
(e) With a depleted industrial base, a reserve currency increasingly being repudiated, and a profligate treasury debasing the $ while diluting interest rates by monetizing Treasuries, that other nations will not see the USA as an entity of seeping irrelevance. When new supply lines are secured, trade routes established, and terms of settlement routed around the $, global trade may well BYPASS the malevolent, evil empire of the USA.
(f) the self-serving, parasitical alliance of US gov't, Fed Reserve, Treasury, and Wall Street is acting responsibly to preserve the virtuous cycle of work-reward, stability, global harmony.
"That plan is: LIE TO OURSELVES, and by corollary, everyone else."
Sartre called this mauvise foi.
from http://en.wikipedia.org/wiki/Bad_faith_(existentialism) :
"Taking on the burden of personal accountability in all situations is an intimidating proposition - by pointing out the freedom of the individual Sartre seeks to demonstrate the social roles and moral systems we adopt to protect us from being morally accountable for our actions."
...let freedom ring...
p.s. damn fine soap anon.
strong dose of lye always works best as a disinfectant.
You, Sir, have a definite way with words. I could quibble with (a) and (b) but I won't.
The debt-to-equity exchange must be massive, and not restricted only to bank debt if you want it to work : it has to go through the whole chain : banks, mortgage borrower, pension funds and government debt. William Buiter has a good piece on this in the FT check :
http://tinyurl.com/yfysnyj
I Agree that this would be the best option. However, Nassim's point is not as invalid as you think, and it's why I think your point #2 is not exactly valid. By converting debt into equity, when equity is almost non-existent, the result is pretty much the same thing as writing down the debt to $0.
The difference is, it will allow for the homeowners to continue living in their house. So I think he's not just looking at it from how best to treat the assets and balance sheets, but how to get rid of the debt without having huge social unrest. Otherwise, you'd have the debt holders seizing all assets and liquidating; this would result in many people getting kicked out of their house.
Having said that, I reiterate that I agree with your conclusion, since that is exactly how a free market should work.
I think Daedal's onto something here.
If you look at the "Equity" section of any balance sheet, you'll see "par", "paid-in capital" and "retained earnings/deficit". The latter includes all income/losses prior to the balance sheet date, including those from the current year.
Nassim may be, in effect, saying, "banks should reflect the toxic loans as losses -- which will drop them into the equity of issuing banks."
This is the fundamental point of his argument I think. The problem is though, you're assuming that the banks will mark this new equity down to zero which it probably won't.
It'll mean a higher equity base which is probably not there. But the social unrest you point to is key during such a severe recession.
I think Taleb is correct in principle, but wrong in practice. We need a new approach to equity, I think.
I advocate giving distressed owner/occupiers and the even more distressed banks the choice of agreeing to transfer the property, to a Custodian, setting an affordable, index-linked rental, and then selling Units in the resulting Rental Pool (which would soon run to thousands of properties) to investors.
Essentially a REIT, but with the interesting quality that Units are redeemable in the right to occupy the property.
For the investor it's an index-linked, low risk (because affordability=certainty), property-based investment.
For the occupier it's an affordable way of occupying and 'co-owning' property, and of course anything they pay more than the rent (either in cash or by doing maintenance) gets them Units, and hence equity in the pool.
For the banks - who can exit to pension funds, and sovereign wealth funds, also Islamic investors, as this model happens to be sharia'h compliant - it's a better outcome than any debt restructuring that leaves the unrepayable debt intact.
See
http://www.slideshare.net/ChrisJCook/equity-shares-a-solution-to-the-cre...
in the context of Ireland, where the property bubble makes the US look tame.
Taleb is missing an important point, imho. Turning banks into hopers is like asking a nuclear missle not to explode too loudly. That is not how they function. Instead, look at data, get emotionally detached. The banks kick the can because they are allowed to and indeed encouraged to. The Administration thinks the kicking won't last very long so let the banks go for it. You don't get price discovery by converting debt to equity.
If, on the other hand, price recovery in residential and commercial mortgages are far away, then the only real option is to write down or off the debt, today. Our economy can't function with years and years of unresolved debt going on. Obviously the bank's balance sheets can't handle this and doing so would result in either many banks asking for more money which would almost certainly mean the Government having little choice but to nationalize them 100%. Not giving them the money and allowing the likes of BAC, WFC, C and JPM go belly up isn't realistic. Having them go belly up under full government ownership is another story, even though I can't possibly imagine these idiotic banks being run by even more idiotic bureaucrats.
Taleb shares in, most of, his view a neo-Pythagorean conviction that social and socially related phenomena can be explained via mathematics, and his problem is that he sees social relationships and social development as functions, and as if that is not enough to find his " preaching " ridiculous; then the following surely is; he thinks of mathematics as if mathematics is religion; and Taleb firmly relies on the dogmas of mathematics to silence his critics, without logically disproving them. I mean i like the guy, but his writings are nothing new, they have been around since Aristotle seriously began to study logic. Again, Taleb is a dogmatic neo-Pythagorean with a deterministic ( yes, its deterministic ) view on the phenomena that surround him. He is a theorist, a pure statistician of the current state; and that my friends doesn't pass my BS detector for the reasons mentioned above.
Umm, no. I assumed that everyone here has read Black Swan and Fooled By Randomness. But apparently not. He definitely understands the limits of mathematics as a fundamental epistemological principle. What he says is that since we can't know all the data, the best thing you (traders) can do is wait for the next black swan (you never know when they're coming--if you did, they're not black swans) and hedge accordingly. He recommends investing a majority of your portfolio (say 85% to 90%) in Treasury paper or something considered safe, and buy out of the money options and wait for the big hit. His Universa Fund hit it big time this cycle.
It isn't as if mathematics has no role in investing. It is a good analytical tool. You just can't rely on math as the whole truth or use it to explain all of human behavior. Free will and all that. Fractal geometry is not Pythagorean and was invented by Mandelbrot as a way to explain the irregular shapes of nature and the real world. It has fundamental applications to the analysis of markets. He started by analyzing cotton prices and then realized he had discovered something fundamental. For those of you interested in the topic there is a good introductory book by Mandelbrot, The (Mis)behavior of Markets.
I think there is a lot of confusion here about Keynesian and Monetarist use of mathematics and what Taleb-Mandelbrot are saying. When I said Taleb has adopted Hayekian-Misean concepts of epistemology it is true. It is what Hayek called "scientistic" thinking by Keynesians and Monetarists, who think they can forecast by applying various formulas to manipulate money supply and such. We all know that's a failure.
But don't throw out math. Throw out Black-Scholes, Modern Portfolio Theory, and Efficient Market Theory which are based on Gaussian statistical analysis. Just ask John Merriwether.
What he says is that since we can't know all the data, the best thing you (traders) can do is wait for the next black swan (you never know when they're coming--if you did, they're not black swans) and hedge accordingly
And so that is his big idea, to simply re-write Laplace in a dialectically opposite way and set the paradigm on the deterministic chaos.
Lame in my book. But you can sell all kind of shit ideas to WS and modern media.
No, CB. Read his books. We're talking about mechanistics vs. the limits of knowledge when applied to human behavior. Go read Hayek (http://mises.org/story/3229). Stop being silly and pretentious.
if he is using Mandelbrot, he is using deterministic chaos. period. it has nothing to do with the economy, its just projected onto it. simple as that. and I'm not being pretentious, but you apparently don't like what you hear. if his theory is a mathematical one it is categorically above the phenomenon which it tries to describe.
also you can find the underlying generality of pretty much everything, that was proven by both Grothendieck and MacLane, but it is only a theoretical generality. Taleb is behaving somewhat like an amateur here by using Mandelbrots fractal geometry in predicting the market trends etc. He is searching for a pattern, which is surely there, if in nothing else, than in the averages and probabilities, but that simply doesn't cut it.
Im sorry, but to me, this is an amateurish theory which Taleb preaches.
I think we're off the track here. I am not a mathematician, CB, maybe you are. But I don't think you "get" where I, Taleb, or Mandelbrot are going. I would first ask you if you have read any of the three books I mentioned above. Based on the way you approach these issues, I would guess you have not. I apologize if I am wrong.
The whole point of Taleb, Mandelbrot, and the Austrian theory economists, is that mathematics, or more specifically its application in econometrics is invalid science when it comes to predicting human behavior or creating, say, economic policy. For example, the Keynesian formula (I can't reproduce it here) has never worked, has never been proven to work, and is based on a false science.
What we are talking about it epistemology, the study of how we know what we know. The above thinkers all reject "scientistic" explanations. This would correlate to (Newtonian) mechanistic explanations of human behavior. Hayek really developed this idea and said since you have millions of economic actors, you simply can't ever know if you have the correct assumptions or data to input into a formula that governs social policy or accurately predicts human behavior. Sure, you can do supply-demand equations to prove basic, broad concepts, but it doesn't work on the micro level.
Mises spent much of his life creating a theory of knowledge for application to the social sciences and rejected much of the mathematical pseudo-science now used, especially in economics. It was ground-breaking stuff.
Taleb, and his mentor, Mandelbrot, came up with the ideas that the current risk models used in portfolio management and market/company analysis were wrong. They are based on Gaussian (since you are a mathematician, Bachelier's) statistical methods. Taleb came up with the concept of the Black Swan which says unforeseeable world changing events (good and bad) occur rather regularly and investors get wiped out because they didn't model them correctly and never saw them coming. The Long Term Capital Management collapse and their use of Black-Scholes was his favorite example. Fat tails have happened, will continue to happen, and no one sees them coming because of these faulty statistical theories.
The use of fractals is only a tool to demonstrate these fallacies. It isn't as if math isn't valuable in investment analysis or in economics, it is just that math is used to measure the wrong things.
I think Taleb is an original thinker about issues, while he hasn't discovered anything new, his synthesis and analysis is very, very good. So when you say (that I say) that Taleb uses fractals to predict market trends, that's not what I meant. He thinks it's a useful analytical tool. I don't claim to understand the math behind fractals, but to write it off as "deterministic chaos" is the opposite of what he believes.
I'm not trying to be argumentative here, I'm trying to convey an idea. I hope I've made it clearer.
First of all i would like to apologize for the tone in my comments that you encountered in them when i wrote them. Was having a bad day and that set a large part of the cockiness i now see in my comments. This time around i will try to give toned down and more elaborate explanation of what i was saying.
That said; i can now start. Yes, you are right, i have not read all the three book about which you have written about, but i am familiar with the concepts which were explained in the " The black swan ", and i will still stand by my original assessment that the idea of a black swan in a financial context is maybe a new concept but it has been around in logic since Bertrand Russell started to undergo serious logical investigation in the beginning of the 20th century. Logically, to speak, it is a fallacy in consequence, and Taleb, apparently took tha basic notion of logical reasoning and applied it to financials.
This part of his theory is correct and i wont dispute is truthfulness, but i will still remain with my assessment that the concept is not original nor new.
Econometrics, with the higher degree of statistics is inadequate and dogmatic way to observe social and economical phenomena, but it is not false when it tries to describe them. I am sure that you are familiar with the distinction between observation and measurement. But, what i could read from Talebs writings, which i have read, is that he incorporates the argumentation for his hypothesis on the synthesis of the fallacy of consequence and the general notion of statistical and probable anomalies which are bound to occur in any system and in any structure. Those anomalies, could also be ascribed to stochastic processes. And there lays my complaint for Taleb. Stochastic process works brilliantly when all the states in the 0-state of some system are known, and hence are known all the future values of that system up to some point t which belong in T. Now, Taleb brilliantly extrapolates that possibility by employing the notion set by Poincare who said, in the end of the 19th century, that all values of some system in 0-state can never be known in their completeness, and hence all the future values Vt can not be known.
That is why i mentioned the concept of deterministic chaos, better known as chaos theory, which directly studies the mathematics which i have presented in the previous parts of this post.
Also,i do know that Taleb and Mandelbrot, are not trying to employ the notions of measurability on to the processes of economy and social processes, but, are, nevertheless, maybe unpurposely , doing so by categorization ( they set a functor between some X and some Y ) and think that categorical deviation of unknown functor will change future known values of all states.
Basically, you and i don't disagree, just have different approaches for approaching Telebs theory, me, from a more technically logical and mathematical side, and you, from a more technical economic side.
It would be fairly easy to fully explain the notions of all the mathematical and logical concept i have used as my argumentation, and as the synthesized identity for Talebs work, but i dont have enough space here to do so, but would be more than glad so send you some links for literature download so you could read that material.
About the epistemology of Talebs writings could be dispute if it is epistemology or not, and if it is epistemology, what kind of epistemology it is. It can be Kantian, Hegelian, solipsistic, moder, post-modern, analytical, synthetikal, Descartian etc.
I say this simply because the difference in epistemological approach will yield a different outcome of the knowledge about that which is observed. But that is for some other discussion so i will just leave it here.
Also, this has been a pleasant and fruitful discussion, hope to see more of them.
And don let my nickname avert you from my comments in the future, we bastards have feelings to :D.
I am glad to see you two speaking more amicably. Much more enjoyable for others reading the postings from you two.
With the change in tone came a more rational and careful/thoughtful debate which serves to enlighten others (beside me i hope) rather than an emotional rant which only annoys us and reflects poorly on the posters.
thankyou both
I don't think he's being silly. I'm engineering trained. I'm well aware that when I do a differentail equation modeling a spring I'm making assumptions along the way. The better assumptions I make the more perfectly it will model the system. I'm making assumptions right now which you have to do when you empath or even communicate with someone. It depends on how I mesh with people but groups where people are generally my age we share enough of outer planet connections that I can actually correct miscommunications between people from failures in intention or importance. I'm assuming that cheeky is more interested in understanding the misuse of mathematics. IE using it at a pure truth, when it's never a pure truth if it's modeling any advanced thing. It's a focusing factor. It's supposed to focus you not RULE you. Assist in organizing your thoughts and understandings. Not set up a slavish devotion to a partial truth.
It really has nothing to do with the article. Nassim just sort of understands that as you run fractional reserve systems you build up debt pressures. He's discussing an orderly relief valve of the debt pressures by tossing out the "rule" of law and entering into contract of mortgages. You're proposing that it's too late to get past that hangup and to just let it fail destroying the debt pressures and letting it naturally realign with workable valuations.
That's simply an expressive phenomenon. Once you learn to express ideas mathematically you want to express all your ideas mathematically. It's the same with any advanced systme of understanding. I get it on astrology forums where people want to express themselves entirely and purely in an astrologocial fashion. To outsiders the expressions make no sense. To them it's an organizing agent of expression and becomes psychological factor validations.
Then I go over to the computer geek group and they are all organized by needs of the computer producers. They are literally computer manufacturers little bitches. Parroting and bobbleheading marketing material as their sole forms of justification and personality identification. Evangalizing according to their technology gods like perverts who can't stop fucking any chicken they meet. Molesting each others inadequacies with half of them tied to miserable gaming existances where zero sum games are hidden and buried in treadmills of stupid beurecratical procedural functions which require them to exert all their resources to overcome game obstacles that get them to new treadmills that rebalance the zero sum baseline to start the addictive repetitive overcoming cycles again.
It's all mental focusing and thought energy orgainization techniques. Fuck em. Fuck em with a powerpoint bullet.
I agree with CB.
In fact, wasn't it mathematics that got us into this mess in the first place...?? All the bankster math models dictated something could not happen within a +/- degree of certainty. Yet it did happen anyway....massive default and deflation in real estate value.
Affordability modeling never entered into the equation. OOPS.
I would have thought that the "application of fractal geometry to investment analysis" was another attempt to explain human behaviour through mathematics. But someone of Taleb's stratospheric intellect would no doubt have no trouble resolving the apparent contradiction. Maybe pop mathematics is exempt.
He seems to embrace the Hayekian-Misean concepts of the fallacies of explaining human behavior through mathematics. He has popularized Benoit Mandelbrot's discovery of fractal geometry and its application to investment analysis
I would have thought the "application of fractal geometry to investment analysis" was an attempt to explain human behaviour through mathematics. But someone of Taleb's stratospheric intellect would no doubt have no struggle with the apparent contradiction.
You do suffer from your austrian views. Converting debt into equity would change the current debt deflation leading to depression into a mere recession. What's more, and this is no doubt what you are trying to avoid: debt to equity conversion would reinstate moral hazard with creditors. And that runs against austrian economics, where creditors can do no wrong.
I think you're already seeing a solution to the crisis, the dollar is devaluing vis a vis other currencies, gold and especially against oil. If the price of everything else goes up and the price a home stays the same hasn't it in effect been devalued? As someone who bought a home in late July of 09 speaking from firsthand experience I can also say that home prices are also going down in nominal terms as well.
You are seeing a write off but I think it's primarily through devaluation/inflation (I consider devaluation and inflation to be highly interchangable in this case).
Property values will reflect their true worth one way or another whether it's through depreciation, inflation or more likely a combination of the two.
The only question is do you prefer to see property values crash or property values and the dollar to crash?
Excellent post and find. I am a fan of Nassim and find his comments on point and enlightening. But I agree with your conclusion, mainly the point about any effort to convert debt to equity would greatly lag the actual market. The conversion, whether in or out of the money would theoretically increase personal/individuals' free cash flow to pay down consumer debt as an intended or unintended consequence.
I wanted to highlight something else Nassim said quite eloquently that i) I find it very important for folks in D.C. to understand and ii) I am scared that they don't:
""[Larry Summers and Co.] are making forecasts on what is going to happen in 2010, 2011. They are building government deficits based on that. They believe in Santa Clause"
White House has been reluctant to adopt CBO budgets at their most conservative. And I am nervous that CBO budgets aren't conservative enough!
Ofcourse, they believe in Santa! If you were a tax collector with a blank check!
1) Agree
2) Largely agree. Example being home with 0% equity, but loans aren't impaired. So no need to convert debt to equity. On flip side, converting an impaired loan into equity doesn't make loan in-the-money. Only reduces burden on homeowner, reduces cash flow potential to bank, and dilutes recovery to bank on any housing recovery. However, if every homeowner did this on their impaired loans, then I guess we should see less pressure on housing, increasing chances for housing recovery, and thus recovery to bank. Seems to be largely theoretical solution.
3) Agree
4) Agree, but I don't think this is central to Taleb's point
5) Agree, but I don't think this is central to Taleb's point
6) Agree, but I don't think this is central to Taleb's proposal. Though I guess this is your own opinion of something more productive than Taleb's proposal.
To your conclusion.. agree. Converting out-of-money debt into out-of-money equity doesn't change fact that you are still out-of-money. Theoretically, implementing this reduces strain on housing markets/economy, so you have better chance for recovery. But this is experimental/a show-me story and not at all practically feasible.
bad debt must be liquidated to free capital for more productive uses....this used car salesman trick is no solution god bless him....