Taleb’s Harsh Assessment of Bankers, Economists, and the Fed

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Reader Michael called to my attention a wide-ranging interview with Nassim Nicholas Taleb, author of the Black Swan and professional iconoclast, in the Times of London. The article is colorful, wide-ranging, and a bit long, so I’ve excerpted some of the most provocative bits. Needless to say, I am particularly taken by his dim view of academic economics as practiced in the US, which tends to place a premium on abstraction and models:

A noisy cafe in Newport Beach, California. Nassim Nicholas Taleb is eating three successive salads, carefully picking out anything with a high carbohydrate content.

He is telling me how to live. “The only way you can say ‘F*** you’ to fate is by saying it’s not going to affect how I live. So if somebody puts you to death, make sure you shave.”…

The world is random, intrinsically unknowable. “You will never,” he says, “be able to control randomness.”

To explain: black swans were discovered in Australia. Before that, any reasonable person could assume the all-swans-are-white theory was unassailable. But the sight of just one black swan detonated that theory. Every theory we have about the human world and about the future is vulnerable to the black swan, the unexpected event. We sail in fragile vessels across a raging sea of uncertainty. “The world we live in is vastly different from the world we think we live in.”

Last May, Taleb published The Black Swan: The Impact of the Highly Improbable. It said, among many other things, that most economists, and almost all bankers, are subhuman and very, very dangerous. They live in a fantasy world in which the future can be controlled by sophisticated mathematical models and elaborate risk-management systems. Bankers and economists scorned and raged at Taleb. He didn’t understand, they said. A few months later, the full global implications of the sub-prime-driven credit crunch became clear. The world banking system still teeters on the edge of meltdown. Taleb had been vindicated. “It was my greatest vindication. But to me that wasn’t a black swan; it was a white swan. I knew it would happen and I said so. It was a black swan to Ben Bernanke [the chairman of the Federal Reserve]. I wouldn’t use him to drive my car. These guys are dangerous. They’re not qualified in their own field.”

In December he lectured bankers at Société Générale, France’s second biggest bank. He told them they were sitting on a mountain of risks – a menagerie of black swans. They didn’t believe him. Six weeks later the rogue trader and black swan Jérôme Kerviel landed them with $7.2 billion of losses.

As a result, Taleb is now the hottest thinker in the world. He has a $4m advance on his next book. He gives about 30 presentations a year to bankers, economists, traders, even to Nasa, the US Fire Administration and the Department of Homeland Security. But he doesn’t tell them what to do – he doesn’t know. He just tells them how the world is. “I’m not a guru. I’m just describing a problem and saying, ‘You deal with it.’”…

He has rules. In California he hires bikes, not cars. He doesn’t usually carry his BlackBerry because he hates distraction and he really hates phone charges. But he does carry an Apple laptop everywhere and constantly uses it to illustrate complex points and seek out references. He says he answers every e-mail. He is sent thousands. He reads for 60 hours a week, but almost never a newspaper, and he never watches television.

“If something is going on, I hear about it. I like to talk to people, I socialise. Television is a waste of time. Human contact is what matters.”…

Startlingly, this great sceptic, this non-guru who believes in nothing, is still a practising Christian. He regards with some contempt the militant atheism movement led by Richard Dawkins.

“Scientists don’t know what they are talking about when they talk about religion. Religion has nothing to do with belief, and I don’t believe it has any negative impact on people’s lives outside of intolerance. Why do I go to church? It’s like asking, why did you marry that woman? You make up reasons, but it’s probably just smell. I love the smell of candles. It’s an aesthetic thing.”

Take away religion, he says, and people start believing in nationalism, which has killed far more people. Religion is also a good way of handling uncertainty. It lowers blood pressure. He’s convinced that religious people take fewer financial risks…

But, crucially, he also learnt from a very early age that grown-ups have a dodgy grasp of probability…For the non-mathematician, probability is an indecipherably complex field. But Taleb makes it easy by proving all the mathematics wrong. Let me introduce you to Brooklyn-born Fat Tony and academically inclined Dr John, two of Taleb’s creations. You toss a coin 40 times and it comes up heads every time. What is the chance of it coming up heads the 41st time? Dr John gives the answer drummed into the heads of every statistic student: 50/50. Fat Tony shakes his head and says the chances are no more than 1%. “You are either full of crap,” he says, “or a pure sucker to buy that 50% business. The coin gotta be loaded.”

The chances of a coin coming up heads 41 times are so small as to be effectively impossible in this universe. It is far, far more likely that somebody is cheating. Fat Tony wins. Dr John is the sucker. And the one thing that drives Taleb more than anything else is the determination not to be a sucker. Dr John is the economist or banker who thinks he can manage risk through mathematics. Fat Tony relies only on what happens in the real world.

In 1985, Taleb discovered how he could play Fat Tony in the markets. France, Germany, Japan, Britain and America signed an agreement to push down the value of the dollar. Taleb was working as an options trader at a French bank. He held options that had cost him almost nothing and that bet on the dollar’s decline. Suddenly they were worth a fortune. He became obsessed with buying “out of the money” options. He had realised that when markets rise they tend to rise by small amounts, but when they fall – usually hit by a black swan – they fall a long way.

The big payoff came on October 19, 1987 – Black Monday. It was the biggest market drop in modern history. “That had vastly more influence on my thought than any other event in history.”

It was a huge black swan – nobody had expected it, not even Taleb. But the point was, he was ready. He was sitting on a pile of out-of-the-money eurodollar options. So, while others were considering suicide, Taleb was sitting on profits of $35m to $40m. He had what he calls his “f***-off money”, money that would allow him to walk away from any job and support him in his long-term desire to be a writer and philosopher.

He stayed on Wall Street until he got bored and moved to Chicago to become a trader in the pit, the open-outcry market run by the world’s most sceptical people, all Fat Tonys. This he understood…..

In the midst of this came his purest vindication prior to sub-prime. Long-Term Capital Management was a hedge fund set up in 1994 by, among others, Myron Scholes and Robert C Merton, joint winners of the 1997 Nobel prize in economics. It had the grandest of all possible credentials and used the most sophisticated academic theories of portfolio management. It went bust in 1998 and, because it had positions worth $1.25 trillion outstanding, it almost took the financial system down with it. Modern portfolio theory had not accounted for the black swan, the Russian financial crisis of that year. Taleb regards the Nobel prize in economics as a disgrace, a laughable endorsement of the worst kind of Dr John economics. Fat Tony should get the Nobel, but he’s too smart. “People say to me, ‘If economists are so incompetent, why do people listen to them?’ I say, ‘They don’t listen, they’re just teaching birds how to fly.’ ”….

And what he knows does not sound good. The sub-prime crisis is not over and could get worse. Even if the US economy survives this one, it will remain a mountain of risk and delusion. “America is the greatest financial risk you can think of.”

Its primary problem is that both banks and government are staffed by academic economists running their deluded models. Britain and Europe have better prospects because our economists tend to be more pragmatic, adapting to conditions rather than following models. But still we are dependent on American folly.

The central point is that we have created a world we don’t understand. There’s a place he calls Mediocristan. This was where early humans lived. Most events happened within a narrow range of probabilities – within the bell-curve distribution still taught to statistics students. But we don’t live there any more. We live in Extremistan, where black swans proliferate, winners tend to take all and the rest get nothing – there’s Bill Gates, Steve Jobs and a lot of software writers living in a garage, there’s Domingo and a thousand opera singers working in Starbucks. Our systems are complex but over-efficient. They have no redundancy, so a black swan strikes everybody at once. The banking system is the worst of all.

“Complex systems don’t allow for slack and everybody protects that system. The banking system doesn’t have that slack. In a normal ecology, banks go bankrupt every day. But in a complex system there is a tendency to cluster around powerful units. Every bank becomes the same bank so they can all go bust together.”

He points out, chillingly, that banks make money from two sources. They take interest on our current accounts and charge us for services. This is easy, safe money. But they also take risks, big risks, with the whole panoply of loans, mortgages, derivatives and any other weird scam they can dream up. “Banks have never made a penny out of this, not a penny. They do well for a while and then lose it all in a big crash.”

On top of that, Taleb has shown that increased economic concentration has raised our vulnerability to natural disasters. The Kobe earthquake of 1995 cost a lot more than the Tokyo earthquake of 1923. And there are countless other ways in which we have built a world ruled by black swans – some good but mostly bad. So what do we do as individuals and the world? In the case of the world, Taleb doesn’t know. He doesn’t make predictions, he insults people paid to do so by telling them to get another job. All forecasts about the oil price, for example, are always wrong, though people keep doing it. But he knows how the world will end.

“Governments and policy makers don’t understand the world in which we live, so if somebody is going to destroy the world, it is the Bank of England saving Northern Rock. The biggest danger to human society comes from civil servants in an environment like this. In their attempt to control the ecology, they don’t understand that the link between action and consequences can be more vicious. Civil servants say they need to make forecasts, but it’s totally irresponsible to make people rely on you without telling them you’re incompetent.”

Bear Stearns – the US Northern Rock – was another vindication for Taleb. He’s always said that whatever deal you do, you always end up dealing with J P Morgan. It was JPM that picked up Bear at a bargain-basement price. Banks should be more like New York restaurants. They come and go but the restaurant business as a whole survives and thrives and the food gets better. Banks fail but bankers still get millions in bonuses for applying their useless models. Restaurants tinker, they work by trial and error and watch real results in the real world. Taleb believes in tinkering – it was to be the title of his next book. Trial and error will save us from ourselves because they capture benign black swans. Look at the three big inventions of our time: lasers, computers and the internet. They were all produced by tinkering and none of them ended up doing what their inventors intended them to do. All were black swans. The big hope for the world is that, as we tinker, we have a capacity for choosing the best outcomes.

“We have the ability to identify our mistakes eventually better than average; that’s what saves us.” We choose the iPod over the Walkman. Medicine improved exponentially when the tinkering barber surgeons took over from the high theorists. They just went with what worked, irrespective of why it worked. Our sense of the good tinker is not infallible, but it might be just enough to turn away from the apocalypse that now threatens Extremistan.

He also wants to see diplomats dying of cirrhosis of the liver. It means they’re talking and drinking and not going to war. Parties are among the great good things in Taleb’s world.

And you and me? Well, the good investment strategy is to put 90% of your money in the safest possible government securities and the remaining 10% in a large number of high-risk ventures. This insulates you from bad black swans and exposes you to the possibility of good ones. Your smallest investment could go “convex” – explode – and make you rich. High-tech companies are the best. The downside risk is low if you get in at the start and the upside very high. Banks are the worst – all the risk is downside. Don’t be tempted to play the stock market – “If people knew the risks they’d never invest.”

There’s much more to Taleb’s view of the world than that. He is reluctant to talk about matters of human nature, ethics or any of the traditional concerns of philosophy because he says he hasn’t read enough. But, when pressed, he comes alive.

“You have to worry about things you can do something about. I worry about people not being there and I want to make them aware.” We should be mistrustful of knowledge. It is bad for us. Give a bookie 10 pieces of information about a race and he’ll pick his horses. Give him 50 and his picks will be no better, but he will, fatally, be more confident.

We should be ecologically conservative – global warming may or may not be happening but why pollute the planet? – and probablistically conservative. The latter, however, has its limits. Nobody, not even Taleb, can live the sceptical life all the time – “It’s an art, it’s hard work.” So he doesn’t worry about crossing the road and doesn’t lock his front door – “I can’t start getting paranoid about that stuff.” His wife locks it, however.

He believes in aristocratic – though not, he insists, elitist – values: elegance of manner and mind, grace under pressure, which is why you must shave before being executed. He believes in the Mediterranean way of talking and listening. One piece of advice he gives everybody is: go to lots of parties and listen, you might learn something by exposing yourself to black swans.

I ask him what he thinks are the primary human virtues, and eventually he comes up with magnanimity – punish your enemies but don’t bear grudges; compassion – fairness always trumps efficiency; courage – very few people have this; and tenacity – tinker until it works for you.

“Let’s be human the way we are human. Homo sum – I am a man. Don’t accept any Olympian view of man and you will do better in society.”…

Taleb’s top life tips

1 Scepticism is effortful and costly. It is better to be sceptical about matters of large consequences, and be imperfect, foolish and human in the small and the aesthetic.

2 Go to parties. You can’t even start to know what you may find on the envelope of serendipity. If you suffer from agoraphobia, send colleagues.

3 It’s not a good idea to take a forecast from someone wearing a tie. If possible, tease people who take themselves and their knowledge too seriously.

4 Wear your best for your execution and stand dignified. Your last recourse against randomness is how you act — if you can’t control outcomes, you can control the elegance of your behaviour. You will always have the last word.

5 Don’t disturb complicated systems that have been around for a very long time. We don’t understand their logic. Don’t pollute the planet. Leave it the way we found it, regardless of scientific ‘evidence’.

6 Learn to fail with pride — and do so fast and cleanly. Maximise trial and error — by mastering the error part.

7 Avoid losers. If you hear someone use the words ‘impossible’, ‘never’, ‘too difficult’ too often, drop him or her from your social network. Never take ‘no’ for an answer (conversely, take most ‘yeses’ as ‘most probably’).

8 Don’t read newspapers for the news (just for the gossip and, of course, profiles of authors). The best filter to know if the news matters is if you hear it in cafes, restaurants… or (again) parties.

9 Hard work will get you a professorship or a BMW. You need both work and luck for a Booker, a Nobel or a private jet.

10 Answer e-mails from junior people before more senior ones. Junior people have further to go and tend to remember who slighted them.

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24 comments

  1. donna

    He might want to eat those carbs in his salads — they’re pretty tasty.

    I think if I had that much money I would be having a lot more fun than he is. Heck, I probably already am. ;^)

    What is the fixation with being executed, anyway? Weird.

  2. Richard Kline

    “Tinker, Tailor, Solder, Pry.” I’ll take a consultant’s fee on that, Nassim: you set it, just so long as it’s not a signed text.

  3. foesskewered

    Fascinating, wish all interviews were that entertaining! But there might just be a certain flaw here; tenacity tends to come from a certain level of self-confidence, confidence however tends to preclude that self doubt that questions and is uncertain.

    That comes from a self-doubter – believe me, it aint easy to live as a sceptic and self-doubter. Come to think of it, seem to be surrounded by very confident people, wonder if that article even made a dent on them?

  4. Anonymous

    The findings in the link below entitled “Debunking Skill-Biased Technical Change” — when juxtaposed to reading the Taleb post are priceless.

  5. Riggsveda

    It casts a sad light on the state of thought in the world when a solidly common-sense person with a healthy inward-directedness becomes a guru for saying things that are within the grasp of every ordinary person.

    I blame our long love affair with authoritarianism. And lousy education.

  6. James

    Great Article. I think he is spot on about Bernake and the fed. The unintended consequences are certainly showing up. Anyone with a third grade education will notice that the CRB exploded in sept of last year when the last rate cutting cycle began.

  7. Anonymous

    While watching the NASA channel this morning, I couldn’t help thinking that the engineers and scientists running mission control should be in charge of our planet’s major decisions, rather than bankers and their paid-for politicians. Even though their track record is imperfect (Columbia,Challenger), in terms of vehicle miles traveled it rivals US auto fatality statistics. That is awesome. We’ve put our faith in a bunch of clowns.

  8. Jas Jain

    –“Needless to say, I am particularly taken by his dim view of academic economics as practiced in the US, which tends to place a premium on abstraction and models.”

    The academic economists, including most Nobel Laureates, are intellectual whores and serve the interests of the Crooks. The real problem in America is one of clouded morality imbedded in legalism, a morally bankrupt social philosophy (anything can be made legal; not much has changed since the days of Henry VIII).

    Jas

  9. Tom Lindmark

    Thanks for the article. It was well done.
    I enjoy Taleb but think that one can err just as easily by putting too much faith in him as by putting too much faith in the mainstream financial community. The truth is usually somewhere in the middle and not all that easy to discover.

  10. Anonymous

    “The world banking system still teeters on the edge of meltdown. Taleb had been vindicated. “It was my greatest vindication. But to me that wasn’t a black swan; it was a white swan. I knew it would happen and I said so.”

    Amen to that. The same with the “free trade” policy. Duh !

  11. Anonymous

    So the world might work better if we have Fat Tony’s rather than Dr. Johns? Really? That is a very simplistic viewpoint.

    I agree that Bankers and academic economists don’t pay much attention to black swans. But on the other hand, how many Fat Tony’s and Joe six packs pay attention to black swans? Honestly, when Fat Tony moved into his McMansion 30 miles from work and parked his two SUVs in his three car garage, was he really hedging against the black swan of $4 gas?

    Taleb reduces the world into a black and white box. It is human nature to ignore black swans. Ask Fat Tony to run our banking system and I guarantee you that history would still repeat itself.

  12. andrew

    It’s funny, he gained his fame (notoriety?) by simply reacting to his bullsh-t-laden environment (Wall Street). He sounds more like a guy who is throwing his hands up and saying, “Enough!” than somebody putting forth a specific agenda. The Black Swan and Fooled by Randomness are merely his efforts to fill the void he created when he said, “None of these Wall Street guys know what they’re talking about, and there’s a whole lot of nonsense inherent in modeling, forecasting, etc.” I don’t think he likes going any further than that, but his critics force him to assert a philosophy whose veracity, in my humble opinion, is subject to debate. To summarize, I value what he negates about Wall Street, but am skeptical about his subsequent philosophical contributions (skepticism merely implying that I don’t immediately nod my head and say, “yup,” not that I don’t think many of his assertions are brilliant…but I’ll answer emails in my own fashion, thank you very much).

  13. Anonymous

    James….
    My point is even if people know about black swans, they would still follow the herd. Only exceptional contrarians plan for black swans.

    In fact forget black swans…..even when events are relatively common but have low probability, people choose to ignore them in favor of the herd. That is why they live on the San Andreas fault in San Francisco and why homes are built on flood plains. A Ph.D. in Economics or an MBA doesn’t take away the tendency to follow the herd….you just follow a different herd.

  14. S

    he seems to be advocating cafes, so lets asume that is a wink to the vitual cafe of blogging. it counts

  15. Anonymous

    Heard or not, most of the people live where the jobs are. Those, who are wealthy enough, don’t care about the floods, earthquakes and other disasters they can buy insurance against.

  16. A.

    A a dose of anti-Taleb is in order here for some balance. See this essay by Eric Falken. http://www.efalken.com/papers/Taleb2.html

    One has to ask why is Taleb writing books and giving lectures instead of trading? Could it be that he’s not very good at it, and yet lectures others? In a prior interview he refused to answer whether he lost money in the recent credit and banking crisis saying he doesn’t mix the personal and professional. Lame excuse.

    While I agree with him about academic economists and bankers, I don’t see much in the way of profound thinkings in his books. I am at a loss at to why anyone would pay him gobs of money for a lecture. But they pay Clinton $100k a lecture, and by that standard he’s a bargain.

  17. Anonymous

    Taleb provides the losers with their alibis and being a loser myself I was more than happy to take his advice and stay out of the market in fear of the black swans or their siblings. True I didn’t make anything but given that with my small means it was more likely that I would have only three or four bites of the apple it pleased me that I had some middlebrow cover for staying out.

    Ivan

  18. ceremona

    I’m puzzled by how the crash of the stock market in 1987 would affect the value of the eurodollar and thus make Taleb Millions. Could someone explain that? Eurodollars are just a reflection of the 3 month LIBOR.

  19. Anonymous

    I gave up on Taleb’s book before page 100. He struck me as an extremely academic dolt consumed with self-amazement. I wasn’t impressed in the slightest.

  20. Anonymous

    Eurodollars rallied big on the crash as everyone knew the Fed would (drum roll please…) slash interest rates and flood liquidity.

    Futures up = yields down. He was long OTM calls, which is akin to being long index puts.

  21. ceremona

    Thanks for that post “anonymous”. I guess I need a history lesson on the crash of 1987 a bit. I was only 17 and not really paying attention to the fundamentals of what was happening at the time. It’s not clear to me what the time range was for the interest rate cuts or why slashing interest rates was the “fix” at the time. It’s clear to me why the Fed thinks that this is the solution during the current downturn though. If the current dynamic is the same as in 1987, then I guess I understand it…sort of.

  22. marine

    donna,if your’re caught in a situation that you can’t control the outcome,like dying, accept it graciously and do it with style.nobody likes a whiner or a cry baby.accept the inevitable.

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