By Arnold Kling
Mark Thoma points to an op-ed by Nassim Taleb. He and I are on the same page in many ways. However, I wish that Taleb would dial back on the colorful rhetoric in order to focus on substance. More detailed comments follow.
Nothing should ever become too big to fail.
I share this wish. However, putting it into practice poses some problems. Does that statement apply only to banks? Does it apply to insurance companies? Auto companies? Google?
The problem with just focusing on keeping banks small is that other institutions could become large and risky in response.
Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing.
Again, suppose we have a large firm like Aetna or GE or Google that arguably has some connection to the financial sector. Do we need to either nationalize it or break it up?
Conceptually, I like the idea of creating two sectors, one government insured and highly regulated and the other clearly bearing risk privately. I don’t know that the low-risk sector has to be nationalized. But it should be very unattractive to aggressive, go-go managers. The challenge is how you keep the uninsured, less-regulated sector from blowing up in a way that causes widespread problems.
Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.
I agree with this. In my chess game essay, I argue for changes in taxes and subsidies in order to shift toward less debt and more equity in home purchase and in corporate finance.
Complex derivatives need to be banned because nobody understands them and few are rational enough to know it.
This is a striking proposal. The question is one of implementation. How do we know when a financial instrument is too complex to be used safely? My own opinion is that instruments that create deep out-of-the-money options are the ones that promote self-deception. However, I am not sure that banning such instruments will solve the problem. You can always attempt to replicate an option through use of a dynamic trading strategy (think of so-called portfolio insurance, which was implicated in the 1987 stock market crash). So I am not sure you can prevent people from creating out-of-the-money options.
Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.
To put it another way, we should be suspicious when government officials diagnose the problem as one of a lack of confidence. For example, I am very suspicious of the view that asset values are low because of lack of confidence. I think that a lot of the toxic assets are options that have genuinely lost value.
We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).
This is too radical a position to toss off in just a paragraph. What I see Taleb saying here is that the tradition of channeling household savings into the stock market is wrong. Instead, more of the risk and return of businesses should be borne by direct owners and managers. Households should invest in low-risk assets.
This raises many questions. Will firms be able to achieve large scale without capital from households? Where would we find the low-risk investment projects to provide households with appropriate savings outlets? Why is it that we have the current financial structure–is broad-based stock ownership more of a political advantage than an economic advantage? That is, does Bill Gates want broad public ownership in order to give more people a stake in Microsoft and thereby reduce the political vulnerability of the company?
Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.
Here is where Taleb’s emotion gets ahead of his reason, in my view. I understand his frustration with the academic establishment. If you disagree with the mainstream, then you have almost no hope that people are going to rapidly come around to your point of view. But I think you’ll change minds faster with substantive arguments than with ad hominem attacks.