The Voice of the Outsider
Russ Roberts interviews Nassim Taleb in a fast-paced discussion. They kick around a number of interesting ideas. One of them is that leverage is linked to overconfidence. When you believe you can predict the future, you borrow a lot. When you doubt the future, you do not.
Taleb is also a fan of small firms. He sees large firms as inherently fragile. He may be right from a social point of view. As an individual, if you want a stable job or a stable supplier, you may actually find that it is riskier to depend on a small firm. In any event, I agree with him that we should let the market decide.
Once again, let me rant that the Insider view of finance is that our biggest financial firms did socially destructive things and took in profits that were not merited–but it is really, really important that they keep doing what they have been doing with as much continuity as possible! Taleb takes the classic Outsider view, which is that they are fragile and we are better off without them.
There are many more ideas, and you can see where Taleb is willing to offend people and risk seeming silly to people. Near the end, you can hear him stating a preference for what I would call Outsider status.
May 3 2010 at 9:53pm
Have you listened to Dr. Taleb’s first interview in 2007 with Dr. Roberts? Made me a fan of EconTalk for ever.
May 4 2010 at 12:40am
Without a doubt, Taleb is one of my favorite guests.
I think Taleb make an excellent point, that big firms are inherently fragile because of how they concentrate capital. If p=10% that all firms will go bankrupt, does it make sense to have 10 big firms or 1000 small ones? The only insurance against that is by having a free flow of capital that can flow out, when the firm starts to show signs of weakness. In today’s Corporate Socialism market, that we have in the US. There is no need for capital to flow out of a firm, because now there is an explicit expectation of bailout. But what happens when the Government can’t bailout anymore?
What happens if the Government can’t give $60 billion to Goldman? It sounds preposterous, but I think it’s a possibility down the line. In that case, those big firm will destroy a significant amount of wealth.
Either way, Taleb has transformed my views on risk and biases. I have recommended his books to everyone I can.
May 4 2010 at 11:02am
“One [idea] is that leverage is linked to overconfidence. When you believe you can predict the future, you borrow a lot. When you doubt the future, you do not.”
This idea is plain silly. If borrowers are overconfident, lenders must be underconfident, and for every borrower there is a lender.
But, obviously, there are many reasons for borrowing besides overconfidence. A little critical thinking, please!
May 4 2010 at 11:17am
If people generally become more optimistic (“confident”) about the future, the interest rate will rise; but there won’t necessarily be any particular effect on the *quantity* of borrowing/lending.
May 5 2010 at 7:33am
I’m not sure that you are correct to think that over-optimism about the future will not lead to more borrowing/lending.
If a government creates the illusion of guarantees (more certainty about life than there really is), then 1) borrowers are more keen on borrowing and 2) lenders are more readily prepared to grant loans – since the risk of running into trouble has become smaller.
If the error term (uncertainty) is smaller (consequence of government causing low risk illusions) then it seems to be a reason for a combination of borrowing/lending amount changes and not only interest rate changes.
1) I have $10 of gold. In a more risky environment, I consider $5 a safe backup and lend out the other $5 at interest rate X-high.
2) I have $10 of gold. In a less risky environment, I’d keep $2 as a safe backup and lend out $8 at interest rate x-low.
My willingness to lend was distorted because I thought that uncertainty was lower. I see no reason why the only change might be expected in interest rates. It is rather to be expected that both interest rate and amount lent/borrowed change.
Maybe you can explain a bit more what you mean by “If borrowers are overconfident, lenders must be underconfident, and for every borrower there is a lender.”
May 6 2010 at 1:01pm
I wasn’t thinking about government guarantees; that’s a special circumstance, whereas Taleb’s claim about “overconfidence” was stated with complete generality. But suppose the government issues guarantees. How does that affect the attitude of the *taxpayers* who expect to have to pay these guarantees? Don’t *they* become *less* confident about the future? You suggest there might be an “illusion”: everyone expects that the government guarantees are free; but the suggestion is unmotivated. Insurance, governmental as well as private, redistributes risk, but does not eliminate it; the market understands this, even if a few foolish individuals do not.
Your example assumes my choice for my savings is between hoarding money and lending it. But I have another possibility: equity investing. Won’t I be more willing to engage in this, as opposed to lending, if I am more confident about the future?
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