Mr. Taleb Goes to Washington

“A deleveraged financial system is a stable one, especially if we increase the redundancy within the system. That’s an idea Taleb has taken from biology. But in finance, redundancy means two things: not having players in the game who are “too big to fail” and not allowing anyone—from the individual to the institution—to play with too much money. Redundancy means have cash on the side, not risking it all, and not becoming dependent upon financial assets for your economic well-being.”…goes-washington

Marion Maneker of The Big Money (part of Slate) has a nice article on Nassim Nicholas Taleb that discusses Taleb’s recent attendance at the Wall Street Journal’s “Future of Finance” conference in Washington D.C. The article describes righteous indignation at the ongoing and deepening financial calamity and what he suggests might be a more robust financial system. It’s a good read it is entirety, though below I’m saving down the major takeaways.

Taleb recently expounded upon the charlatan theme (and their positive advice) on his personal “blog.” Also, note Taleb’s closing words and see if you aren’t reminded of Jon Stewart’s big point in his recent interview with Jim Cramer.

… Taleb’s anger at the economic establishment [3] that drove us over this cliff—and populates the Journal’s conference—makes him a representative figure of ordinary people. Like most Americans, Taleb is seething with rage about the financial establishment’s role in bringing the about credit crash. “Nobody saw the crisis coming,” he says. “Bernanke, all these guys, I want them out. They proved incompetent, they crashed the plane.”

Unlike us … Taleb is comfortable with the theory and practice that undergirds the whole system of options, derivatives, and risk management that has spun so recklessly out of control. That talent mixed with his righteous anger makes him a rare bird: an Everyman who can do the equations. …

In normal times, the conferencariat are an arrogant bunch. This is something [Alan Murray of the WSJ] knows well from his travels on the conference circuit, which begins each year with the World Economic Forum in Davos. “Davos is usually filled with people who have all the answers,” Murray says. “What was so striking about Davos this year was all these people, for once, didn’t have all the answers. No one could tell you with certainty what was happening or what needed to be done.”

No one but Nassim Taleb. Before Davos, Murray read The Black Swan. At the conference, the newspaperman and the trader had many conversations over the course of four days. Murray came to the conclusion that Taleb was the iconic figure of Davos in 2009. “In my mind, he had the perfect message for the moment.” …

[As for the Future of Finance conference, Taleb] left after dinner the first night. While the 130-person conference debated the government’s new regulations that George Soros described as merely “tinkering” with the system, Taleb has a clear-eyed plan.

First, he says, we have to unmask the charlatans of risk like Myron Scholes. To Taleb, Scholes is the Great Oz in this Emerald City because his work on options and derivatives allowed the whole of the financial system to adopt poorly understood products-like the ones that brought AIG down-that hide risk. To Taleb, Scholes’ academic work, which enabled the widespread use of complex derivatives, was like “giving children dynamite.”

“This guy should be in a retirement home doing Sudoku,” Taleb says. “His funds have blown up twice [6]. He shouldn’t be allowed in Washington to lecture anyone on risk.”

With complex derivatives unmasked and, in Taleb’s vision of the future, outlawed, the next step is to create a more robust version of capitalism. Taleb calls it Capitalism 2.0. Robustness begins with a dismantling of debt. Leverage was the gas that inflated the financial system until it was too big, too fragile, and too volatile.

Over the past 20 years, the financial system has grown ever more complex. Building on a greater computing capacity and communication speed—”Bank runs now take place at the speed of BlackBerry”—Taleb recognizes that the financial system now possesses an efficiency that creates volatility. That cannot and will not go away.

We cannot have both debt leverage and a hyper-efficient system—the volatility is just too great. What Taleb explains—which no one else does—is that efficiency is already a form of leverage. A highly efficient system removes slack and magnifies small changes. Think of the efficient system as a high-performance aircraft. Each minute of steering input creates a rapid and violent shift of course, speed, or altitude. The system itself is souped up even before you add the debt. Once you do, the pilot is equally jacked up and twitchy, creating an explosive combination. Now imagine that fighter jet trying to fly in a 1,000-plane formation, and you get an idea of the world financial system in the 21st century.

We can’t erase the technology that created the planes, so we’ll have to make sure we fly sober, maybe even with an onboard computer that dampens the controls. That means getting rid of the debt. It’s that simple.

A deleveraged financial system is a stable one, especially if we increase the redundancy within the system. That’s an idea Taleb has taken from biology. But in finance, redundancy means two things: not having players in the game who are “too big to fail” and not allowing anyone—from the individual to the institution—to play with too much money. Redundancy means have cash on the side, not risking it all, and not becoming dependent upon financial assets for your economic well-being.

Nassim Nicholas Taleb: “Bankers Designed Banks to Blow Up”…mMd4PSxEKeE.asf

Just watched a fifteen minute interview by Bloomberg of Nassim Nicholas Taleb (The Black Swan). In the interview Taleb discusses the current crisis, robust systems, nationalizing the banks and the fallacy of using narratives of history to guide present-day policy/response.

Below are some quotes from NNT, which I’ve organized into like-nuggets of wisdom:

  • Looking at biology, things that survive have redundancy . . . we have spare parts, which is the exact opposite of leverage. . . . We have diversity and nothing is too big. Things fail early. . . . Banking is organized in a completely opposite way. . . . Complex systems have properties that banks don’t have. And biological systems have survived.
  • [We have an] Illusion of stability and then blow-ups are larger. Imagine if half-country was fed by one restaurant it’d be okay except one day people would starve.
  • Bad news travels immediately . . . This environment won’t tolerate the smallest mistake . . . I don’t know the system can allow for too much leverage.
  • People can invest in real things – they don’t have to invest in paper. . . .
  • What we have is a system of deposit where people buy a company, they borrow against it, and buy another company. . . . If that disappears we have less growth but it would be a more robust economic system.
  • The government is neither nationalizing the banks nor letting them break.
  • [With regard to banking,] separate the payment system from the risk taking system.
  • It looks like we have no control. The government has no control over what the banks are doing. The banks aren’t in control of what they are doing.
  • The press reports everything except the important stuff. September 18th . . . we had the run on money market funds and the government had to step in.
  • The situation is not comparable to the Great Depression. The situation is very different.
  • This crisis is not so much a Black Swan to me. It’s like saying you’ve got a pilot who doesn’t know about storms. . . . The Black Swan for me would be to emerge out unscathed and go back to normalcy.
  • We should be very careful when we make a historical analogy like the Great Depression because the world is not like it was in the Great Depression.
  • Capitalism is you let what’s breakable break fast.

Bloomberg also ran an article on the interview with Taleb, but it is spartan as far as quotes or insights from the actual interview.

From what I can tell, it seems Taleb views bank nationalization as similar to taking out plane hijackers. It’s an interesting, more palatable way to look at nationalization in that it frames the situation as one where the public will be harmed unless someone (in this case the government) steps in and takes drastic action.

Having said that, I don’t get the impression that Taleb is a proponent of long-term nationalization. NNT would prefer banking be structured similarly to a biological system where there are redundancies and fragile things “break early.” This system wouldn’t foster as much leverage and therefore would slow growth, but it would be considerably more robust.

This is more or less what I believe, as well. A free market is an organic, naturally forming system that is decentralized and redundant. It’s robust because market actions failing apart at any micro level will not break the entire system.

How do we get there from here? Good question.

(H/T to Jesse)

Paul Volcker: “Not an Ordinary Recession”

Paul Volcker recently gave a speech that has gotten a lot of replay action on the blogosphere. I believe most are saying that Volcker is calling for a return to “narrow banking” (see Jesse).

A lot of people listen to Volcker as he led the charge at the Fed over taming inflation back in the late 70s and early 80s. I wonder more if he wasn’t just at the right place at the right time, doing what had to be done — raising rates. I’m convinced that most people give entirely too much credit both on blame and accolades. Don’t get me wrong, the Fed has enormous power, but my estimation is that they are almost always messing things up. The Fed is reactionary always and almost always reacts too far.

Therein lies the problem. The Fed fails at regulating. Hardly surprising, really. Is it not a joke to pay lip service to free markets, which are incredibly dynamic decentralized systems, and then use a central body to regulate the blood of the system, money? It’s a sad joke.

I could go on, but I’ll hold off. There are two pieces of Volcker’s recent speech I want to quote and comment on briefly. First:

One of the saddest days of my life was when my grandson – and he’s a particularly brilliant grandson – went to college. He was good at mathematics. And after he had been at college for a year or two I asked him what he wanted to do when he grew up. He said, “I want to be a financial engineer.” My heart sank. Why was he going to waste his life on this profession?

A year or so ago, my daughter had seen something in the paper, some disparaging remarks I had made about financial engineering. She sent it to my grandson, who normally didn’t communicate with me very much. He sent me an email, “Grandpa, don’t blame it on us! We were just following the orders we were getting from our bosses.” The only thing I could do was send him back an email, “I will not accept the Nuremberg excuse.”

There was so much opaqueness, so many complications and misunderstandings involved in very complex financial engineering by people who, in my opinion, did not know financial markets. They knew mathematics. They thought financial markets obeyed mathematical laws. They have found out differently now. You know, they all said these events only happen once every hundred years. But we have “once every hundred years” events happening every year or two, which tells me something is the matter with the analysis.

So I think we have a problem which is not an ordinary business cycle problem. It is much more difficult to get out of and it has shaken the foundations of our financial institutions. The system is broken.

The system is broken. The system was too opaque. Finance is incredibly complex. It is here where I actually started wondering if Volcker “gets it” as far as understanding that our system is far from robust as centrally controlled and designed. As it is, Nassim Taleb is the only person I’ve seen who seems to glimpse the complexity of the financial system. However, I’ve seen even Taleb defer in theory to people “who saw this coming,” like Nouriel Roubini, for potential ways to “fix” the system.

Volcker’s comment about his grandson also hits home with me as I went into finance/accounting. When everyone you know is running into a field, that may be cause to rethink your choice of education (Everyone I knew in college was getting into Real Estate — this was back in 2001). Then again, I still wish I had gone and pursued computer science, but the dotcom crash (2000) scared me away.

More from Volcker:

What do I mean by different? I think a primary characteristic of the system ought to be a strong, traditional, commercial banking-type system. Probably we ought to have some very large institutions – or at least that’s the way the market is going – whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the credit and financial system. …

What has happened recently just underscores that. And I think we’re at the point where we can no longer fool ourselves by saying that is not the case. The government will support these institutions, which in turn implies a closer supervision and regulation of those institutions, a more effective regulation than we’ve had, at least in the United States, in the recent past. And that may involve a lot of different agencies and so forth. I won’t get into that.

So just as soon as I thought maybe Volcker “gets it,” he goes and says we should have a strong core (read: centralized) system of banking that is heavily regulated. He wants this core to be firewalled from entrepreneurial finance to eliminate conflicts of interest.

I’ll be brief. Regulation has failed. The Federal Reserve is a monstrous regulatory body that has repeatedly exemplified failure, and I’ve already mentioned its innate centralization. The SEC? Failure at every turn. More regulation? More centralization? How many examples do we need whereby larger organizations display a need for more regulation, and when more regulation is presented, said regulatory agency is either captured by the body it intends to regulate or is inept?

What we need are decentralized banking systems that are free enough and unencumbered enough to fix themselves or self-destruct without taking down the entire network.

The great centralization experiment has failed. Let’s move on (and follow the example of the internet, which exemplifies the power of decentralization).

Enough for now.

Update 2/24/09: Saw a youtube clip of Volcker’s speech. Wanted to get this quote down:

The description of a fat tail reflects a kind of analysis that isn’t appropriate. They think that financial markets follow normal distributions. pattern like the law of physics. The one remark I’ll leave with you: if you think the financial world follows a normal distribution pattern like the laws of physics. If you think that you’re a financial engineer but you’re not a very good financial analyst.

So he recognizes how inherently unpredictable financial markets are but then goes on to suggest that the Federal Reserve can fix imbalances that present themselves.

Cognitive dissonance.



Control Theory by William Glasser

Control Theory by William Glasser

William Glasser’s 1985 book Control Theory is subtitled “A New Explanation of How We Control Our Lives.” This review covers many components of the book, which makes it fairly long. In short, Control Theory is an excellent read that I heartily recommend.

Control Theory details a framework for understanding how humans choose behaviors to assert control over the world. These behaviors include depressing, angering, phobicking, etc. Glasser reframes all feelings as behaviors that you choose. As such, individuals go from being something to doing something.

This is expressed right out the gate in the Author’s Note:

Much of this book is concerned with the behaviors we choose as we attempt to control our lives. As I will explain in great detail, all behavior is made up of three* components: what we do, what we think, and what we feel. Doing and thinking are always expressed as verbs, like running or meditating, but feelings are usually expressed as adjectives, like depressed, or nouns, like depression. . . .

To say the man is depressed would be to infer that the depression happened to him. What I will explain in this book is that it is a behavior he is choosing in order to deal with the difficulty of losing his job. To describe accurately what this man is feeling as a behavior and also be grammatically correct, I would have to say that he is depressing or choosing to depress.

When feelings turn into things we do — Though you might be inclined to write-off talking about feelings like “anxiety” as “anxieting,” having read Glasser’s work and reflected on my own behaviors I think he is really on to something. The telltale sign of a good idea is it’s usefulness, and it has become incredibly useful to view my own behaviors and those of friends and family from the perspective of control theory.

For example, when a friend starts depressing about their job, he is actually trying to control a situation where he has lost control. Through depressing he can exact behavioral change — i.e. people react to his depressing by trying to cheer him up. Of in the case of someone who could effect change in the friend’s job, reorganize the workflow. Via depressing the friend can take back some control.

Awareness of how we work to exert control is paramount. Being aware of how I can use painful emotional behaviors (like depressing) to re-exert control makes me more aware that I could choose other, more productive behaviors. Rather than depressing to control, I can go play a sport, read a book, or do some chores. I may not want to do something more productive — sometimes its very clear to me that I just want to depress/anger/whatever — but since it is very difficult to change my feelings or think my way out of an out-of-control situation, at least by doing something productive I can improve my situation.

Control theory does not mean that all misery is chosen. In the short term, our reaction to losing control is usually some form of painful emotion. It’s the longer-term reaction whereby we either choose to emote our way back into control, which is almost always counterproductive, emotionally painful, or a waste of energy, or we do something which may change our feelings, buy us time or improve our situation, snapping us back into control of our lives.

Pictures in our heads — Glasser explains that humans convert experience into mental “pictures” that we file away in our memory for future reference. For example, a chocolate-chip cookie satisfies a baby’s hunger for something sweet. Chapter 3, The Pictures in our Heads notes:

This means that we store in our personal picture albums the pictures of anything in the world that we believe will satisfy one or more of our basic needs. For the rest of his life, when that baby gets hungry, he will start turning the food apges of his album. Many times, when he comes to the pictures of chocolate-chip cookies, he will say to himself, “That’s what I want right now,” and he’ll try to find a chocolate-chip cookie in the real world. . . . With a little thought, it will become apparent that your personal picture album is the specific motivation for all you attempt to do with your life.

And later:

It is not easy to change our own pictures, but it is even more difficult to persuade others to change theirs. To change a picture, we have to replace it with another that, if not equally satisfying to the need in question, is at least reasonably satisfying. This can be done only through negotiation and compromise; force will not work.

We behave to satisfy the pictures in our heads. It’s a simple truth that has some profound implications, particularly with regard to relationships. In particular, Glasser discusses how relationships that succeed are those where the friends, family or lovers have enough common pictures to share. In a situation like a marriage (or with parents or children), it is paramount to the ongoing success of the relationship to share common pictures.

Sometimes one person may have a picture that is irreconcilable with the picture of their significant other. Compromise and negotiation are key in these situations. What more, the couple should work towards finding ever more pictures that both can share with each other. Success in relationships is dependent on sharing mutually satisfying pictures (This doesn’t mean all the pictures have to be the same).

The process of creative reorganization — Another great concept that Glasser describes in Control Theory is that of “creative reorganization,” which is a process by which our minds attempt find usable ideas and behaviors. In Chapter 10, Creativity and Reorganization, Glasser writes:

The behavioral system is a two-part system. One part contains our familiar organized behaviors; the other part, which is the source of our creativity, contains the building blocks of all behaviors in a constant state of reorganization. By themselves these building blocks could not be recognized as discrete actions, thoughts, or feelings; but as they reorganize, they may become recognizable and usable. . . .

As active as this process is, we may have little or no awareness that it is going on. . . .

From this bubbling, ongoing creative reorganization comes a random stream of mostly minimal but occasionally well-organized new behaviors that are available to us to try if (1) we pay attention to them and (2) we decide that those two which we pay attention may help us gain or regain control over our lives.

Glasser importantly notes that creative reorganization often produces junk ideas. It’s up to us to sort out the good ideas from the bad.

Creative reorganization hits on an idea that is so pervasive in life and success that I have to mention it here: it is that the best ideas, businesses and, well, things emerge from massively iterative processes. They survive by being most fit and useful. Look at markets, biology, ideas, blogs, products, etc. And most of the time, these things aren’t planned in advance — they emerge out of the ether — the random iterations of life. Robust, dynamic and successful systems provide for huge volumes of iterations.

Other useful clippings — While reading the book, I typed up some more insightful quotes.

From Chapter 17, Taking Control of Your Life:

In an effort to deny what they really want, people like Susan often sigh and say, “What’s the difference what I want? I’ll never get it.” But her sighs and depressing are still her way of choosing to suffer to try to get what she denies she wants. From the standpoint of the pain she chooses, it makes no difference if she is aware of what she wants or not. If we don’t have what we want, we will choose to anger or suffer just the same. Once you know control theory, you will not waste your time and energy refusing to face what you want just because it is hard to get, because you know that you will choose to suffer just the same.

Chapter 18 Control Theory and Raising Children:

Try as hard as possible to teach, show, and help your children to gain effective control of their lives.

I was remarking yesterday about extending the above quote on child-rearing to managing employees. A powerful manager empowers employees to improved responsibility and control over their job. The opposite is also true: the manager who strips control from employees will have miserable employees who essentially do very little productive work.

Conclusion — Glasser discusses control theory as it pertains to drugs and alcohol, child-rearing, health and more. This idea-packed, paradigm-shifting book weighs in at a paltry 236 pages. It is out of print, but as you can see there are some 70+ copies at Amazon. I highly recommend picking up a copy.

Glasser discusses towards the end of Control Theory a book he wrote in 1976 titled Positive Addiction. Glasser describes Positive Addiction as an activity where, while in a state of control, you achieve a period of creative reorganization. The example of positive addiction he describes is running. Running allows for a period of “in-control time” (Something we all need every day) and can take the runner into a meditative state of creativity. Because creative states have the potential to produce unpredictably good ideas via the iterative process, finding and pursuing positive addictions could be incredibly beneficial. Since I’m no runner, I’d like to discover what other activities might qualify. I might need to pick up this book, too.

Finally, hat tip to Dr. Michael Eades for alerting me to this great book.

*Glasser actually writes about a fourth component of behavior, the physiological response (i.e. the way our bodies react to a stimulus — usually a reaction we cannot control).

Below are all William Glasser books that I have read to date:

  • Control Theory — the most comprehensive and useful of Glasser’s books that I have read, this one covers the basics of control theory (also known as choice theory and reality therapy).
  • Positive Addiction — a more niche focus on acheiving meditation and creative reorganization via pursuit of positive addictions.
  • Staying Together — focuses on applying control theory, the ideas of “pictures in your head” and quality worlds, and matching up basic needs (or accounting for differences in these needs) in relationships.

Nassim Taleb and Nouriel Roubini on CNBC

Video from CNBC. Hard to glean anything particularly new from this. It is maddening to watch the CNBC pundits try and talk over Roubini and Taleb and then demand investment advice from them. What a bunch of whiny, idiotic children.