July 23, 2010

Nassim Taleb's "Epistemocracy" and His 10 Principles for a Black Swan-robust Society

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The author of "The Black Swan" proposes some fundamentals so simple that even a Neanderthal can implement them. Hence chances for implementation approach absolute zero until the coming catastrophe subsumes trillions of dollars and billions of people and members of our "expert elite ruling class" are demoted to pinatas and lampost decorations.

My dream is to have a true "epistemocracy"; that is, a society robust against expert errors, forecasting errors and hubris, one that can be resistant to the incompetence of politicians, regulators, economists, central bankers, bank ers, policy wonks and epidemiologists.Here are ten principles for a Black Swan-robust society.

What is fragile should break early while it's still small: Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks become the biggest.

No socialisation of losses and privatisation of gains: Whatever may need to be bailed out should be nationalised; whatever does not need a bailout should be free, small and risk-bearing. We got ourselves into the worst of capitalism and socialism. In France, in the 1980s, the Socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

People who drove a school bus blindfolded (and crashed it) should never be given a new bus: The economics establishment lost its legitimacy with the failure of the system in 2008. Find the smart people whose hands are clean to get us out of this mess.

Don't let someone making an "incentive" bonus manage a nuclear plant - or your financial risks: Odds are he would cut every corner on safety to show "profits" from these savings while claiming to be "conservative". Bonuses don't accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives.

Compensate complexity with simplicity: Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. Complex systems survive thanks to slack and redundancy, not debt and optimisation.

Do not give children sticks of dynamite, even if they come with a warning label: Complex financial products need to be banned because nobody understands them, and few are rational enough to know it. We need to protect citizens from themselves, from bankers selling them "hedging" products, and from gullible regulators who listen to economic theorists.

Only Ponzi schemes should depend on confidence: Governments should never need to "restore confidence". Cascading rumours are a product of complex systems. Governments cannot stop the rumours. We just need to be able to shrug off rumours, to be robust to them. Do not give an addict more drugs if he has withdrawal pains: Using leverage to cure the problems of too much leverage is not homoeopathy, it's denial. The debt crisis is not a temporary problem, it's a structural one. We need rehab.

Citizens should not depend on financial assets as a repository of value and rely on fallible "expert" advice for their retirement: Economic life should be definancialised. We should learn not to use markets as warehouses of value.

Make an omelette with the broken eggs: The crisis of 2008 was not a problem to fix with makeshift repairs. We will have to remake the system before it does so itself. Let us move voluntarily into a robust economy by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, 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. Then we will see an economic life closer to our biological environment: smaller firms and no leverage - a world in which entrepreneurs, not bankers, take the risks, and in which companies are born and die every day without making the news. -- Excerpted from the author's New Statesman article, Beware those Black Swans.

Posted by Vanderleun at July 23, 2010 12:25 PM
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"It is impossible to speak in such a way that you cannot be misunderstood." -- Karl Popper N.B.: Comments are moderated and may not appear immediately. Comments that exceed the obscenity or stupidity limits will be either edited or expunged.

How 'bout this for starters: Don't elect as your President an Indonesian-Kenyan Socialst bent on turning you country into a third-world slum.

Posted by: Blastineau at July 23, 2010 1:15 PM

Regarding the problems with the banking system, the solution could be made a lot simpler.

Nationalise the entire banking and financial system; fire everyone above counter-assistant grade without compensation, and make it an offence punishable by a long stretch in jail for any of them to handle anyone else's money ever again. Once done, put the system back into private ownership, with no one unit any bigger than 1% of the total. Permanently; amalgamation of financial companies of any sort into units bigger than this to be illegal.

And ban completely the practise of short selling, and the sale of financial derivatives of any sort whatsoever.

That might just keep the crooks currently running the financial system under control. Might.

Posted by: Fletcher Christian at July 23, 2010 2:51 PM

Walt's Simple Rules for Investing that have served me very well over the years, and are applicable to any manner of investment:
--Never put your money into something you don't understand.
--Know how the revenues and profits are generated.
--Cast a skeptical eye at "leverage", i.e., debt (although shell games like Enron and CDOs make this difficult). Debt increases your potential gain, but also your downside risk.
--Don't throw good money after bad. Be willing to cut your losses and walk away.
--Beware of geeks bearing equations.
--Run like hell away from hype.
--Read the fine print.

Posted by: waltj at July 23, 2010 6:18 PM

Note this gem from the mastermind:

"Citizens should not depend on financial assets as a repository of value and rely on fallible "expert" advice for their retirement: Economic life should be definancialised. We should learn not to use markets as warehouses of value."

I've studied this for three weeks, barely stopping for sleep, and can only conclude the mastermind is firing off rhetorical artillery in the hope of completing his bamboozlement. Bunk for the boobs who read the NEW STATESMAN, Britain's equivalent to the NATION watered down generously with SALON.

Still, it's easy to see how such gibberish gains traction. Mr. Christian has been listening to Michelle Obama again with his idiotic,

"And ban completely the practise of short selling, and the sale of financial derivatives of any sort whatsoever."

This article "A Trillion Unintended Consequences" from the 6 July WALL STREET JOURNAL will show the imbecility of banning all derivatives. Such a notion is worthy of the Congressionals who sponsored the Toyota "runaway mad car" hearings.

Posted by: Gregory Koster at July 24, 2010 3:15 AM

Black Swan is so contradictory as to be incontinent. His vision is only another version of the attitudes that got us here. A little Hayek would go a long way, if he will go to the bother.

Posted by: james wilson at July 26, 2010 9:02 AM

This post and the mutineer's comment are mostly putzy advice from people who don't actually do business or finance.

Here's the golden rule, the only rule, all else is dross and useless: "There shall be no fraud."

The only role of the government is to enforce that. Being what they are, they'll mostly screw it up, but if we can keep them out of anything else, all will be well, even with multiple loused up prosecutions.

Didn't 70 years of Bolshevism tell the lunatics that 5 year plans, state supervision, civil servant involvement of almost any sort, micromanagement etc. etc do not work?

Posted by: Fred Z at July 26, 2010 1:23 PM

Fred Z, that depends on the definition of fraud, doesn't it? The problem is that fraud is a moving target. Include an activity under the umbrella of "fraud" and the financial community will promptly find an even more complex and difficult to understand way of cheating others out of their money. One that once explained, most reasonable people would agree is cheating - but isn't defined as fraud yet.

Taking the example of short selling, it basically consists of selling something you don't own in the hope of being able to buy it back cheaper later. In any other sphere of activity, one goes to jail for that.

Or one might throw in the example of critical illness insurance. There are a huge number of recorded instances of people not getting paid out on such insurance, because of not disclosing some medical information that is in fact completely irrelevant to their claim - as agreed by medical experts.

The real problem with the financial "industry" is the prevailing attitude; the fact that it is essentially run by that unrespected firm Wendowey, Cheatham and Howe.

And by the way, I do in fact do business. I am a small business owner - unfortunately.

Posted by: Fletcher Christian at July 28, 2010 12:17 AM

Note this gem from the mastermind:

"Citizens should not depend on financial assets as a repository of value and rely on fallible "expert" advice for their retirement: Economic life should be definancialised. We should learn not to use markets as warehouses of value."

I've studied this for three weeks, barely stopping for sleep, and can only conclude the mastermind is firing off rhetorical artillery in the hope of completing his bamboozlement.GK@7/24

O.K. then, I will make it simple for you. Don't expect your financial investments (home, stocks, bonds, etc.) to carry you through. You must rely on your own labor productivity if you expect to prosper. This is a good piece of advice.

Admittedly, the other nine precepts are of questionable value because government intervention in the economic sphere is admissible only when the enforcement of contracts is a consideration.

Posted by: MALTHUS at July 28, 2010 8:17 AM
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