Link: http://www.ft.com/cms/s/0/5d5aa24e-23a4-11de-996a-00144feabdc0.html?nclick_check=1

Nassim Taleb’s latest from the Financial Times titled Ten principles for a Black Swan-proof world provides a brief insight into what Taleb believes caused our current financial crisis and what might prevent a similar crisis going forward.

I’ve excerpted those principles below (pushing the fair-use envelope a bit, perhaps). All italics are NNT’s.

Before delving into Taleb’s ten, I’d like to suggest that NNT’s principles can be (and should be) boiled down to more simpler structural problems/observations. Taleb’s folksy expressions make for useful analogies, but they needlessly complicate some simpler realities:

• Government-made negative externalities [1, 2, 7] — Legal constructs like corporations and limited liability companies are exploited to offload risk to the public. This subsidizes risks resulting in agents (CEOs, Managers, etc.) taking more and more chances with other people’s money. This is related to the principle-agent problem, which Taleb indicts in [4]. The Ponzi aspect of all of this is intrinsically tied to our leveraged financial system, which is inextricably tied to our centralized, fiat-"money” banking system. To me, this is the biggest point that I’ve yet to see Taleb make — centralized fiat currency is a fragile entity that is inherently leveraged (out of thin air) but can be used to build complex systems of finance. This won’t tend to break early (as we’ve seen). To kill the leverage you have to kill the source of it, which is our centralized non-robust banking system!
• The Authority Complex [3, 4, 6, 9] — we need a great deal more skepticism in our system and we should not have such centralized power. The problem here is the authority complex — the so-called experts all pontificate to the “ignorant” masses. The masses are too busy or too confused by the magical words of the experts to deduce that the experts don’t know what they are talking about. And like any good con, the con-artistsexperts are able to trick the masses into giving them all the power. I would argue that NNT’s #9, which more or less argues that we should question authority and not trust experts, completely negates NNT’s #6, which suggest that we should be protected from ourselves. Well who is going to protect us when we can’t trust the would-be protectors? That is a problem.

• Robust complex systems have simple base units that scale [5, 8, 10] — This is the biology angle that is exemplified by metabolic rate scaling over 27 orders of magnitude. A robust system requires simplicity at it’s base. Accounting is a good example of this. Accounting can get incredibly nuanced and complex but can always be brought back to debits and credits. The simplicity of this fundamental rule still enables incredibly complex book-keeping, but puts a governor on the system. You can’t make up assets without creating corresponding credits to the books.

  Compare this to our non-simple, non-robust banking system that holds as it’s core principle the notion of stability in prices and jobs while allowing for unlimited credit (money creation). Not simple.

  Simplicity lends itself to ease of understanding and puts a governor on shenanigans. It’s this fundamental simplicity that enables massive scalability and the emergence of complex systems that are robust.

I’m afraid I might have gotten overly complex in the above. I think what Taleb wants is an organic financial system, one that starts from real economic transactions between human beings and scales upwards from there. Thus, the solution is pretty simple. The base unit is the individual. Fictitious business entities that exist apart from owners are made illegal. No systemic credit structures, which fundamentally follows from the base unit being limited to the individual. This is because such a system would have decentralized banking that would evolve out of whatever needs such an organic economy would require.

This would be the (completely free) market solution, which incidentally most closely mimics biological systems. After all, where in biology do you see stuff created out of thin air (like Corporations or fiat currency)?

And life has been getting along fine for untold millions of years with a simple base units that are the molecules that make up DNA.

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. …

2. No socialisation of losses and privatisation of gains. …

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. …

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. …

5. Counter-balance complexity with simplicity. 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. …

6. Do not give children sticks of dynamite, even if they come with a warning . … Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. …

8. Do not give an addict more drugs if he has withdrawal pains. …

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. …

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. …

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

Link: http://video.google.com/videoplay?docid=7108406426776765294

Randomly came across this video of a lecture given at Google by Geoffrey West on how biological “laws” scale. For example, flow through capillaries and metabolic rate scale from small to large organisms. What is mind-boggling is how metabolic rate scales “over 27 orders of magnitude.” The video is almost an hour long and is pretty dense, but the first 20 minutes or so explain the metabolic scaling, which is incredible. The last ten minutes apply the idea to social organizations (starting around 47 minutes in). Apparently, human organizations actually scale at 1.05 (versus 3/4).

The big takeaways for me: simply, for complex systems to work, they must scale. On a more complicated level, evolution is a blind process of trial and error that nonetheless created fantastically scalable, complex, decentralized systems that aren’t given to catastrophic failures. Therefore, it’s reasonable to postulate that, as opposed to using central, pointed, monopolistic planning (Think: few iterations) to design systems that scale without catastrophic loss, perhaps we should default to decentralized, immensely iterative trial and error as our basis for system design. The former is unnatural, the latter organic. The former is monarchistic, the latter anarchistic. The latter provably works whereas the former has failed over and over and over again.

Geoffrey West’s takeaway: “One, that inevitably [for biological systems] the bigger you are, the slower the pace of life—your heart rate decreases, your life span is longer and so on. In social organizations the bigger you are, cities in particular, the faster life is.”

Final note, I’m reminded of Gilbert’s super-replicator idea in Stumbling on Happiness.

The abstract on the video:

Life is very likely the most complex phenomenon in the Universe manifesting an extraordinary diversity of form and function over an enormous range. Yet, many of its most fundamental and complex attributes scale with size in a surprisingly simple fashion. For example, metabolic rate (the power required to sustain the system) scales as approximately the 3/4-power of mass over 27 orders of magnitude from molecular levels up to the largest multicellular organisms. Similarly, time-scales, such as lifespans and growth-rates, increase with exponents which are typically simple powers of 1/4. It will be shown how these universal quarter-power scaling laws follow from fundamental generic principles embedded in the dynamics and geometry of underlying networks, leading to a general quantitative theory that captures essential features of many diverse biological systems. Examples will include animal and plant vascular systems, growth, cancer, aging and mortality, sleep, DNA nucleotide substitution rates. These ideas will be extended to discuss social organisations such as cities and firms: to what extent, if at all, can we think of these as very large organisms and therefore as an extension of biology? Analogues to metabolic rate and behavioral times in cities scale counter to their behaviour in biology. Driven by innovation and the creation of wealth this has dramatic implications for their growth, development, sustainability and pace of life which, left unchecked, potentially sow the seeds for their collapse.

Link: http://tbm.thebigmoney.com/articles/judgments/2009/03/26/mr-taleb-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.

Link: http://www.bloomberg.com/avp/avp.htm?clipSRC=mms://media2.bloomberg.com/cache/vmMd4PSxEKeE.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)

Link: http://www.nytimes.com/2009/02/15/magazine/15Battier-t.html?ref=magazine&pagewanted=all

Interesting article on Shane Battier, Houston Rockets b-ball player whose conventional stats are totally unimpressive but unconventionally, he makes all his teams much better. Interesting read from many angles.

The 3-point shot from the corner is the single most efficient shot in the N.B.A. One way the Rockets can tell if their opponents have taken to analyzing basketball in similar ways as they do is their attitude to the corner 3: the smart teams take a lot of them and seek to prevent their opponents from taking them. In basketball there is only so much you can plan, however, especially at a street-ball moment like this. As it happened, Houston’s Rafer Alston was among the most legendary street-ball players of all time — known as Skip 2 My Lou, a nickname he received after a single spectacular move at Rucker Park, in Harlem. “Shane wouldn’t last in street ball because in street ball no one wants to see” his game, Alston told me earlier. “You better give us something to ooh and ahh about. No one cares about someone who took a charge.” The Rockets’ offense had broken down, and there was no usual place for Alston, still back near the half-court line, to go with the ball. The Lakers’ defense had also broken down; no player was where he was meant to be. The only person exactly where he should have been — wide open, standing at the most efficient spot on the floor from which to shoot — was Shane Battier. When Daryl Morey spoke of basketball intelligence, a phrase slipped out: “the I.Q. of where to be.” Fitting in on a basketball court, in the way Battier fits in, requires the I.Q. of where to be. Bang: Alston hit Battier with a long pass. Bang: Battier shot the 3, guiltlessly. Nothing but net.

Link: http://www.blog.sethroberts.net/2009/01/31/interview-with-leonard-mlodinow-part-3/

There are 15 parts and counting to this interview with writer, scientist Leonard Mlodinow (they are all about a page long). He’s wrote The Drunkard’s Walk, which I’ve ordered from Amazon – it sounds similar to Taleb’s The Black Swan, which was fantastic and crystallized some thoughts that had been racing around in the ether of my brain. Saving this one down as I particularly liked Mlodinow’s commentary on writing here.

For the rest, here’s the current directory:

1. part 1
2. part 2
3. part 3
4. part 4
5. part 5
6. part 6
7. part 7
8. part 8
9. part 9
10. part 10
11. part 11
12. part 12
13. part 13
14. part 14
15. part 15

Also mentioned in part 15 is a documentary about Cal-Tech basketball that sounds intriguing – it is called “Quantum Hoops.” Might be worth renting.

MLODINOW I think that in a way . . . I guess there’s two components to being able to write. One is your natural proclivity, I try not to say talent, but it’s your voice or the way you express yourself. And the other is the craft part of it that you learn by doing. I think I always had a good sense of humor and maybe a way to say things colorfully or think in terms of dramatic or powerful situations and I guess that’s the first part and served well. The other part is the things you learn as you go, such as what puts people to sleep or how to abandon what you think are good ideas but really aren’t. That’s a hard lesson to learn because it’s difficult to let go of things you might like and to realize that it just doesn’t belong or goes on too far or the idea that sometimes it’s hard to recognize things that may be good but just don’t belong there–that are tangents and they take away the dramatic thrust of where you’re going and they really have to be cut even though they’re good and you like them. You know, lessons like that, lessons about pacing–you learn by doing, by failing. You learn more about pacing, all sorts of technical aspects of writing, whether its fiction or nonfiction or TV or books; there are certain principles that you just learn by repeatedly doing and doing wrong and realizing, absorbing what went wrong and fixing it and you grow that way. In book writing you’re able to do that a lot with rough drafts so a lot of your mistakes don’t end up getting published–you know? TV writing can be so fast that often you don’t see the problems with the script until you actually watch it on the air and then you go, ‘Next time I think I won’t have that guy climbing the stairs for four minutes in the middle of the scene; I think five seconds is enough to get the idea across.’

…

ROBERTS Yes, that kind of brings us back to the very beginning. I feel like somehow the times have changed and people are smarter. Now you can make a living from what you’re doing. You’re writing this very entertaining intellectual history; finally there’s a market for it. Finally people are smart enough to be at your level so that you can write a book that you respect but you can get a wide enough audience.

MLODINOW Are you saying that in the 50s that couldn’t have been done? I don’t know.

ROBERTS Well, nobody did it; let’s put it that way.

MLODINOW No, nobody did it. I don’t know why.

ROBERTS As I said before we started recording, you’re the first person to ever do this. Will you be the last? I don’t know but you’re the first. You’re the first person to write intellectual histories that actually are popular and that people want to read, that they’re not forced to read by their teachers. It’s not just a tiny group of people reading them. Professors of course write them but they’re not well written and it’s just their job to write them; they get a salary from the government to write those books. You’re not getting any salary. You’re an entrepreneur and it’s just so different. Your books have to be popular or your job goes away. It’s just a different level of competence; your books are just infinitely more accessible, infinitely better than a professor would normally write. A professor is subsidized and that’s what is basically comes down to. Practically everybody who writes about science is subsidized but you’re not.