Nassim Taleb Part 1: “We don’t need financial reform, we need definancialization”
Nassim Nicholas Taleb is, in my humble opinion, one of the most important modern public intellectuals we have. His views are a practiced blend of heterodoxy, originality, and common sense. Although he seems incredibly well read, the influence of thinkers such as Mises and Popper shines through (he cops to being a Popper junkie in “Fooled by Randomness”). Perhaps most importantly, he seems to have a singular understanding of his own limitations, and by extension the limitations of economists and self-proclaimed financial experts.
Businessweek has a short new profile of Taleb, with the blurb: “In a new edition of The Black Swan, author Nassim Nicholas Taleb warns against depending ‘on financial assets as a repository of value’.” However, there’s far more in the interview than the article writer has referenced, and probably far more than he even understands. Clearly, because I’m not Taleb, I cannot speak for him; however, I will try to explain some of what he means, and what it should mean to you.
Beginning with Taleb’s skepticism of financial assets, he says:
The problem is that citizens are being led to invest in securities they don’t understand by people who themselves don’t quite understand the risks involved. … People use “risk measures,” but you’re really not measuring anything like you measure temperature or distance. You are making a speculative assessment of a future event.
This is demonstrably true. In fact, none of what securities brokers understand about markets can’t be gleaned from a textbook, and few of the somewhat more complex models couldn’t be generated by one with a knowledge of computer programming and access to said textbooks.
How do those who hold themselves out as experts in the securities retail market become “experts”? On the most basic level, you need to be licensed as a securities broker; your starting point is usually the Series 7 General Securites Exam (often in conjunction with the Series 63). Pertinently, the test is almost all consumer-driven. More than half of the questions on the test evaluate your ability to prospect for customers, explain markets to customers, listen to customers to determine what they want, handle customers’ confidential records, and process customers’ orders. A small part tests your very basic knowledge of financial instruments.
Frankly, you need minimal knowledge of securities and securities markets to pass this test. So why isn’t everyone their own broker? As it turns out, the most important thing you need to become an “expert” is someone to give you a job as an expert. You’ll need a licensed brokerage firm to sponsor you before you’ll be allowed to sit for the exam, and brokerages are only interested in salesmanship. Those who understand the business understand that selling securities into the retail market is a relationship-driven business, not a success-driven business. As Mr. Taleb (I believe) would agree, customers create any number of fictional narratives in their head as to why their portfolio has gone up or down, none of which have any likely nexus to reality, but whether the broker is blamed depends almost entirely on whether the broker is liked.
You may be thinking that, at least those who are higher up understand the risks of the securities markets and guide the client-facing brokers. I doubt Mr. Taleb would agree; I certainly don’t. The financial system is broken, and that fact has been borne out over the last couple of years. (Although I would argue that the problem stems from the 17th century, when the first “banks,” really just goldsmiths, began issuing credit notes in excess of their reserves. This was exacerbated by the 18th century removal of the bailment relationship from banking services, whereby your deposits at a bank ceased to be “your property under the care of a custodian” and became “your loan to a financial institution.”) The fact is that for myriad reasons, financial institutions make no meaningful distinction between customer assets and risk capital, and they have made none for decades. No amount of understanding could possibly remove the risks from the equation.
Taleb goes on to say of the current financial reform monstrosity:
I don’t like complicated regulation. I think we should not need financial reform. What we need is definancialization. What we need to do is break the financial community’s grip on society. And you can do it very easily by transformation of debt into equity. Banks have an interest in building debt, but equity in society is vastly more stable than debt.
Again, I would have to agree. Purveyors of financial reform are attempting to address a real problem, but they’ve come up with the world’s most most expansive band-aid. If you liken the financial system of late 2008 to an airplane spinning wildly while plummeting to the ground, you can easily liken the regulators to an air traffic controller who says, “now wait a minute here, if you’re going to plummet to the ground, you had better take a direct flightpath to get there!” To further torture transportation-related metaphors, we’re on the world’s largest runaway freight train, and we’re worried about whether the tracks curve left or right.
Here is where I diverge from Mr. Taleb. (In actuality, I’m not sure if I’m diverging, since to my knowledge he hasn’t addressed what I’m about to say.) The ONLY way to break the grip that the financial community has on the rest of society is to remove the sanction of government. How would we be so debt-hungry if we removed the favorable tax treatment of debt over equity? How would we be forced into a one-size-fits-all model of financial services if the government didn’t prescribe exacting rules on the activities of institutions? Similarly, how would the rules be less helpful to society if institutions were unable to lobby for the rules that they wanted (instead of competing on the merits of their products) because there was no one to lobby?
The answer, like always, isn’t more misguided “reform.” It’s a freer, more competitive system.