Typical Taleb

April 8, 2009

Op-ed in FT from Nassim Nicholas Taleb on how to avoid Black Swans. One of his points that is really revolutionary

Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

This is the an extraordinary piece of advice. He essentially seems to be saying that people should completely stop investing in the equity markets, even debt which chases for yields is verboten. Somehow this does not strike as being very sensible. People get accustomed to a lifestyle and they chase returns so that when they retire they are able to live a meaningful life. In a world of scarce resources, how those resources will be allocated depends on the price that it’s users are willing to pay. However harsh it may sound, a richer/high status person will always get better treatment in most aspects of life than someone lower down the totem pole.

Everyone implicitly understands this and tries to maximise their usage of resources by trying to garner as much as possible in every way possible. A more nuanced and meaningful solution is needed to the question of providing for the future.


Alchemy of Finance

March 18, 2009

Steve Waldman riffing off on a statement by Arnold Kling that the key job of the financial system is to intermediate, to transform long term risky capital into short term liquid capital. As he rightly points out, there is no magical way to do this except through a misdirection of people and an implicit government guarantee of all capital.

This goes to the heart of the current financial crisis, that an intermediary could take on all sorts of risks funded via capital which they classified to their investors as risk-free.

Steve Waldman goes on to list a number of suggestions of what can be done in the future such as dis-intemediate, through equity arrangements rather than debt. But even equity arrangements need intermediaries and as long as people are not aware of the risks that they are undertaking or the intermediary obfuscates the risk.

A big reason for this is the bank depositors, house buyers, investors, insurance buyers have been innured to the fact that they are carrying any risk. Most people don’t expect to sell their cars or electonics at a higher price than what they bought it for. These are not seen as store of value, but rather consumption goods.

What a majority of people want it a store of value which will protect them against rising cost of consumption in future. The government should issue Inflation adjusted bonds and go on a campaign that this is the only reliable store of value. In every bank branch there should be signage just like there is on cigarette packets that there money is at risk with photographs of people made destitute by foolish investments. Everytime someone buys any asset which they buy simply because they think it will go up in value, governments should proactively start a Public service campaign which talks about how asset prices tend to fall after they have gone up. They do it for cigarettes, AIDS, STDs, flu epidemics, so why not for financial epidemics. It’s not bullet proof but atleast a counter-balance to the irational exuberance of people.

Mark-to-Market for Assets – Normal & Financial

March 14, 2009

John Gapper FT’s Business Editor writes

However, just as an exercise, imagine what it would be like if all homeowners were forced to mark to market the value of their homes, and post cash collateral in cases of negative equity.


Of course, households are not banks and do not have shareholders and bondholders, so there is probably no good reason for them to mark to market their assets. Still, it makes you think.

What is wrong with this is that it doesn’t matter if households have shareholder or not, actually they very much do have at the least stakeholders, people who are part of the household.

The key determinant of marking an asset to current prices or cost which ever is lower, is whether the asset is used as a trading asset or is it a holding asset. Businesses do not mark to market their plant & machinery, furniture or office buildings as long as they are not trading in these things. If a business buys and sells houses then they would mark-to-market if the house prices fall, else they would simply keep it at cost at which it took to acquire the inventory.

The obvious problem with Financial Assets is that their cost price especially for complex options, derivatives etc is essentially a combination of market prices and the model used for valuation. This gives unrealised gains and losses for these assets which can be huge.

The key to solving this is to go back to basics, look at the point of time when the asset was created and simply treat that as the cost of the asset, banks should not be allowed to take profits if prices move up unless they actually sell the asset, but they should have to write-down the value if the prices fall.

This will create a natural disincentive to creating complex products where the financial institutions cannot realise the gains without actually selling the asset, but would take losses if prices fall.