Taleb: I Have Discovered The Solution To The Global Financial Crisis

nassimtaleb erase tbi

Nassim Taleb and his hedge-fund partner Mark Spitznagel weigh in in the FT with an analysis of the world’s problem (too much debt) and a reasonable solution (convert some of the debt to equity). 

As usual, Taleb lards up his argument with guru-speak and smug swipes at every other economist on the planet, which undermine the point.  But in this case, the point is a good one.

Converting debt to equity is what corporations do when they go bankrupt.  GM and Chrysler just did it, and the airlines will do it next time they go bust.  Same for the hundreds of other companies that go broke every year.

For some reason, however, this solution has NOT been seriously considered as way to mend the housing market.  It should be.  Reducing a strapped homeowners monthly payments (as in Obama’s mortgage-mod plan) will help, but it won’t address the fact that many homeowners are underwater.  Converting some of the mortgage to equity, however, will.

(This can be done in a variety of ways.  John Hussman has been proposing “property appreciation rights” for years.)

Here’s Taleb:

Against this background [mountains of debt], we have two options. The first is to deflate debt, the other is to inflate assets (or counter their deflation with a collection of stimulus packages.)

We believe that stimulus packages, in all their forms, make the same mistakes that got us here. They will lead to extreme overshooting or extreme undershooting. They lead to more borrowing, by socialising private debt. But running a government deficit is dangerous, as it is vulnerable to errors in projections of economic growth. These errors will be larger in the future, so central bank money creation will lead not to inflation but to hyper-inflation, as the system is set for bigger deviations than ever before.

Relying on standard models to build policies makes us all fragile and overconfident. Asking the economics establishment for guidance (particularly after its failure to see the risk in the economy) is akin to asking to be led by the blind – instead we need to rebuild the world to make it resistant to the economist’s mystifications.

Invoking the pre-internet Great Depression as guidance for current events is irresponsible: errors in fiscal policy will be magnified by this kind of thinking. Monetary policy has always been dangerous. Alan Greenspan, former Federal Reserve chairman, tried playing with the business cycle to iron out bubbles, but it eventually got completely out of control. Bubbles and fads are part of cultural life. We need to do the opposite to what Mr Greenspan did: make the economy’s structure more robust to bubbles.

The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.

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