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Nassim Taleb: End Bonuses For Bankers
- endtime 15y ago>The asymmetric nature of the bonus (an incentive for success without a corresponding disincentive for failure) causes hidden risks to accumulate in the financial system and become a catalyst for disaster. I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary.
- barrkel 15y agoSuppose there is a bet that has an 80% chance of success (a payout of 100), but a 20% chance of catastrophic failure (a loss of 500, which results in a bail-out). On average, this bet loses 20; it should not be made at all. But suppose you make a bonus of 20% of your gains, and no bonus for losses. Would you make this bet? Is opportunity cost a sufficient disincentive, or is that an elementary mistake, since the expected return seems to be 16?
- wmf 15y agoThis is true, but the downside is capped: a bonus can't go below zero. Thus traders may become insensitive to the amount of money they lose and thus increase risk.
- jpwagner 15y agoyou could improve the compensation algorithm to adjust for risk.
- endtime 15y agoA bonus can go "below zero" if you need to get a >0 bonus just to reach your market salary.
- flourpower 15y agoBut it can only go as far below 0 as the amount in salary you sacrificed in exchange for a potential bonus.
- endtime 15y agoYyyyes...? What is your point? Edit: To clarify (since someone downvoted me), you are making a true statement, but I don't see how it is in conflict with anything I'm saying, or what other point it supports.
- flourpower 15y agoWhat Taleb is saying is still true. If I have a 400k market salary and I give up 200k of it for the right to 1% of the profits I generate, then I still maximize the expected value of my compensation that year by maximizing the size of my bets. I could bet a billion dollars on a coin flip, get 9.8 million (after recouping foregone salary) on heads and lose 200k on tails. Moreover, there is a well established history of traders that lost large amounts of money finding gainful employment regardless. See Boaz Weinstein, for example.
- notahacker 15y agoBased on those figures, earning a profit worth a bonus of 400,000 and losing far more the following year breaks even with respect to salary, so there's hardly an incentive to ensure consistent trading success to average well above market salary. If you can adopt worse trading strategies than martingaling a roulette wheel and still come out far ahead on salary, the incentive scheme isn't well designed.
- rhizome 15y agoThus traders may become insensitive to the amount of money they lose and thus increase risk. They're already doing that.
- dminor 15y agoI agree. The real problem he's describing is the bonuses reward short term success regardless of the long term risks. Bank shareholders who are long term investors should demand bonuses that incent long term success, rather than short term.
- fleitz 15y agoAnd what about the short term holders of bank shares? Not all market participants are investors, many are traders.
- nickik 15y agoWow yeah traders should really be the first thing we think about when we want to save the world economy because traders are improtend, I mean what would we do without traders?
- kevinpet 15y agoThe problem is that there's no difference between failing to make a profit and losing $5B in shady mortgage derivatives.
- weeksie 15y agoYou miss the point. It's possible to make huge returns on risky investments and get paid huge bonuses for several years until the investment fails. The the worst that happens is that you don't collect your bonus that year.
- andylei 15y agothere are lots of bonus structures that mitigate this risk. some things you can do: 1. clawback clauses. when investments underperform, you take back bonus money. this goes well with: 2. long term vesting. you don't collect the entire bonus up front. you get it spread out over an extended period of time (say, 10 years), contingent on continued success / your bank still existing. in fact, many banks and hedge funds already implement these ideas. of course, if you're writing a newspaper article, you can get a lot more pageviews by papering over this fact and saying the most populist thing you can think of.
- KVFinn 15y ago>I think this claim contains a pretty elementary mistake. No bonus is a disincentive, because base salaries can be relatively low; not receiving a bonus is a large opportunity cost. If I could get a 400k salary, but I instead opt for a 200k salary with a 400k expected bonus, then if I don't get my bonus I'm 200k behind where I could have been if I just took the salary Say my bonus is, I dunno, 2% of profits. I go put 100 billion dollars on a single hand of blackjack. If I win, I make 2 billion. If I lose, I'm out 400k. Easy choice. Do it! The Black Swan is an interesting book. You might disagree with Taleb's claims, but he's not making elementary mistakes.
- marze 15y agoIn a Ponzi scheme, you give money to the Ponzi operator, the operator does "complicated" things with it, those who withdraw early do well but at some point there is no money. How is this different from the bailed-out banks, or an over leveraged banking system in general?
- Ant11 15y agoIn a Ponzi scheme you have to actually participate to get burned.
- fleitz 15y agoIf you don't participate in the global economy you can't get burned by it. People who subsistence farm are largely immune to problems in the global economy.
- marze 15y agoNot if it was such a large Ponzi scheme that it impacted the global economy.
- salvadors 15y agohttp://en.wikipedia.org/wiki/1997_rebellion_in_Albania http://en.wikipedia.org/wiki/1997_rebellion_in_Albania
- anonanon123 15y agoEnd Bonuses For Software Engineers!
- deleted 15y ago[deleted]
- rdl 15y agoAnother option is for banking (of the high risk investment banking kind) to be conducted by partnerships, with only natural persons as members, rather than corporations. One's ownership would be long-term, and actions could claw back previous upside. Goldman Sachs was a partnership until its IPO in 1999. A lot of finance houses were closely held partnerships until the late 20th century.
- flourpower 15y agoThat would work if we wanted to stop banks from transferring losses to shareholders - the real problem is that they transfer losses to taxpayers. Pre-IPO Goldman Sachs was probably considered "systemically important" enough for their losses to have been covered in the event of a large trading loss.
- rdl 15y agoYeah, there needs to be a clear distinction in advance between entities which can be bailed out (and thus must be highly regulated) and entities which can experiment/innovate freely (but which can't socialize their losses). LTCM would have clearly been "not bailed out", except it was. Admittedly not directly by the USG/FR, but at the direction of the Federal Reserve.
- flourpower 15y agoAnd even then it's tricky, because a non-regulated entity can make a bet with a regulated one and end up getting bail-out money by virtue of that bet. That seems undesirable, but you also can't really stiff the non-regulated entity, because then nobody will ever want to bet with the regulated one again, thereby destroying its ability to hedge.
- rdl 15y agoI wonder what the costs to the economy would be if we had Canadian levels of regulation of the financial industry, or even greater (something like how utilities themselves are regulated).
- jcampbell1 15y agoI think a better solution for "too big to fail" banks would be to require bonuses are paid in restricted stock. That way if the bank needs a bailout, then bonuses would be automatically clawed back. The bigger the bank, the larger the portion that is required to be RSUs. This would give a recruitment advantage to smaller banks, thus serve as an automatic limiter to bank size.
- fleitz 15y agoAn even better solution would be to just allow the market to take its course. Thinking up ways to allow to big too fail institutions to keep existing is counterproductive. Just allow it to fail and people will stop doing those things. If your bank doesn't exist you can't very well collect a bonus from it. I bet you if the big money families started losing big chunks of their fortunes that there would be serious reform. Same with retirees and their pensions. How do you think the prosecution of bankers would go if bankers put the DOJ pension at risk?
- st0p 15y agoAh, like what happened in 2008.
- fleitz 15y agoI wasn't at all aware of the market being allowed to take its course in 2008. (Save for LB/BS)
- st0p 15y agoWell, the market successfully lobbied against regulation on CDO and CDS. It was the market that pushed the Gramm–Leach–Bliley Act. It was the market which gave AAA ratings to junk investments. I see your point, but I think that if the whole deregulation (and thus free market) hadn't happened, a lot of the damage could have been avoided.
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- wsetchell 15y agoThis sounds like we're tackling a symptom not the disease. Instead of figuring out how to stop bankers from being paid so much in bonuses, we should answer ask why a few times. "Why can banks pay their employees so much?" - because they make so much money, and have so few employees. "Why can banks make so much money?" - I'm not sure but it seems like banks can take risks, but pass off the real risk to others. "Why can banks take risks, but not have to worry about the downside of those risks" - ... I think if you follow that train of thinking you'll get to some structural problem in our current system. It doesn't seem like there is an easy fix here.
- rhizome 15y agoWell, it used to be that banks were prohibited from taking risks. 100 years ago banking was a boring job.
- albertsun 15y agoIt sounds like you're responding to the headline and not the article. Taleb didn't say anything about bankers being paid too much (or "so much"). His argument was that bonuses encourage risk taking and that having bank compensation be less variable (i.e. base salary would go up, but not fluctuate) would lead to less risk taking.
- barrkel 15y agoDid you read the article? Taleb was arguing against bonuses as incentives to take risk, without corresponding downsides. He was not arguing against bankers being paid lots of money.
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- MaxHop 15y agoThe author of the article and the people who advocate his opinion are delusional! Giving bonuses is how banks work these days.
- RockyMcNuts 15y agoBecause it currently is thus, therefore it must be efficient and optimal, and any attempt to change it is delusional... you sound like an economist! But I think a lot of HN is about challenging incumbents and the status quo...
- RockyMcNuts 15y agoIt exists, therefore it must be optimal (unless government is involved) - The economists' credo
- shareme 15y agoThe problem is what we are attempting to regulate culture wise does not view at as a problem..to change that culture requires some heavy duty court convictions and jail time...if Obama get his 2nd term some of those court cases in fact come to trial via the DOJ and SEC, etc.
- jpadkins 15y agoWhat evidence do you have that Obama administration will prosecute their campaign financiers in the 2nd term? They had more (electoral) incentive to prosecute in the first term... They have no reason in their 2nd term.
- pkaler 15y agoThe real solution is to either disintermediate the banks or eat away at their profits. LendingClub, Covestor, SecondMarket, Simple, Square, WePay, and Mint come to mind.
- mkramlich 15y agoagreed. it's simple and it only requires direct action on the part of the "little guys", and doesn't require Congress. also, shift more money into credit unions rather than traditional banks. generally, if we as a society make less money available for the Wall Street types to play with, they'll have less to play with, and the chance/magnitude of them fucking with the normal/base/productive part of the economy will be lessened in the future.
- RyanMcGreal 15y agoOr the US could simply re-regulate financial institutions the way it did during the period from the 1930s through the 1990s.
- j_baker 15y agoI do like this idea, but I'm a bit skeptical that a relic of the 1930s would work in our modern economy. Thus, I suspect the answer is a bit more complex than "Bring back Glass-Steagall".
- cynicalkane 15y agoI think the economics is pretty timeless, actually. A lot of the regulation was aimed at preventing catastrophic bank failures, before the idea of Too Big To Fail was invented. Glass-Steagall contains the idea that a commercial bank, which gets major regulatory freebies by virtue of being a commercial bank (FDIC, Fed access, &c), shouldn't have access to unfettered financial markets. And so on.
- rayiner 15y agoBanking hasn't changed so much since the 1930s.
- damoncali 15y agoIt's really not that complicated. It's just proper alignment of risk.
- dredmorbius 15y agoGo and read J.K. Galbraith's The Great Crash: 1929. It's a short book, an easy read, and quite informative. Particularly interesting is his examination of causes and ramifications. If you buy a recent edition, these have been updated through the 1960s and 70s, with a foreward by his son in 2009 (the book was first published in 1955). Though the situation of the 2008-2011+ crash/depression isn't an exact reflection of 1929, there are very strong rhymes.
- tryitnow 15y agoThere's a problem with the "go back in time" policy proposals. If the banks beat the regulations we had in place before, what makes us think they won't beat them again? This is why Taleb is proposing a simpler solution - it might be hard to get around. I am skeptical of all proposals, but I think it's important to understand that going back to the previous set of regs might not work since the banks busted through those.
- geogra4 15y agoTaleb is an excellent writer and not (as someone here has stated) someone completely delusional. He, in fact, worked in the financial industry for many years and I thoroughly enjoyed reading his book "The Black Swan"[1] about how we've basically all been duped by large banks that expose us to risk and keep the profits for themselves. [1]http://www.fooledbyrandomness.com/imbeciles.htm http://www.fooledbyrandomness.com/imbeciles.htm
- mbesto 15y agoIn order to understand why bankers get such massive bonuses it would probably be good to read this first: Michael Lewis - Liar's Poker http://www.amazon.com/Liars-Poker-Michael-Lewis/dp/039333869X/ref=sr_1_3?ie=UTF8&qid=1320795652&sr=8-3 http://www.amazon.com/Liars-Poker-Michael-Lewis/dp/039333869...
- zanny 15y agoThe fundamental problem is that when a corporation has so much money they can throw tons of it at the upper management and executive, and not go out of business because they are undercut by a competitor that doesn't waste money like that, then something is wrong with capitalism at that point. That is the problem you try to fix, you don't just throw more regulation on the banks that will backfire like software patents.
- jwallaceparker 15y ago>> I HAVE a solution for the problem of bankers who take risks that threaten the general public: Eliminate bonuses. I'm sorry but that's not the solution. The solution is for the government to stop bailing out private institutions, regardless of whether they are deemed "too big to fail." There are some incredibly elegant natural laws built into the fabric of the universe, one of which is expressed through economic systems in which corrupt, reckless institutions are eliminated because they go broke. The only way corrupt, reckless institutions are allowed to persist are when they are propped up by taxpayer money.
- tptacek 15y agoAnd if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations, well, "externality" is just a fairy-tale idea thought up by ivory tower economists? I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail".
- prostoalex 15y agoA system that's based on infallibility of a few large proxies is unstable to begin with.
- jwallaceparker 15y ago>> I'm sorry to be so glib, but if the answer isn't as simple as "end bonuses", it also isn't as simple as "just let the banks fail". But there is a "simple" difference between philosophies of how to address corruption in financial markets. >> And if tens of thousands of people lose their jobs because the corporate credit markets freeze and otherwise-profitable companies can't fund their day-to-day operations There is no way to avoid the day of reckoning. Don't pretend that any crises that were avoided in 2008 won't be that much larger when they eventually materialize.
- drusenko 15y ago>> There is no way to avoid the day of reckoning. That would be true if it weren't for the fact that a good bit of our economy relies on confidence and trust. Confidence that there isn't a huge recession or depression in the near future, and trust that others will remain in business if you deposit/lend them money/invest. So in a very real sense, a panic, even if it isn't based on anything fundamental, can set you back very significantly.
- gallerytungsten 15y agoThe problem that Taleb unfortunately doesn't address is that the bankers have captured the political system. For this reason his solution unlikely to transpire.
- pyoung 15y agoI like the decimation idea. Before they can be bailed out, capital punishment should be randomly applied to one-tenth of the bankers of the failed institution. The lottery can be weighted based on bonus size, to ensure that the big wigs are fairly represented in the sample.
- spacefungus 15y agoTaleb rocks. The funniest thing is that he hates the NYT but is able to recognize the chance for a big audience.
- spacefungus 15y agoWhy did this get downvoted?
- uwe 15y agoI like the general idea of linking the consequences of some actions to the actors involved to prevent cheating and bad behavior. The examples from Babylon and Rome were probably much more effective in this than cutting the bonus of a banker (ie they paid with their lives). I had a similar thought when I started reading about fracking (http://www.propublica.org/series/fracking http://www.propublica.org/series/fracking). A simple solution there for the pollution caused by the wastewater is to force the executives and their families from the companies doing fracking to live in the communities they affect and use/drink the water they claim is safe.
- fennecfoxen 15y agoA debate with some merit, but not "hacker news". I say flag it.
- bandushrew 15y agoYou cannot control payment to employees like that, companies just find a way around those kinds of laws. Better to regulate the institutions themselves so that they dont get 'to big to fail', don't get to combine access to cheap money with access to the financial markets, don't get to insure themselves and so forth.
- brown9-2 15y agoInstead, it’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed should not get a bonus, ever. In fact, all pay at systemically important financial institutions — big banks, but also some insurance companies and even huge hedge funds — should be strictly regulated. I'd really like to see someone attempt to express such a condition in the type of legalese that appears in legislation. How do you ban something based on a hypothetical possibility? How do you write this condition down?
- ihodes 15y agoThis is absurd. Regulating private companies' compensation? Instead, the government should either make sure companies don't get "too big to fail", or make it very clear that banks don't have the Geithner Put option. Simple and unobtrusive.
- jwallaceparker 15y ago>> the government should either make sure companies don't get "too big to fail" Exactly. And the best way to do that? Never bail them out.
- jshen 15y ago"Never bail them out." Even if it destroys the economy for everyone?
- guylhem 15y agoUntil you consider that like a road side casualty, some people will use your fears against you. Never bail them out.
- bydesign 15y agoBailing them out is the same as adding RAM to a server to fix a memory leak. The problem isn't a temporary, transitory state - it's a systemic design flaw in a system filled with rogue actors.
- jshen 15y agoRight, you need to combine saving the financial system with systemic change. Letting them fail is equivalent to letting the system crash and the doing nothing.
- nickik 15y agoI just dont understand why people talk about the "financial system". Its a bunch of banks and some of them fail. The only banks that failed are those who are bad.
- 3d3mon 15y agoI think strict regulation is the way to go. Banking in a modern economy is really a utility like gas, electric, and water. Another solution that is more long term oriented and market based: create rival capital-formation pools outside of Wall and Broad, say in the Midwest, South, and West Coast. That way if one pool blows up, we can let them fail and it won't take out the whole economy. It also removes single points of failure from the system. I think the crowdsourcing bill floating in Congress is a great start as it decentralizes capital-raising.
- mey 15y agoBonuses are incentives. What they are giving bonuses for is wrong. Not the bonus concept itself. Eliminate the bailouts, require a certain percentage liquidity, force assets to be marked to market on a certain interval. Suddenly the bank's finance sheet to it's investors won't be so rosy, investors will demand change, change will happen.
- radikalus 15y agoNot everyone who works at a bank is a "banker" -- going after bonus structure holistically without regard to station/role seems impractical bordering on impossible. Beyond even that, one might imagine that if US banking regulations get extremely prohibitive, banks will just move offshore. (And still be too big to fail with regard to the US economy) I think that a little divide-and-conquer is needed to fix some of the smaller sub problems...
- inthewoods 15y agoPart of the issue you're highlighting has to do with banks being able to engage in risky behavior - the traders that argued, after the collapse of, say, AIG, argued that they still deserved their bonuses. End the mixing of risky and non-risky behavior and you put most of that problem to bed. Banks moving offshore isn't really realistic - you can't avoid, at the moment, having America as part of your bank - too much of a market. So even if, like UBS, the bank isn't in the US, it doesn't mean that they wouldn't be subject to regulation.
- Aloisius 15y agoThere are plenty of fine ways of reducing risk for companies which pose a systemic threat the US economy, eliminating bonuses is probably not one of them. The most obvious is, if a company ever becomes Too Big To Fail, you simply force them to break up. We do this with monopolies because they could harm competition. We have plenty of experience with it. Surely we could do it with companies that represent a massive threat to our economy. The second one I see is to force any Too Big To Fail company to hold a very large percentage of their value in a bond they hold with the government. Now, they could be a standard federal bond or a special insurance bond, but it would basically mean that if the sh*t hit the fan, there would be enough company assets in safe holding to fail in a more controlled manner.
- anamax 15y ago> The most obvious is, if a company ever becomes Too Big To Fail, you simply force them to break up. Surely that also applies to GSEs (such as Fannie Mae and Freddie Mac), govt programs, and even govts themselves. If not, why not?
- wtvanhest 15y agoI love hacker news for discussions about business and about learning about how the smartest programmers in the world think about programming. When articles that deal with the world outside of startup finance appear on Hacker News, the articles and comments usually have so little knowledge behind them they are practically unreadable. It would be nice if this community could keep the articles they post based on VC funding, angel funding, debt funding for start ups, option pools, etc. The comments here are more representative of political ideals and not based on facts. (Also, I understand that is not entirely true as some comments are actually quit interesting, but I have to wade through so much garbage to find them that it isn't worth it.)
- Dbkasia 15y agoI would tend to disagree that this article is not relevant, startup finance and access to funding for startups is highly dependent on the health of the financial system, and this article deals with the economics and the gaming of that system.
- adamtmca 15y agoHe didn't say the topic wasn't relevant, he said getting to an insightful comment required wading through a ton of garbage. I tend to agree. Designing comp packages that work is incredibly complicated. Anyone who proclaims some sort of blanket "solution" to the problem of how to compensate "bankers" probably knows so little that they don't know what they don't know. Normally in situations like that people on hn don't comment at all, but because this issue is so political everyone thinks they have the answer and need to share it with the world.
- wtvanhest 15y agoYou mentioned how bankers you worked with gamed the system in your other post. If gaming the system is so easy as a banker, please tell us how much money you gamed? If you were there for 18 years as you said you were then you should have gamed a ridiculous amount of money out of the system and you would have been through at least 1 if not 2 recessions, 1 of which as a fairly senior banker.
- MKT 15y agoIf you don't pay bonuses, do you give a managing director at a bank a 1 million dollar salary independent of performance? How is that a good thing? And if you tried to pay her very little, the bank would just turn itself into a shadow bank and proceed as before. Remember, GM was not a bank, at least nominally, and it was bailed out
- Dbkasia 15y agoAs a former banker with 18 years experience, this article is 100% on the ball. Having worked as a senior executive during the times of Global Crossing and Enron I saw how the system was gamed!. Working at this large institution I saw how the bonus system, made the supposedly senior bankers act like a group of Mary Kay cosmetic sales girls, seeing how they could optimize their bonuses by playing the game, and how they got the lower levels of the pyramid to play along because of the partial subjectivity and discretionary aspect of the bonus system. Because of this discretionary aspect, lower levels of the pyramid, we're unlikely to question the creation of complex and funky new products specifically designed to overcome impediments to maximize that short term bonus. When this giant "ponzi" scheme began to collapse, I saw how those same greedy senior executives proceeded to panic and destroy significant strategic parts of the business solely to stop the leakage of their bonus pool and try and cosmetically dress up the banks short term results to justify and maintain those 6-8 figure bonuses they had thought they were going to receive. Many of these executives later "resigned" or were "retired" by their boards who should have been accountable for the damage reaped by these masters of gaming. Most of them(I think all of them!) retained huge bonuses all at the expense of the shareholders and employees. Writing off 100's of millions of $ of shareholder and depositor value. With middle class retail shareholders, depositors, and employees paying the price of this borderline criminal behavior. Most galling to me is that one of these executive used some of his "hard owned bonus" to have a faculty/ building at my alma mater named after him. I believe this was probably more driven by ego than guilt! Nassim is 100% on the ball. Nothing has really changed and history repeats itself, and unless government starts to listen then I fear the outcome will either be financial collapse or revolution (#occupywallstreet?).
- T_S_ 15y agoThis fails because it ignores the root cause. All banking crises are informational in nature. Circulating more of the right kind of information is nearly all the regulation you need. What information? Positions, live or daily, in detail. No more too big to fail, and many other problems simply disappear. In contrast, most regulatory proposals betray a belief in installing a tough cop of some kind to combat 'evildoers'. Guess what, the evildoers are just people doing their jobs. We need to tweak the system to stabilize it, and for a regulated industry like banking the government has all the power it needs to do so.
- jonhendry 15y agoWhat about accounting tricks which seem to move risks off an institution's books, but don't actually do so, and nobody notices until it's too late?
- T_S_ 15y agoWhat I am suggesting is to allow the public and analysts to see the detailed positions of the institution and make accounting superfluous. We can view accounting as an extremely flawed model that lacks timely updates. By operating in the sunshine an array of activities permitted by information hoarding will no longer be sustainable.
- jprobert 15y agoHow about structuring bonuses more like an earn out. When companies are acquired an earn out is typically included so that the owner of the acquired company has an incentive to run the company in the most profitable way. If bankers bonuses were based on earn outs that are paid over 3-4-5 years then they will reconsider risk since compensation is deferred.
- HSO 15y agoMixed feelings about this article. > The potency of my solution lies in the idea that people do not consciously wish to harm themselves; I feel much safer on a plane because the pilot, and not a drone, is at the controls. What about myopia, self-delusion, panic, sheer intellectual dishonesty or even disability, and all the other assorted biases that afflict human judgment? Humans hurt themselves all the time. In fact, there are instances when putting more pressure or increasing the (financial) incentives hurts performance and increases risk. > I believe that “less is more” — simple heuristics are necessary for complex problems. So instead of thousands of pages of regulation, we should enforce a basic principle: Bonuses and bailouts should never mix. Having said that, I'm still all for the use and (re?)discovery of heuristics in regulation, combined with judgment on the part of the enforcer. It's high time we moved past the game of who can outlawyer who. There is a reason that posts like yesterday's knife maker capture the attention of many people these days and why firms like Apple or Leica are so successful these days. Life is becoming so complex, we can't write every contingency into a law; so much is becoming possible today that we need more and more conscious, i.e. editorial constraint.
- OllieJones 15y agoNassim Taleb is making an argument about the structure of the banking system's risk management schemes. This is an attractive article for us to comment on because, doh, we'd like to punish somebody for the 2005-2008 Collateralized-debt-obligation and Credit-default-swap Cluster-f* (I'll call that the C3F from here on). And, surely it would be good to hold somebody accountable for what happened. Not that they'll be able to fix it. But still, it will feel like justice. But that's not Mr. Taleb's point. The real C3F problem is of TREMENDOUS professional interest to creative software folks. Most of us work on systems that can aggregate lots of measurements to try to get a big picture of the system. Some of us look at video and audio signals. Others of us look at web server logs. Today, I'm trying to troubleshoot slow DBMS performance. Our brothers and sisters in banking and trading look at measures of risk. And we all know what we do to make sense of these measures. We average them. We sometimes throw out the outliers. We measure their standard deviations, or maybe their quintiles if we're sophisticated. And then we track the averages and other aggregates, assuming that it's sound to do so. My boss asked me today, "is the average query time going up?" I responded, "wrong question! we need to look at the outliers." This approach to averaging measurements feels like something we got from our mothers' milk as infants. But it's based on Gauss's Central Value Theorem, which shows that independent (repeat INDEPENDENT) measurements tend to have a normal bell curve distribution. (We call that a Gaussian distribution in honor of the Central Value Theorem). So, what the heck, let's sell mortgages to poor folks, and huge mortgages to rich folks. They can't ALL fail to pay, can they? The ones who fail to pay will be the outliers, won't they? The Central Value Theorem teaches us that the average person will pay up. So we can manage the two-sigma risk by buying a credit default swap (you have AIG's phone number, call them!), and all is well. Except for one thing. Mortgage defaults aren't independent of each other. When one property on the block goes into default, it becomes harder to sell the others or refinance them. So the Central Value Theorem's premise of INDEPENDENT measurements fails. Big time. Lo and behold, C3F. Mr. Taleb's point is that in the real world of risk management, things aren't Gaussian. The events he calls black swans are long-tail events (that is, their probability curve falls off far slower than the Central Value Theorem predicts). Why is this relevant to HN? Because we can easily deceive ourselves by ignoring outliers (black swans) in our fields of work. Hopefully it won't be as catastrophic as C3F, but we should beware. Seriously, if you haven't read Mr. Taleb's book The Black Swan, it's worth your trouble.
- kahawe 15y agoWhat people seem to often forget is... during the financial crisis following the housing crash governments (especially in the USA) passed out significant amounts of bailout money for all those banks but completely failed to get them under control - so banks just used that bailout money to temporarily guarantee their vital liquidity and once things were looking up again a few months later, they just kicked them out and went right back to their old business, including bonuses and everything. There were even farce attempts to "get them under control" and the banks themselves would have votes in these decisions HOW they were going to be controlled and regulated. Excuse me??? That is like putting the mafia on trial and making their family the grand jury. "Too big to fail" has proven time and again to be the absolutely best way of gaming the system almost any way you want. We even bent the very rules of capitalism and free market backwards multiple times to accommodate for these behemoth institutions and to this day, justice hasn't happened and nobody has ever been responsible for this mess.