Nassim Nicholas Taleb discusses his book: Skin in the Game: Hidden Asymmetries in Daily Life

the subtitle of this book kind of gives it away if you will hidden asymmetries in daily life so many people who claim to be in the business of finance are in search of that mythical asymmetrical trade yes this book is full of practical advice yes explain in fact what i mean it tells you what's morally both morally and commercially acceptable for for the commune uh for the greater good for the greater good no for a community okay and and also for the individual what's more of an individual and what's useful for the community is that when you you should you thou shall not have profits okay and transfer the risk to others you should share the risk you want the profits you got to take a portion of the risk you you call this the bob rubin trade no the bob roman trade as is about uh is after a person who made a wealth of companies the former treasurer secretary of the treasury he made 120 million dollars in compensation from citibank over 10 years selling uh you know out of the money option things that explode rarely okay what we call taylor risk and uh while heads he wins and when when the thing happened citibank was insolvent goes to 97 cents a share exactly and then he said oh black swan you know and then someone else is bearing the cost the shareholder and the taxpayer stopping them out on the trade so he was not alone of course of course you use him as an example because he's emblematic of the problem exactly it's that generation of people who think that a society owes them profits but they don't want to bear the risk why is it that wall street still has what you claim and argue persuasively is a misconception or a misattribution yes if you will about the notion of skin in the game yeah because they don't understand that three things number one that skinny game is not just incentives two that incent disincentives are there for a reason since the beginning of times for 4 000 years beginning of civilization we have had rules that don't allow the architect to build a structure and then walk away if it collapses and kills people so you have one of the laws of hammurabi okay and i can third one exactly and the third one is skin in the game is a filter it's an evolutionary mechanism if you don't have very dangerous drivers on the road it's because they own their own risk they die in an accident they're likely to die in an accident if you have a bad driver not likely to die in an accident and not like to be penalized you've got a problem so let's get practical nastiness how do we make the financial system more darwinian if you will it is working on you know by itself and let me explain hedge funds most of the risks have migrated to hedge funds or structures like hedge funds in a hedge fund typically investors require that the owner or the owners have more than or something equivalent 50 of their net worth in the fund not just not just their you know non-reinvested profits we invested profits it's their net worth why to prevent them from playing the bob rubin trade because if the fund loses money they suffer as well they suffer as well and this claw back is not sufficient you need the person to have they're so like you need someone who cooks the food to taste it just in case it's poisoned but there are still let's talk about hedge funds for a moment though because there are still asymmetrical qualities to the way hedge funds are structured in other words if the hedge fund if the hedge fund makes money i as the investor make money yes but the hedge fund itself gets to keep a management for your share of the profits yes and the trader gets paid a percentage yes of those profits if the hedge fund subsequently loses money it's not like the hedge fund gives me money back and it's not like the trader surrends money to the hedge fund or to the client many hedge funds have clawbacks and then consider the other situation where the hedge fund loses money then they gotta wait to recover back to the high bar exactly so there are things but the essential attribute the risk attribute is handled by forcing the person to eat his or her own cooking okay so the argument you make is that the risk has been transferred from previously banks yes proprietary trading desks to hedge fund but that's only really in the securities business banks are still in the business of making loans exactly the problem is as many bankers have said there's nothing you could nothing riskier you can do than make a loan yeah citibank the the current shared person of citibank the success successor now is making what 20 some million dollars in bonuses one of those banks okay i don't know if it's citibank it doesn't make a difference okay so you we're still in a situation where you have what you call rent seeking people benefiting taking advantage of that situation and misunderstanding of symmetry so i want to if i may borrow a quote from the book yes you say quote our message is to focus on those who are professionally slanted causing harm without being accountable to it by the very structure of their own occupation yes most 99 of people you see are calibrated they they don't hard you know you see the idea they don't inflict more harm on society than they take drivers are calibrated butchers are calibrated airline pilots everything they're on a plane most people except for policymakers people in the profession that we are rebelling against in italy the rebellion against these bureaucrats they have absolutely no penalty if you know they encourage the government to attack the european government to attack some things that encourage that's why the league and the five-star movement made the gains in yesterday's election people are detecting i know from the mail i'm getting particularly from italy right so people understand that you have a class of people who are not accountable if you live in a community you see if you live in a community you have skin in the game in the sense that you live with the consequences of your decision if you're sitting in an office with a spreadsheet no so some europeans yes are freaking out about the italian elections what do you think the whole class we have to worry not just about europe the united states a whole class now people are going after the pseudo expert the black swan started with a solar expert there's a whole class of people pass for experts because and they're not penalized because they have no contact with reality they got no p l of their own and they're not penalized when they make a mistake someone else pays the cost people are detecting it would you call then the italian election result a favorable one well i think that any consciousness of the problem is the first step towards the remedy whatever the remedy may be here there whatever it is in america your confidence is our problem except for a certain class of people and bureaucrats and academics most americans are calibrated and they're fed up with these sort of experts so that's what put donald trump in office someone else could have won the election it can be go left or right the idea that you cannot fool people forever and there is a class of economists for example they have absolutely no clue about economy they're judged by one another and the book offers metrics methods you can guess if an industry is calibrated like the restaurant industry the restaurants are not judged by restaurant owners they're judged by their clients okay things that are not judged by their you know constituents they eventually rot fields i want to take these ideas these concepts that you explore in the book and bring it back to the very business you started your career in options trading yes in recent weeks we saw an explosion in the vix exactly and a lot of people lost a lot of money yes what are the lessons to be like okay well i mean that was that was that's the story of my life that's you're telling me the story of my life the problem is they don't understand that uh this concept that i wrote about in dynamic hedging okay you discovered very very very early on as a trader never cross a river if it's on average four feet deep so what happened is that they were right they measure volatility not realizing that they may blow up in short volatility so and these indices okay uh uh were right in the in their concept hey where you know if the vix is overvalued yes it is overvalued but all you need meaning a vix under 10 shouldn't or seven or whatever it is no no the vix is overvalued so you short the vix you make the difference between the vix and and but they didn't get that the idea that the vix is overvalued okay doesn't necessarily imply you can make money shorting it you see you can effectively they were right and blown up this is what i called the old days of neither hoffer trade he was right on the market and always bust so how do you extend that principle to financial markets going forward what do people need to keep in mind they have to understand non-linearity you have to have fewer finance professors fewer of these bad models involved learn from all traders learn from traders and survive people who have grey hair myself they know these tricks the minute there's a little bit of education is very destructive you say as well in the book no individual can get the same return as the market unless he has infinite pockets and no uncle points exactly this is something you know when you trade well it says here on etfs but yeah that's because i think that this is effectively an argument for being a passive investor unless unless you're prepared to accept unless no no it's it's an idea to be more conservative than than you think you should be and you should have a protection if you have exposed some kind of insurance if you have an exposure if the market going down 30 percent harms you to the point okay of threatening your you know your financial health completely complete financial health and and maybe bankrupting you or something like that then you need protection naseem one thing keeps coming through for me in every one of our conversations yes and it's almost as if nobody has learned anything no have you learned anything no you only learned via survival there's one thing about about you know i just noted i think in an article summarizing the book i said the following restaurant owners the restaurant don't improve because restaurant owners learn restaurants improve bankruptcy from bankruptcy to bankruptcy okay you see so it's the same thing in the ecology of markets you only learn via survival those people have not been exposed to the threat of you know bankruptcy of a p l a real p l will never learn because they're not harmed by we used to be saying when goldman sachs was a part of the governor's sec was a partnership they understood markets today the incentive is to not understand markets okay naseem i'm afraid we have to leave it there thanks such a pleasure my favorite interviewer oh please thanks

Channel: Huber Hernandez

Views: 4,849

Keywords: nassim taleb, nasim nicholas taleb, taleb

Id: xB_tbyih1to

Length: 10min 55sec (655 seconds)

Published: Fri Aug 28 2020