The 2008 financial crisis and the economy - The New Yorker Festival

hi I'm James for Wicky the business columnist for The New Yorker and we are here today with the seem to let the author of the Black Swan one of the most important and most interesting books of the past decade and one that in many respects perhaps and we'll talk about it today anticipated the financial crisis of 2008 and so we're gonna be talking today about the Black Swan which is coming on a new paperback edition we'll be talking about the current state of the economy and the world and host of other issues knowing machines so thanks very much for for being here thank you for inviting me sure so let's start with kind of a an obvious question which is was the financial crisis of 2008 Black Swan was your white swan I mean I there's something called gray but after when I wrote the Black Swan I spoke like grey Swan events okay and let me describe what a great Swan event is it's a bridge that's built for trucks that can only handle a say certain size trucks a two tons and you know trucks can be even bigger than that exactly so all it would take is a couple of those for the original collapse that would be a grace wand right a white swan for me it would be a bridge that can only handle these trucks of course and and you are certain because you've seen all right from a helicopter a few six ton trucks you know comment on the highway you're now heading towards it so you know the brain is gonna climb you know it is going to collapse it's just a matter of time okay it's still not deterministic but but it's pretty another metaphor I've use is when a planes flown by an incompetent pilot you know that the errors are going to help all right my focus is on the role of the rare events and academics of course use a you know framework that doesn't really allow for rare events so rare events are analyzed an afterthought but they thought it was an easy problem you just add in some stress testing or something like that and what I discovered in my paper that you don't know okay you don't know they're all of that rare event so there's no way even to model it 87% of the information we have on the role of rare events in the stock market over four years of data close to 12,000 observations come from one day and that day was the crash in 1987 exactly that day determines the fatness of tales all right is 7% of the you know fatness of the earth so in other words these metrics we would normally use to say how little we know about the role of rare events are so unstable that we don't know anything so we don't know how little we know about the rare event so even when people were saying we're taking into account the fact that these events have you know there are fat tails and even when people were saying we're taking into account the possibility of extreme events you're saying in effect it's impossible to take into account exactly and and and but but the error typically is is under estimation error not an overestimation okay okay so so I'm saying at best these company are gonna be safe at worst collapse so that's the first piece of research that that came out you know my period post black swan theory and of course I synthetized it now the second thing I thought I was convinced this thing's gonna fall apart completely the most vulnerable thing in the world is the banking system because you know when you're woken up in the middle of the night and a chairman of the bank that it's not gonna be good notes all right well it's not like there's never a positive soup remember us by the surprise right so it's not gonna be good news so you know that these people are fragile all right there's like sitting under Democrats or meanwhile basel ii and the regulators were overtly encouraging people to take hidden risks because they're offering them to use metrics that don't understand my point so I knew it was like incompetence generalized incompetence the way in other words the way the banking regulators measured risks simply didn't take into account exactly what it encourage risk-taking and the things that were not captured by that number right right so of course people are going to build a lot of risks plus the Triple A business the Triple A people accumulating positions on things deemed to be triple-a all right well in fact these things just bring your pennies if you're right and can cost you huge amounts very wrong okay like something's worse a hundred dollars you make ten cents or lose one hundred dollars and people lost a hundred dollars right so so it was a plus there's a history of incompetence on the banking sector I showed them the Black Swan I got a lot of hate mail from bankers when I said that 1982 the lost every penny made in history money senate banking in 1991 also all right and then visibly I'll do it again so the plus third factors of course Bernanke's incompetence because the guy doesn't understand that risk involved totally as two different things and in a complex system ok the risk is thing are typically the calmest outside of explosions ok can you talk a little bit about that I mean that's an important concept that so people typically looked at the years leading up to the crisis and said you know there was very little volatility in the stock market you know everything the Great Moderation you actually argued that that was a sign of in effect of increasing risk exactly because when I looked at for example one example is you look at Fannie Mae ok it's a company that was not volatile but you you're accumulating lot most of his risks and the tails banks were accumulating most of the risks not and the things that moved on a daily basis but things that just explode so just an accumulation of risk only in the tails ok so it's exactly the opposite of the land saying fluctuates but doesn't sink it sinks but doesn't fluctuate so everything is fine until exactly but now nature is a complex system that seems to do reasonably well right exactly and the way I explained it in my additional Black Swan nature knows how to constrain size and the the to give you an idea an elephant is the largest mammal we find on land but if an elephant dies doesn't bring down the equity ecosystem right all right so it's it's designed for externalities of one you know element not to be too big or as we don't have that with with max okay tomorrow Citibank goes under you know what's going to happen right the other element that that people don't understand that we uncovered here with a researcher a friend of mine working here at that poly is that as companies get larger there's that nonsense called economies of scale right that seems to give you good numbers but companies don't survive I mean look at the data people merge people get bigger and they disappear okay and what this important for a company is not the numbers it's survival all right like you know you want long alright so a winning is surviving all right if the company disappear now why then we need to notice that they become more fragile when they've got bigger and mother nature constrains you for that reason it makes you go bust early so there's no government support and final there are no bailouts if you know Bella exactly exactly there's no bailout if you get sick in the end lost company's totally in compensation be there the hijacking the state at the expense of new comer and a small guy just like the banks and the car companies hijacked the state the United States at the expense of the hairdresser and where I live the the barber I mean they're starving these guys they don't gotta tart how responsible can we hold who should we hold responsible for it and we hold people responsible for was it effective oh no no no it was not a predictable number one the first person to be held responsible is I think it's Bob Rubin or this crowd is under Clinton the people who repeated glass-steagall Act you have to understand the notion of debt when the system is settled was that like that bubble is is almost impossible to survive okay and we've known that sense of babylonians you know what I'm saying was present in the consciousness system Babylonians whether it's collective this is why you know the Mediterranean culture banned debt and we have experienced anyway anybody it's a no-brainer we had a equity bubble bursting in 2009 Marvel burst nothing nothing okay but look what's happening now is that bubble alright okay what happened to all that collective wisdom 3,000 years the Bible the Quran early Christianity the Romans everyone learned perils of debt now what happened to that wisdom business wolf if you are facing uncertainty it's a bad idea to have that private okay but I think it's criminal to transform private debt into public that because you're taxing the unborn so you think government debt is worse than private debt in exactly because the private debt is transformed into equity eventually gets eventually alright eventually although it's a stepping function and stuff and banks of course the government prevents that from happening prevent that from happening it's not a smooth transition so two idols make a mistake washing my children and your children pay for it now let me tell you why I'm worried about that the whole world now the government's are in need of facing the unexpected right right and they don't have redundancies namely cash on the side so they got tomorrow it's very nonlinear okay okay that's one other thing kind of a property of a complex system now let me at least it means you push you push you get no results and you push it and get a lot now you may tell me oh but we're in trouble yeah so what's the answer what do you do not my answer love sweat and tears you get rid of that I spent a lot of time alone alright a lot of time alone either at home in my library or an airplane thinking about what if there's another solution and there's not bring down worldwide the level of debt through a very severe austerity measures just bring down the level of that we spent the money people people think that we have a father-in-law there who will protect us Cersei will protect us we don't he doesn't exist anymore we're on our own why do you think lenders have been so willing to offer up all day I mean someone's lending they've all this money or not because as some moral hazard argument look at the chain reaction okay who's creating a lot of that banks and private equity firms it's very simple private equity firm they load on that the thing fails the bank takes a hit they get their bonus and they have very out okay so we have a you have an asymmetry like someone is has an option all right so it's exactly like real estate developers all right the the thing blows up okay the bank takes a hit and the thing works they make them make the money so we have that that we have the lenders private equity firm and the bank's backed by society by the taxpayer okay so they lend because there have agency problem it's not their money they're lending okay it's the capital of the shareholder right k but given that the losses can exceed right you know these amounts sure the individual main guy who's running this tonalities our society pays for it okay and a society paid for it in 1982 right 83 yes we nationalize you had to nationalize Cornell Illinois people forget that on the Volcker I mean Volcker is not a very responsible that sugar Volcker okay what if I mean all the other banks were exactly and then when we did the 1991 bailout of SNL it was taxpayers okay we're stopping them out okay and now we stop that goldman sachs my solution is not to try to change the world my solution is to make it more robust to have a robust society needs lower level of that okay so let's see yeah let's move to this concept so in the addition to the new edition of the black swan is titled at least on robustness and fragility and those are the two fundamental concepts in a way those concepts were both deeply implicit in the in the original edition but but they're centers so one of the problems i think when you read the black swan is in trying to figure out well what does this mean you know can I leave my house if you know if I don't know what's gonna happen to me how am I supposed to how am I supposed to act and so in a way that's probably what I think your concepts of robustness and fragility are about is and and what is robustness I mean what do you mean when you say you want us to have a more robust society robust society is a society that can withstand large shocks and survival and and the analogy I use is that of you know animals or humans okay human body is a robust system it has what we call redundant pathways you know we're not made to eat carbohydrates but we eat them because you know their environments you can encounter in an environment in which they have redundant pathways you know you can metabolize directly you can eat sugar if you want them and okay all right a lot long term but short term you can do these things we also have spare parts an extra kidney an extra stuff all right we which is the exact opposite of that by the way redundance is the exact okay we have redundant pathways and we have redundant organs and we have written the function the same function can be performed by two different organs often or the same organ can perform more than one function all right nature build things in a very robust ways it seems very inefficient for an economist but its robust that's what I mean by robustness it's okay to leave the house because you have some sense of some said we'd measure these risks type one randomness we know them right you can be careful and you can eliminate like 90% of your daily risks you know that right by number one if you stop smoking or smoke yeah if you just stop smoking you you you have more you use the MOR to the health your health or if you stop me from smoking the health of the community then every single medical discovery intervention last 60 years okay five years so so if you don't smoke don't ride a red vest bar as I do okay all right don't ride the motorcycle all right and don't fly a plane unless you're a professional pilot okay okay and then a few minor other things don't drink of Saudi Arabia all those things okay some rules if you observe these rules all right you've eliminated most of your right I mean you pretty much have the money most of your risk in a very effective way but more generally in the last 40 or 50 years there really has been a really strong push to ring redundancies out of the system right we've tried to make companies as efficient as lean as possible companies that carry a lot of cash people don't like that they want you know leverage have more debt etc etc we also have much greater connectedness so we have these supply chains that reach across the world which are very efficient very how do we you your argument is if this has made us while it may have made us more efficient it also makes us much more ultimately fradulent yeah in a way you think efficiency means cost savings right all right but you're not saving cost you just come it's like what Bernanke idea of low risk is you have a little more cash on a daily basis but you're gonna spend more if you have a snack you know if you have snack yes it's efficient on days when we don't have an accident right to me the best way to solve the problem is to close down finance departments because it's almost everything they teach you think Oh funny experiments in universities yeah because everything they teach is backwards all right they analyze your earnings per share they don't look at the risk and when they use of risk adjustment they use a Gaussian distribution all right and they use metrics that don't work ok I mean business schools are very good your computer science business law or counting yes it's very good but don't teach them what they teach them in finance because everything is backwards it keeps from debt they teach them to optimize you know something called to optimize and they teach them a lot of the wrong things so how do you how do we actually move toward a more what you would see as a more robust well number one you don't want government to try to restore confidence because in the age of Internet you could no longer control the crowds all right so you want to be immune to that robust of that ok so the rules are number one load that the financial eyes is the economy automatically ok ok and the banking problem disappears because you know what banks are there for not to issue equity it doesn't make any money right to stuff you I did it was Greece with some swap or long term something like that or quasi didn't that recruit event so if you reduce debt that automatically just means it's just like something smoke stuff in smoke right reduces risks immediately the second thing eliminated derivatives complex derivatives keep the products that don't require formulas I've been trading for 100 some years a third thing III suggested was eliminate moral hazard is very easy to automate other I'll never make you out you want to take all the risk you want I'm gonna have to make sure they have no externalities you can pay each other bonuses as much as you want it's your problem but whenever society is involved all right no moral hazard another one of my rules is don't give a drug addict more or heroin all right even if he has withdrawal pains and we're facing now with Rob's it easily deficit the deficit this year deficit or what the governor is doing so coherent to tell people listen you have to watch that what you spend more how you want to spend more and they tell banks you have you know your balance sheets are to leverage why you want to do men get funding I don't understand this thing the forecasting impulse seems to be kind of universal right it's very hard not to predict and certainly very hard for policymakers not to in some sense rely on so so how do we get around that if there's no problem let them predict all they want okay if you have less debt you can make mistakes and that's the keys I think yourself your bus to the possible but exactly robust to the incompetent okay yeah to the incompetence of Larry Summers to the incompetence of all these forecasters okay make yourself or a bus to that okay it's much easier to focus that people didn't get from our Black Swan is don't try to predict black swans all right right just make sure that you're robust so it happened in the Black Swan you talk about the possibility of posit we've been talking about our disaster yes you talk also about the possibility of positive black swans do they exist in economic life I mean is it or is it primarily one where it's a positive Black Swan for individuals basic no I don't know me when you have that you've eliminated the impact of positive black swans just like for a company all right the bank doesn't have positive like Swan a venture capital firm has bothered Black Swan okay it's a bank when good things happen just the way it's supposed to be an end but exactly I don't have a event okay so the Black Swan is gonna hit the bank and heard it right the black swans like you to hit the research firm and either be harmless or helpful all right so yes society's a little bit of money but make huge exactly exactly so society if we lowered that would be closer to that situation so you want society more like a venture capital firm then I want society because now we can afford to not make as much GDP right to be more robust and more open to up side you

Channel: The New Yorker

Views: 4,598

Rating: 4.8461537 out of 5

Keywords: New Yorker Currents, Nassim Nicholas Taleb, James Surowiecki, 2008 financial crisis, economy, politics, culture, now, current

Id: Y_NqImYe3eI

Length: 20min 16sec (1216 seconds)

Published: Tue Jul 22 2014