Thursday, May 31, 2012

Taleb: Antifragile, and anti bankers bonuses

I never thought a presentation peppered with words like ‘stochastic’ and ‘heuristic’ would make me laugh out loud, but such is the talent of Nassim Taleb. Best known for his book, The Black Swan, he is on the road discussing his forthcoming book Antifragile: Things That Gain from Disorder. He is also an advisor to Universa LLP, an investment management firm that specializes in convex tail hedging. I attended his talk in Toronto yesterday as a guest of Horizons, who have just launched the Horizons Universa Canadian Black Swan ETF and the Horizons Universa US Black Swan ETF, the first ETFs that pair a tail risk hedge with an equity index investment.

Continuing the theme of the Black Swan (hard to predict events that have an extreme impact), Taleb’s new work is on fragility. “You can’t predict rare events, but you can tell who is going to blow up when rare events happen. It’s about vulnerability to extreme events.”

He began the presentation by asking the audience which was more efficient, a book or a Kindle. We agreed that it was the Kindle. However, pour water on a Kindle and it’s done for. The book – not so much. His point? You cannot have gains in efficiency without offsetting losses in robustness. There’s nothing wrong with going with ‘more efficient’, as long you accept this will also be ‘more fragile’. And the opposite of fragile? Not robust or strong, but antifragile – something that actually benefits from disorder. In the world of investing for example, debt might be fragile, equity might be robust and venture capital might be antifragile.

Taleb has been outspoken in his criticism of bankers, and suggested that the financial industry ‘needs to be bar belled’. He went on to explain that those who take risk should bear the cost of that risk. The system as it currently stands is skewed in that when the risk pays off the bankers benefit, but when things go wrong, bankers don’t suffer to the same extent, viz. J.P. Morgan’s Ina Drew. Those who can be bailed out by taxpayers should not take any risk at all. He was categorical, “Bankers should not take risks with taxpayer’s money.” And going one step further, he was firm in his view that ‘nothing linked to bonuses should be guaranteed by the taxpayer’ as bonuses encourage gaming results for short term payoffs.

Referring to the Code of Hammurabi, Taleb suggests that in today’s world, the risk gets hidden in the basement while the architect is far away, and the solution is in law 229 ‘If a builder build a house for some one, and does not construct it properly, and the house which he built fall in and kill its owner, then that builder shall be put to death.’ He quickly added that he meant this metaphorically only.

I have not been able to do justice to Taleb’s humorous anecdotal delivery. I encourage you to watch the video clips in the sidebar. Many commentators have addressed the issues of banker’s compensation, but none in such a common sense manner.

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