Nassim Taleb and the Ubiquity of Moral Hazard

Nassim Taleb would be the first to tell you that the runaway success of his books was an utterly unpredictable black swan event. You might or might not believe him — but in his interview today with Lloyd Grove, there’s a datapoint which more or less proves it outright: Taleb’s books sell three times as many copies in the UK (population 61 million) than they do in the US (population 304 million).

This is a function of the snowball effect: people read what other people are reading. Taleb has lucked in to being one of the top beneficiaries of the snowball effect in the UK.

The fact that there is a snowball effect is not a black swan at all — in fact, it explains why the baseline for any regularly-updated blog is a steady increase in its readership. But in the UK, 200,000 books are published every year. You know that a very small percentage of them will snowball; which books exactly will snowball is random.

Elsewhere in the interview, Taleb says that he was prescient about Fannie Mae, when he was quoted in a NYT article by Alex Berenson. The article’s worth reading, in hindsight, because Taleb was pretty vague — talking about Fannie Mae relying on computer models which can’t model black swans. Berenson, by contrast, was very specific about exactly what risk Fannie was facing — interest-rate risk. And he explicitly downplayed Fannie’s default risk, which turned out to be the thing which brought the company to its knees:

To buy those mortgages, Fannie Mae raises money by selling bonds. It makes money on the spread between the interest it receives on the mortgages and the interest it must pay on its debt.

That business plan seems relatively safe, since people typically do not default on their mortgages.

So there’s an irony here, which Taleb is alert to. He says that he wishes he could have warned people about Fannie earlier, but the fact is that if Fannie had taken Berenson’s concerns seriously, it wouldn’t really have helped. They would have beefed up their hedging against interest-rate risk, and they would still have been left wide open to default risk — the unexpected black swan. As Taleb says later on in the interview:

The thing you have to be aware of most obviously is scenario planning, because typically if you talk about scenarios, you’ll overestimate the probability of these scenarios. If you examine them at the expense of those you don’t examine, sometimes it has left a lot of people worse off, so scenario planning can be bad. I’ll just take my track record. Those who did scenario planning have not fared better than those who did not do scenario planning. A lot of people have done some kind of "make-sense" type measures, and that has made them more vulnerable because they give the illusion of having done your job. This is the problem with risk management. I always come back to a classical question. Don’t give a fool the illusion of risk management.

In a weird way, however, Fannie’s risk management did make sense. In our financial system, all the truly enormous negative black swans are, ultimately, insured by the government. It’s not just Fannie which has an implicit government guarantee: if a big bank or a big insurer or a big fund manager suddenly implodes, then the government is very likely to somehow step in and fix things. With Fannie, the risks of the government having to do so were if anything more understood than they were with, say, Bear Stearns or LTCM or the S&L crisis or even the Mexican debt crisis of 1994. If you can’t make black swans go away, that just means that you can’t make moral hazard go away either.

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