[Spyro7]

Dr. Taleb's book, Black Swan, was a truly interesting treatment of long-tail statistical events and how humans perceive said events. It is unfortunate to see him indulging in so much hand waving in this article.

"For banks that have filings with the US Securities and Exchange Commission, the sum stands at an astounding $2.2 trillion...... is directly transferred from the American economy to the personal accounts of bank executives and employees"

I don't understand where this number is coming from. According to the data from the 2007 Economic Census[1], the U.S. commercial banking sector employed (approx) 1.6 million employes and compensated them with a total payroll of (approx) 95.8 billion dollars. Total payroll for the finance and industry industries is $502 billion for 6.2 million employees.

What is this $2.2 trillion that he is referring to? In his opening statement, he makes it sound as if this amount is direct compensation, but the actual numbers for the industry make that figure seem unlikely. (I am not an accountant, but I seriously doubt that some type of compensation that doesn't appear on the annual payroll is going to make up the bulk of that difference.)

"That $5 trillion dollars is not money invested in building roads, schools, and other long-term projects"

First of all, this $5 Trillion dollar number is a projection, and projections need to be analyzed critically[2]. Second of all, this is wrong (as pointed out by yummyfajitas elsewhere in this thread). So long as money is not being (quite literally) stuffed into a mattress, it is doing something in the economy. Now whether that something offers benefits over opportunity cost may be a product of market failings and questionable regulations, but that can hardly be blamed on the banking industry.

"It is (now) no secret that they have operated so far as large sophisticated compensation schemes, masking probabilities of low-risk, high-impact \“Black Swan\” events and benefiting from the free backstop of implicit public guarantees."

I think that it is disingenuous to paint the entire industry as being composed of individuals out to cheat the system. I think that it makes more sense to note the behavioral economics at work.

A disturbing number of financial institutions were making money from home mortgage loans. Any financial industry not doing so would be left out of the crowd. Regulations allowed for massive leveraged financial positions to be taken in the market. Financial companies became more and more aggressive (after all, the models say everything is fine, and if we don't play along shareholders will question our financial performance). The bottom fell out and everyone got clubbed (but some worse than others).

There is no great, malevolent force working in finance. The industry was governed by (and possibly still is) some pretty lackluster regulations, but it is a questionable premise to paint the entire industry as willfully fraudulent.

"it also has provided secret loans of $1.2 trillion to banks."

Activity by the Fed is not "secret" but rather it is a matter of public recored: http://www.federalreserve.gov/

(Or, more specifically: http://www.federalreserve.gov/releases/h41/current/h41.htm )

"We don’t believe that regulation is a panacea for this state of affairs. The largest, most sophisticated banks have become expert at remaining one step ahead of regulators"

This is not really the case. It is more the case that the regulators are often underpaid (relative to what they could make in the private banking industry) and over-worked (due to staffing cuts). This creates an accelerated revolving door between the public and private spheres. This revolving door makes it very hard to get any good regulations out of our current institutions.

"A well-functioning market would produce outcomes that favor banks with the right exposures, the right compensation schemes, the right risk-sharing, and therefore the right corporate governance."

A well-functioning market would favor the banks that offer the best risk-return ratios. Now whether or not the measure of risk is correct will only be obvious in hindsight, but market outcomes are a product of aggregate information on a grand scale. Exposures, compensation schemes, risk-sharing... These are not the kind of factors that are rewarded in a free-market (unless his definition of well-functioning is some variation of central control).

If you want to institute a change in the incentives within the finance and banking industry, just institute a very, very small transactions tax. This would decrease the viability of trading for its own sake (make enough trades fast enough, have a slightly more than random number of successes, and profit).

It wouldn't fix everything, but if you are a critic of the current structure of the industry, then a small transaction tax is the thing that is most likely to move the industry further away from the temptation to function like a glorified roulette wheel.

I'm not even going to address the problems with Dr. Taleb's proposed solution to problems in the banking industry (last three paragraphs of the article). It makes no sense.

[1] 2007 is the most recent data available. It is not the most up to date (the banking sector is likely a bit smaller now), but it is worth using some actual facts and figures. Direct access here (industry code 522110 for commercial banking): http://factfinder.census.gov/servlet/DatasetMainPageServlet?...

[2] http://xkcd.com/605/

[gavanwoolery]

Respectfully, I think you are overanalyzing something that is very simple.

1) Humans are very good at cheating the system. In fact, we are built to cheat, and we have come up with amazing ways of cheating and scamming people out of their money. To ignore this is to ignore hard facts that are right in our face.

2) Most people are honest. But it only takes a few dishonest people to do a lot of damage. And with the right amount of money, you can get away with anything in this country.

3) Corruption is the most seductive activity you can engage in with your clothes still on.

4) It goes beyond conspiracy at this point - we can literally see money transferring hands. Is it not funny that almost everybody was against the bailouts, but the govt. green flagged them regardless? Is it also not a bit strange that every past Secretary of Treasury for the past few decades has been affiliated with Goldman Sachs?

As for free markets and regulation:

Do you believe in evolution? I do. Evolution gets a LOT of things wrong in the beginning, but in the end, it usually produces pretty ideal designs. Evolution is what happens when you have an environment free of artificial contraints.

Likewise, I think that the best economy will be produced by many mistakes, and learning from them. One thing I am pretty sure we will learn is that no corruptible entity should ever control an economy, because corruption is always the end result. (All hail our new robot overlords :D)

And I will just leave this here: http://en.wikipedia.org/wiki/Friedrich_von_Hayek I'm sure you have probably read up on this guy.

[Spyro7]

I appreciate your thoughtful reply. While I am making the transition to a web developer at the moment, I have a graduate degree in Economics and I have spent some time working in the investment industry (Main St, not Wall St). I would just like to share an alternative viewpoint with you:

1) I wouldn't think of it as "cheating the system", but I would think of it as rational self-interest. Given a set of constraints, people will optimize for the best personal outcome.

2) People maximize their utility (utility is a measure of happiness). Whether someone is honest or dishonest is nothing more than a preference input into their utility maximization functions.

What this means is that if the punishment for breaking some law is exceeded by the benefits (to the individual) of doing so, then that individual will break the law. Think about how many people casually drive 5 to 10 miles over the speed limit (or 20 to 30 down here in Texas).

With that said, whose dishonesty is responsible for the housing collapse:

* Were the homeowners dishonest for taking on loans they could not afford to pay back?

* Were the lenders and real estate agents dishonest for making the loans to the home owners?

* Were the finance guys responsible for thinking that risk could be mitigated using the tools of finance?

* Were the investors being dishonest for cheering on returns that were above market-average without considering the risk?

Painting a market with the brushes of corruption and dishonesty does very little to advance an understanding of how the event happened and what can be done to prevent it in the future.

4) Professionals with an understanding of the financial industry were generally in favor of the bailouts. The government listened to the professionals.

Goldman Sachs hires a lot of economists and finance guys, and they hire the people with the best resumes. One should hardly scream conspiracy if it turns out that some of these "cream of the crop" individuals end up working in the treasury. Statistically, the probability of it happening randomly is actually quite high.

"Likewise, I think that the best economy will be produced by many mistakes, and learning from them."

I completely agree with this.

"One thing I am pretty sure we will learn is that no corruptible entity should ever control an economy, because corruption is always the end result. (All hail our new robot overlords :D)"

There is no need for us to resort to robots. We simply have to understand that people are self-interested and build a system that channels this self-interest into outcomes that are efficient for society as a whole.

"And I will just leave this here: http://en.wikipedia.org/wiki/Friedrich_von_Hayek I'm sure you have probably read up on this guy."

Hayek was an amazing logician, but the application of his theories to the modern economy is unproductive. The questions that he asked have been answered by modern economics in the 50 years that have passed since he asked them.

I consider myself an advocate for breaking down the wall that exists between modern economics and people that would like to increase their understanding of modern economics without being economists themselves. If you have anything that you would like to ask me about anything that I wrote above (or any of Hayek's specific points), then I would be happy to answer them (regardless of the beating that my karma takes).

[gavanwoolery]

Thank you for your thoughtful response to my response :)

As for who was responsible - I agree that finger-pointing and conspiracy does not really get us anywhere. In fact conspiracy is the least of my concerns...I am more concerned about the money that is being handed out in plain sight.

When it comes down to it, you cannot pin responsibility on any one party, but one thing did happen as a result, and some of this result was intentionally manufactured. That end result is the poor/middle-class getting poorer, and a few (transparently) dishonest people getting richer. But worst of all, a huge blow was taken on the economy that is affecting everybody, including the (honest) wealthy classes.

You can trace the beginning of the recession back 15 years or so. The funny thing is that people try to point fingers at Democrats or Republicans exclusively, while both parties have done their fair share of damage. And even US citizens have done a lot of damage, but there is a difference between being reckless and being naive. The former describes the people who leveraged debt, the latter describes your average US home buyer.

When it comes down to it, maybe no one was singularly responsible, but that does not really matter. What matters is that wealthy owners of private organizations were given tax-payer money. Executives were given golden parachutes even though their companies were bankrupt - guess who paid for these? Tax payer money was funneled into private companies with the purpose of "saving" them, only to have them trade as junk stock within a few months. Honest people were given mortgages that would soon turn into foreclosures - no one's fault, but I think they should be the people bailed out, not these corporations.

[iand]

"There is no need for us to resort to robots. We simply have to understand that people are self-interested and build a system that channels this self-interest into outcomes that are efficient for society as a whole."

Here's the difficulty that Hayek was pointing out in his book Road to Serfdom. Who gets to decide what the right outcomes are and whether they are efficient?

[Spyro7]

"Who gets to decide what the right outcomes are and whether they are efficient?"

Whether or not an outcome is "right" is subjective, and is more in the field of law and philosophy than economics.

Whether or not an outcome is efficient for society does not need to be determined as it can be measured. An outcome is efficient for society if it makes at least one individual better off without leaving any other individuals worse off. (This is Pareto efficiency).

Of course in the real world, there will almost always be winners and losers with any policy change. The solution is thus to make sure that the total net benefits of any policy change is positive.

The net benefits are the benefits (both implied and explicit) of a policy minus both the costs of doing the policy and the costs of potential gains that could have been had by pursuing alternative policies. Both the costs and the benefits should be aggregates that include the costs and the benefits to all parties affected by a policy.

One thing that I think is worth thinking about when you look at recent developments in the markets is this. From the time period of roughly the 1950s to roughly the 1980s this form of detailed cost-benefit analysis was popularly employed by both governments and private companies. (I am not actually this old, but I have heard this story multiple times from economists considerably more seasoned than me).

Unfortunately, starting in the 1980s, a more expedient form of cost-benefit analysis that focuses mostly on the immediate costs and benefits to the organization conducting the analysis began to dominate. This type of analysis was championed by the finance and accounting oriented economists that began to spring up at around this time. (Disagreement over this and other issues led to university economics departments around the nation dividing from business departments and finding a new home - and less funding - with the liberal arts and social sciences.)

It is expensive and time-consuming to conduct a thorough impact analysis, so I can understand why the more academic approach would fade away in favor of something more expedient. However, I think that a lot of the recent problems we see in governance can be traced to this fast-food economic analysis:

* Lack of investment in infrastructure? - Well, this report on my desk says that it will be expensive to fix those roads and the ones we have now seem to be holding up just fine

* Internet providers want to throttle bandwidth based on its source? - Makes sense, according to this report on my desk providing bandwidth obviously costs money - why not charge for it?

* A tax on transactions? - Well, this report on my desk says that would make it more expensive to trade stocks - there's no way this could be beneficial.

While the right answers to many of these questions can be found either in economic journals or by speaking with an independent consultant, policymakers rarely have the enthusiasm for a topic to dive so deeply.

I hope that soul-searching due to the financial meltdown brings the old approach back in favor. It is sorely missed.

[wnight]

> 1) I wouldn't think of it as "cheating the system", but I would think of it as rational self-interest. Given a set of constraints, people will optimize for the best personal outcome.

In doing so they did break a number of laws, isn't that "cheating"?

But despite the technicalities, the point of it is that any adult could look at the results of their actions and decide that because they would produce negative outcomes for society that they should stop doing them, regardless of laws.

If these were Montana hermits hiding from civilization I'd cut them a break but these are giant institutions demanding not only legal protection from people trying to reclaim their funds, but bailouts as they hold our economy hostage.

> With that said, whose dishonesty is responsible for the housing collapse: > * Were the homeowners dishonest for taking on loans they could not afford to pay back? > * Were the lenders and real estate agents dishonest for making the loans to the home owners? > * Were the finance guys responsible for thinking that risk could be mitigated using the tools of finance? > * Were the investors being dishonest for cheering on returns that were above market-average without considering the risk?

Yes.

But the bankers who saw the big-picture were more dishonest and more responsible than the mortgage pushers and the investors who both should have known it was too good to be true, and all of them more responsible than the consumers who we don't actually expect to be actuarial experts, who did what their bank and society were encouraging them to do.

But yes, to the degree that they couldn't read that fine-print and educate themselves appropriately, then lobby to change things, they are ultimately responsible as they are where the government derives its mandate - to the degree that it does.

> Painting a market with the brushes of corruption and dishonesty does very little to advance an understanding of how the event happened and what can be done to prevent it in the future.

The reality is corruption and dishonesty, painting that picture is the only reasonable thing. Yes, we do need to understand that humanity is rife with the willingness to lie for gain, but we don't have to embrace it and treat it as okay just because it's normal.

"Normal" in that context is a branch up-side the head and the other guy is "right". But we strive for more than that, and need to be held accountable when we hurt others by failing.

We need reality-based finance, which assumes every other player is Mallory or Eve. Like with security.

> Goldman Sachs hires a lot of economists and finance guys, and they hire the people with the best resumes. One should hardly scream conspiracy if it turns out that some of these "cream of the crop" individuals end up working in the treasury. Statistically, the probability of it happening randomly is actually quite high.

Not at all. You approach it like working for or against corruption is the flip of a coin. Most people who'd go into regulatory agencies for reasons the public would approve wouldn't be interested in an industry job after. The fact that there's such a crossover only goes to show the positions are being held by amoral defectors.

[pradocchia]

I don't understand where this number is coming from. According to the data from the 2007 Economic Census...

Then go check the SEC filings. If they refute Taleb's numbers, bring in the Census as corroborating data.

I think that it is disingenuous to paint the entire industry as being composed of individuals out to cheat the system. I think that it makes more sense to note the behavioral economics at work.

This is precisely what happened, though. The large investment banks went public and externalized their risks. 10 years of bonuses (privatized profit), then a big blowup (socialized loss). Was it planned that way? Does it matter?

By contrast, private partnerships never developed as much exposure or lost as much money, since they could not externalize risks to the same degree.

I bet you worked for an LLC, no?

There is no great, malevolent force working in finance. The industry was governed by (and possibly still is) some pretty lackluster regulations, but it is a questionable premise to paint the entire industry as willfully fraudulent.

Why not? Because you were once involved in investment management yourself, and you are a good & decent person, and therefore the industry as a whole must be comprised of similar people and follow similar patterns of behavior and judgement?

This is not really the case. It is more the case that the regulators are often underpaid (relative to what they could make in the private banking industry) and over-worked (due to staffing cuts). This creates an accelerated revolving door between the public and private spheres. This revolving door makes it very hard to get any good regulations out of our current institutions.

So you think paying regulators more would somehow auto-magically deal with regulatory capture? Seriously?

[Spyro7]

"Then go check the SEC filings."

Which ones? There are quite a few companies in the finance industry. If we are going to paint them as good guys and bad guys, then it is important to note that those are subjective criteria.

"This is precisely what happened, though. The large investment banks... Was it planned that way? Does it matter?"

Well, if your objective is to tar and feather people then I would suppose that it is important to find a villain.

However, if your objective is to understand what happened and how it could be prevented, then I think it is important to ask if something was planned or if it was a product of a flawed system. I can understand why you may disagree with me.

"Because you were once involved in investment management yourself, and you are a good & decent person, and therefore the industry as a whole must be comprised of similar people and follow similar patterns of behavior and judgement?"

No, actually quite the opposite. Please read my reply to another gentleman here:

http://news.ycombinator.com/item?id=2962088

If you have any questions, please ask me, I would be happy to discuss with you (regardless of the beating that my karma would likely take).

"So you think paying regulators more would somehow auto-magically deal with regulatory capture?"

There is no magic solution for regulatory capture, but the disparity in pay is a glaring problem. People respond to incentives.

Right now, many people view regulatory agencies as a career springboard to higher paying positions within the large investment banks. If the pay at the regulatory industries was more in line with what an individual with a similar background would earn elsewhere, then that would dramatically decrease this effect.

While we are talking about fixes, one more possible fix would be to dramatically restrict the creation of derivatives, because their complexity exceeds their usefulness as financial instruments at this point in time.

These are the types of things that would be useful to talk about. Dr. Taleb has both the knowledge and the breadth of experience to talk about them. Unfortunately, he chooses to focus the majority of his influence on labeling people within the banking industry as ethical and moral evildoers. (South African apartheid? Really? I find the implied analogy to be disgusting.)

[more_later]

Taleb says $2.2 trillion is for 5 years - which is ~5*505B (total payroll for finance as per your information). So, it looks ok to me.

[corysama]

Taking Spyro7's estimate of 6.2 million employees in the financial industry that comes out to $2,200,000,000,000 / 5 years / 6,200,000 people = $70,968/year salary per person. Sounds like a lot less of a robbery when you divide it out.

[jurjenh]

That is a bail-out salary from the tax payer! I'd say that's a pretty hefty robbery, I believe it is well above the average per-capita income, so for most people this is more than a year's wages handed to them by the government.

[corysama]

Guess that's what I get for doing math with no context. Thanks for the reminder to RTFA.