The International Herald and Tribune reports a surge in shanty towns in US cities, reminiscent on a smaller scale of 1930’s era ‘Hooverville’ Shanty Towns. The newly foreclosed and jobless are making a simple tent home on vacated land in major American towns.
Meanwhile, Barry Ritholtz covers The Future of Finance Initiative in Washington D.C. attended by Nicholas Nassim Taleb. Taleb is an expert on risk, and as an option trader made millions during the current market collapse. An ardent critic of the mathematics behind the pricing of derivative products (in particular Value-At-Risk, and Black-Scholes), Taleb argued that you can’t have both high leverage and high efficiency. Efficiency is already a form of leverage, in combination with debt it drastically reduces any margin for error. Taleb explains
“A highly efficient system removes slack and magnifies small changes. Think of the efficient system as a high-performance aircraft. Each minute of steering input creates a rapid and violent shift of course, speed, or altitude. The system itself is souped up even before you add the debt. Once you do, the pilot is equally jacked up and twitchy, creating an explosive combination. Now imagine that fighter jet trying to fly in a 1,000-plane formation, and you get an idea of the world financial system in the 21st century.”
Highly efficient and highly leveraged
The implications for our society are plain. Individuals loaded up on debt, in the US and the UK they stopped saving entirely (Charlie McCreevy’s SSIA scheme probably saved the Irish), across the Anglo-phone world workers lived pay cheque to pay cheque, borrowing and spending leaving no slack in the system. However, when the pay cheques stop the debt becomes unserviceable, the house purchased with loan is repossed and the workers end up in one of the new shanty towns with their families.
For the financial system Taleb argues that we can’t undo the technology & the just-in-time algorithms that lead to the efficiencies, that leaves us with the debt.
“A deleveraged financial system is a stable one, especially if we increase the redundancy within the system. That’s an idea Taleb has taken from biology. But in finance, redundancy means two things: not having players in the game who are “too big to fail” and not allowing anyonefrom the individual to the institutionto play with too much money. Redundancy means have cash on the side, not risking it all, and not becoming dependent upon financial assets for your economic well-being.”
Did the attendees agree with Taleb? According to The Big Money, no. Like on this side of the pond the Zeitgeist is that the cure for too much debt, is more debt (government debt this time). Of course there are dissenting voices…
No bio, some books worth reading – The Rational Optimist: How Prosperity Evolves – Matt Ridley .
Crisis Economics: A Crash Course in the Future of Finance -Nouriel Roubini, Stephen Mihm