Taleb : Convert debt to equity, stimulus packages repeating the mistakes of the bubble era

In article in yesterday’s Financial Times Risk experts Nassim Nicholas Taleb and Mark Spitznagel argue that our economic system is laden with too much debt (triple the debt to GDP levels of the 1980’s) and that the government stimulus packages which rely heavily on additional borrowing risk repeating the errors of the recent past. They argue that the large deficits increase the likelihood of hyper-inflation.

Instead they argue the solution is to transform debt (where risks are hidden) into equity (where the risks are more visible). In addition they argue that equity is more robust than debt, the bursting of the dot.com bubble did not cause the same levels of distress within the financial system.

In making this argument, they are echoing sentiments recently expressed by Irish economist, and chief merchant of doom, Morgan Kelly. In a recent article in the Irish Times he argued NAMA is a mistake and better solution would be to transfer ownership (equity) to the bond holders (current owners of debt) .

From the FT –

The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action. Banks would turn from “hopers”, hiding risks from themselves, into agents more engaged in economic activity. Hidden risks become visible; hopers become doers.

It is sad to see that those who failed to spot the problem (or helped to cause it) are now in charge of the remedy. Just as the impending crisis was obvious to those of us who specialise in complexity and extreme deviations, the solution is plain to see. We need an aggressive, systematic debt-for-equity conversion. We cannot afford to wait a day.

FT article