Chris Dillow: Taleb vs Economists

Over at Stumbling and Mumbling Chris Dillow asks important questions: "Were banks risk managers really that bad? Are bosses an order of magnitude stupider than even I had thought? Or is something else happening?" The answers seem to be, some risk managers likely were "really that bad" others were just playing the game, knowing that when the music stopped they hopefully will have a sack of cash piled up that will tide them over until they can find another game. Same true for managers. Same true, by the way, for politicians and government agency heads and subordinate bureaucrats. What else is happening? Part of this mess is brought about by herd effects, people being squeezed, or believing they are, then selling out of (earlier "buying in to") hedge funds, 401Ks, IRAs, etc thus forcing fund managers to do what they wouldn't do in normal times. Beyond that, you tell me. To Dillow:

Taleb vs Economists, Chris Dillow, Oct 14: Everyone seems to be hailing Nassim Nicholas Taleb as the man who saw the crisis coming. I have a problem with this. It's not that what Taleb says about risk is wrong. Quite the opposite. It just strikes me as trivially true.

We've known for ages that returns are non-Gaussian, that extreme events are more common than a normal distribution predicts, and that risk can't be quantified simply, if at all. The Black Swan, then, was just an entertaining if a little egocentric way of telling us what we already knew.

So, when I read in it (p43) that bankers "are not conservative at all; just phenomenally skilled at self-deception by burying the possibility of a large, devastating, loss under the rug" I thought: "But surely they've learnt from statistics and experience by now. Their risk management can't be as terrible as Taleb claims. I know bosses are stupid, but they can't be this gibberingly, imbecilically, carpet-chewingly, moronically cretinous, can they?" I suspect most economists thought my way.

It looks like we were wrong and Taleb right.

But this isn't because Taleb had any great insights into the nature of risk. It's because he thought banks' risk managers were idiots, whilst economists didn't think so - not even me.

In doing this, however, we were just following economists' standard procedure - of assuming that agents were if not rational then at least not wholly stupid.

For me, all this is very troubling.  It suggests that what we economists have to learn from Taleb has nothing to do with the nature of risk – we've all known that - but about others' rationality. We should ditch the assumption - which in a sense is mere courtesy - not only that others are rational but even the weaker assumption that they are nearly so. Perhaps we should indeed regard them merely as "empty suits."
But this is a vastly greater departure from standard practice than anything Taleb has suggested about the nature of risk.

All of which leaves me genuinely puzzled. Were banks risk managers really that bad? Are bosses an order of magnitude stupider than even I had thought? Or is something else happening? Help me.

More on Taleb:

Taleb Outsells Greenspan as Black Swan Gives Worst Turbulence, Bloomberg, Stephanie Baker-Said, March 27

Comments

[mtd]

I think Taleb says following: If we look at distribution functions on most of economic variables (including stock values), we should find that the values are distributed non-gaussian way (see Mandelbrot for more detail). But most economic and stock models are created around assumption of gaussian distribution of variables.

So, basically, Taleb says that most economists are idiots because they believe into the model more than into the reality.

[Timothy]

You seem to be forgetting that the managers of the 'system' were given a strong incentive to enter into risky behavior via large gains over short periods of time. They were not managing risk, they were managing their own bonus pools.

I think think current perverted attempt by these inept managers to provide themselves bonuses from public bailout money defines their sociopathic character.

Executives in the US are lower than the muggers or drug dealers , yet they are to be rewarded? And the nonsense claim of 'losing talent' in an economic recession is laughable. What they really mean to say, is that they have already been so grossly overpaid, they can simply retire with their ill gotten gains.

Please, let's unleash the noose and gallows. These people are criminals.

[Seamless]

Bailout 2008, a poem by David Jeffrey

Like a bloodied warrior,
laying broken and torn.

Like a dying soldier, hopeless and forlorn.

But the blood, it be green,
the color of money.

And the soldier is an economy,
and it is anything but funny.

Broken are it's people and shattered are their dreams.

Thanks to the ultra rich and their full proof schemes.

It is a tragedy with more pain to come.

Finance will be Hell, and their wills will be done.

[dunnage]

Great to see someone else recognize that Black Swan was a mud hen in disguise.

Bankers are mostly conservative. Bank of Canada charts Commercial vs. "Investment" bank use of leverage. Commercial banks don't swallow, Investmant players do.

As far as brains, well there really are none once you've drunk the Supply Side Kool aid. My favorite is "excessive unemployment" -- even guys that think they are liberal like Krugman believe, and it has to be a belief, in a "natural level of employment". Long Term Capital didn't teach anybody anything. Now did these folks figure they were getting carried away and maybe screwing some people? Sure, but loading the dice is standard while getting carried away is euphoric. Look around, most of these folks still don't have a clue today.

Looking forward to the Fear. The Big9TF probably need a couple Trillion more.

[E.L. Beck]

Bankers were enablers of the crisis, but I won't get into their intelligence at risk management. I will, however, get into the intelligence of those at The Fed. From 1989 to 2004, The Fed's own household surveys showed the bottom 80 percentile of households gaining mere single-digit percentage increases in income, while households increased their debt loads by triple-digit percentages. Someone should have noticed this trend couldn't continue indefinitely.

I provided the pertinent numbers in my December 8 post, in simplistic fashion:

http://www.the-small-r.com/the-small-r/blog/Entries/2008/12/8_Entry_1.html