Taleb

All posts tagged Taleb

One of my favorite investors, Nassim Nicholas Taleb, founder of Empirica investment management funds and author of Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets, was recently quoted on Bloomberg advising every single human being to short the US Treasury bonds. While this news is about a week old, I thought I’d still comment on it given the fact that it’s a pretty strong statement and that I recently exited a similar paired-trade.

Taleb said investors should bet on a rise in long-term U.S. Treasury yields, which move inversely to prices, as long as Bernanke and White House economic adviser Lawrence Summers are in office, without being more specific. Nouriel Roubini, the New York University professor who predicted the credit crisis, also said at the conference that the U.S. dollar will weaken against Asian and “commodity” currencies such as the Brazilian real over the next two or three years.

The Fed and U.S. agencies have lent, spent or guaranteed $9.66 trillion to lift the economy from the worst recession since the Great Depression, according to data compiled by Bloomberg. Bernanke, who in December 2008 slashed the central bank’s target rate for overnight loans between banks to virtually zero, flooded the economy with more than $1 trillion in the largest monetary expansion in U.S. history.

President Barack Obama has increased the U.S. marketable debt to a record $7.27 trillion as he tries to sustain the recovery from last year’s recession. The Obama administration projects the U.S. budget deficit will rise to a record $1.6 trillion in the 2011 fiscal year.

“The problem we have in the United States, the level of debt is still very high and being converted to government debt”, Taleb said in an interview with Bloomberg Television. “We are worse-off today than we were last year. In the United States and in Europe, you have fewer people employed and a larger amount of debt”.

Moody’s Investors Service Inc. said on Feb. 2 that the U.S. government’s Aaa bond rating will come under pressure in the future unless additional measures are taken to reduce budget deficits projected for the next decade.”.

Do I believe him? Absolutely. So why did I exit my highly profitable trade? Several reasons. During times of global economic uncertainity, there has always been a flight to quality. We saw this during the financial meltdown in 2008, where US Treasury prices soared and yields tanked. Right now, there is uncertainity in Europe regarding the debt of Greece, Portugal, Ireland, and Spain. People are worried this might have lasting consequences on the Euro as a viable currency. These fears are probably overblown, but until everything settles down and we have more clarity, there will be a flight to quality, which means that people will sell the Euro and flock to US Treasuries.

At least thats my hypothesis and I sold all my positions (except Berkshire Hathaway), shorted the Euro and also the S&P500. The one thing I didn’t do is go long the US Treasuries, since inherently I feel Nassim Nicolas Taleb is correct. At some point, I’ll most likely re-enter my short US Treasury trade, but in the meanwhile I happy to see how the European Union handles the issues of excessive debt.

Here’s a reprint from an article that appeared in the Financial Times today by one of my favorite author’s Nassim Nicholas Taleb. I first mentioned Taleb in the post Its Official: Hell Freezes Over. If you are unfamiliar with his work, definitely check out Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets. It’s one of those life-enriching books (in a geeky sort of way).

Ten principles for a Black Swan-proof world

By Nassim Nicholas Taleb

Published: April 7 2009 20:02

1. What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.

2. No socialisation of losses and privatisation of gains. Whatever may need to be bailed out should be nationalised; whatever does not need a bail-out should be free, small and risk-bearing. We have managed to combine the worst of capitalism and socialism. In France in the 1980s, the socialists took over the banks. In the US in the 2000s, the banks took over the government. This is surreal.

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

4. Do not let someone making an “incentive” bonus manage a nuclear plant – or your financial risks. Odds are he would cut every corner on safety to show “profits” while claiming to be “conservative”. Bonuses do not accommodate the hidden risks of blow-ups. It is the asymmetry of the bonus system that got us here. No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.

5. Counter-balance complexity with simplicity. Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products. The complex economy is already a form of leverage: the leverage of efficiency. Such systems survive thanks to slack and redundancy; adding debt produces wild and dangerous gyrations and leaves no room for error. Capitalism cannot avoid fads and bubbles: equity bubbles (as in 2000) have proved to be mild; debt bubbles are vicious.

6. Do not give children sticks of dynamite, even if they come with a warning. Complex derivatives need to be banned because nobody understands them and few are rational enough to know it. Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.

7. Only Ponzi schemes should depend on confidence. Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.

8. Do not give an addict more drugs if he has withdrawal pains. Using leverage to cure the problems of too much leverage is not homeopathy, it is denial. The debt crisis is not a temporary problem, it is a structural one. We need rehab.

9. Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised. We should learn not to use markets as storehouses of value: they do not harbour the certainties that normal citizens require. Citizens should experience anxiety about their own businesses (which they control), not their investments (which they do not control).

10. Make an omelette with the broken eggs. Finally, this crisis cannot be fixed with makeshift repairs, no more than a boat with a rotten hull can be fixed with ad-hoc patches. We need to rebuild the hull with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.

Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news.

In other words, a place more resistant to black swans.

The writer is a veteran trader, a distinguished professor at New York University’s Polytechnic Institute and the author of The Black Swan: The Impact of the Highly Improbable

Last week, hell froze. The Financial Times reports:

In a rare unplanned investor call, the bank revealed that a flagship global equity fund had lost over 30 per cent of its value in a week because of problems with its trading strategies created by computer models. In particular, the computers had failed to foresee recent market movements to such a degree that they labeled them a ‘25-standard deviation event’ – something that only happens once every 100,000 years or more.

“We are seeing things that were 25-standard deviation events, several days in a row,” said David Viniar, Goldman’s chief financial officer.

Losses in the Goldman fund could go over $1.5 billion. But heck, everyone makes mistakes. And even a great mathematician such as James Simons, founder of Renaissance Technologies, takes a loss from time to time. Simons used to do math for the Pentagon. Then, he discovered that he could make billions running a math-based hedge fund. But last week, Simons was forced to write a letter to his investors. His fund lost about 9% in the first few days of August…and now Simons says, “we cannot predict the duration of the current environment.

So apparently, math whizzes find they don’t know which way the market is going, despite all their fany financial modeling and risk calculation and mitigation through the use of derivates.

No matter what kind of math you do, sometimes things take you by surprise.

According to Nassim Nicholas Taleb’s latest best seller, The Black Swan: The Impact of the Highly Improbable , improbable events with infinitely small odds of occurrance seem to occur every so often, especially in the financial markets. And with disastrous results!

And if this wasn’t enough, Sentinel Management Group, with $1.6 Billion under “management” has frozen access to Money Market Accounts!
According to the Chicago Tribune,

“If you attempt to withdraw money from Sentinel, they will tell you they will not honor that request,” said lawyer Jeffrey Barclay, who represents some of the futures brokers and investment pools whose money is frozen at Sentinel.

With $1.6 billion under management, Sentinel had advertised itself as an ultrasafe cash manager for people in the futures industry, corporate treasurers and well-to-do individuals.

Now the company is saying nothing publicly and has taken down its Web site. “We are not taking any media calls,” said a person who answered the phone at Sentinel on Wednesday.

What is the world coming too?

Related Readings:

1. The Black Swan: The Impact of the Highly Improbable

2. Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets

3. When Genius Failed: The Rise and Fall of Long-Term Capital Management