•Taleb Says Governments Should Let Big, Complex Firms `Creatively Destruct'

[ByLoSellHi]

http://www.bloomberg.com/apps/news?pid=20601087&sid=a_ll9FxmPM6Y&pos=7

Governments Should Let Firms ‘Creatively Destruct,’ Taleb Says
Share Business ExchangeTwitterFacebook| Email | Print | A A A

By Mary Childs and Lynn Thomasson

Nov. 3 (Bloomberg) -- Companies that become too big, complicated and debt-ridden should be allowed to “creatively destruct,” said Nassim Nicholas Taleb, author of “The Black Swan.”

Governments shouldn’t rescue firms that become too big to fail because that rewards incompetent actions and adds to deficits, Taleb said today. When regulators become involved in the financial system, they tend to protect the largest businesses, he said.

“Why is it on land you don’t have an animal bigger than an elephant?” Taleb asked at the Aspen Institute’s “Capitalism and the Future” forum at the New York Public Library. “Because Mother Nature knows it’s too big to fail.”

Taleb is a professor of risk engineering at New York University and a principal at Universa Investments LP, a $5 billion hedge-fund firm focusing on protecting investors against stock-market crashes and hyperinflation. He argued in “The Black Swan: The Impact of the Highly Improbable” that history is littered with events that can’t be predicted by trends. The best-selling book came out in 2007 before the global credit crisis sparked an economic slump and $1.66 trillion of losses.

“Companies, when they get too big, become fragile,” Taleb said. “You have rising complexity and rising fragility. At some point that’s going to blow.”

He said that if companies go bankrupt to get rid of debt instead of being bailed out by the government, there will be less incentive to take excessive risk.

“We’re not destroying debt,” Taleb said. “When you move it into the government, it stays in the government and that’s a problem.”

To contact the reporters on this story: Mary Childs in New York at mchilds4@bloomberg.net; Lynn Thomasson in New York at lthomasson@bloomberg.net
Last Updated: November 3, 2009 21:43 EST

 

[achilles28]

The argument against allowing bank failures is "systemic risk".

That one bank can bring the rest down, like domino's.

That argument is simply wrong.

As of 2008, the largest 10 American banks had capital assets worth 8.5 Trillion.

Total sub-prime mortgage debt - the entire basis for the collapse - was 1 Trillion dollars.

Even if every sub-prime borrower went bankrupt (they didn't), maximum losses are 1 Trillion dollars.

Bank of America or JPM could absorb that entirely, themselves.

"Too big to fail" is just a mantra repeated by the ignorant to justify their faith in the traditional explanation.

They don't know why banks are 'too big to fail', they just know they are!

 

[ambienCR]

Quote from achilles28:

The argument against allowing bank failures is "systemic risk".

That one bank can bring the rest down, like domino's.

That argument is simply wrong.

As of 2008, the largest 10 American banks had capital assets worth 8.5 Trillion.

Total sub-prime mortgage debt - the entire basis for the collapse - was 1 Trillion dollars.

Even if every sub-prime borrower went bankrupt (they didn't), maximum losses are 1 Trillion dollars.

Bank of America of JPM could absorb that entirely, themselves.

"Too big to fail" is just a mantra repeated by the ignorant to justify their faith in the traditional explanation.

They don't know why banks are 'too big to fail', they just know they are!

interesting, but you are forgetting the deriviative shake and bake chop chop shops that have pushed the figures--- the domino is indeed probable.

 

[achilles28]

Quote from ambienCR:

interesting, but you are forgetting the deriviative shake and bake chop chop shops that have pushed the figures--- the domino is indeed probable.

Exactly.

The only logical source of additional losses over that 1 Trillion figure, give or take, is derivatives.

That knowledge alone makes all this Government intervention entirely suspect.

Why?

The largest sellers of derivatives contracts (insurance policy writers), were large Banks and Investment Banks. Wallstreet.

It wasn't the smaller guys and regionals selling Credit Default Swaps. It was JPM, Citi, Goldy, Bear, BoA etc.

All the Sellers of those Credit Default Swaps wrote insurance contracts on big, speculative banks/investment banks that were long-heavy subprime.

So if a few Lehmans went down, those Credit Default Swaps come due, and the large Big Banks who insured their solvency have to pay out many multiplies of that bankrupt firms debt to its Bond holders.

That's the argument for "Systemic risk", in a nut shell, correct?

That argument is simply wrong because a ton of small and regional banks exist with little-to-no subprime exposure AND never wrote Credit Default Swaps. These banks are well-capitalized, have very little toxic exposure, and, by all means, are extremely "healthy"!

Even if 25 Trillion in derivatives contracts came due in a nightmare scenario, the contagion is limited only to the banks who wrote Credit Default Swaps. The Top 5 Banks (Bank of America, Citi, JPM, Wachovia etc) and Wallstreet get liquidated for the most part, and CDS buyers get 40-50 cents on the dollar.

That's where it ends.

Nobody pays the 25 Trillion because the insurers never had it. They only had 10 Trillion between them, so they pay it. Close up shop, sell the furniture and that's it.

The smaller banks become regionals and the regionals become the next Citi or Bank of America.

The World Does Not End. Capitalism Works.

Knowing that Credit Default Swaps (derivatives) were the hidden-culprit behind this entire meltdown, what's the implication here for Government who, instead of acting to void, break and outlaw those contracts to save the Taxpayer Trillions in payouts, chose not to, but to honor those contracts, saddle the Taxpayer with literally 3-5 Trillion in debt, and, as a direct result, save Wallstreet from Chapter 11? Who wins, here? Who loses?

Also, where did the money go?

All we hear about is losses on derivatives contracts. But derivatives are zero-sum. For every seller who lost, there was a buyer who won. So who got the money? And why hasn't any Company reported windfall income from owning Credit Default Swaps, knowing that several Trillions have been paid out, thus far?

 

[Lethn]

More and more "Too big to fail" honestly seemed like more of a threat by the banks to me than a fact. The only way they could be too big to fail is if they had the power to cause as much destruction as possible because they went under.

I think I just discovered where America's 'spoiled brat' foreign policy syndrome comes from.

 

[Misthos]

Quote from achilles28:

All we hear about is losses on derivatives contracts. But derivatives are zero-sum. For every seller who lost, there was a buyer who won. So who got the money? And why hasn't any Company reported windfall income from owning Credit Default Swaps, knowing that several Trillions have been paid out, thus far?

You neglect the amount of leverage used with those derivatives. The numbers were probably astronomical, and as such, would have been akin to letting a mountain of dynamite "self explode." The deflationary effects would have been awesome.

"The world does not end, Capitalism works..." I think ignores the secondary, tertiary, etc... effects of such an implosion.

 

[achilles28]

Quote from Misthos:

You neglect the amount of leverage used with those derivatives. The numbers were probably astronomical, and as such, would have been akin to letting a mountain of dynamite "self explode." The deflationary effects would have been awesome.

"The world does not end, Capitalism works..." I think ignores the secondary, tertiary, etc... effects of such an implosion.

I don't think you read my post.

I said, that if Banks were left to fail, Wallstreet would be forced to liquidate themselves to make good on their contracts. The equivalent payout being Trillions of dollars.

There's no deflationary pressure, except from the natural economic fallout and recession.

Money paid out from credit default swaps doesn't get destroyed. It gets transferred.

Its not principle on a bank loan. Its real cash money that changes from one hand to the next.

Can you clarify exactly what you mean? I found your post rather ambiguous.

 

[Misthos]

Quote from achilles28:

I don't think you read my post.

I said, that if Banks were left to fail, Wallstreet would be forced to liquidate themselves to make good on their contracts. The equivalent payout being Trillions of dollars.

There's no deflationary pressure, except from the natural economic fallout and recession.

Money paid out from credit default swaps doesn't get destroyed. It gets transferred.

Its not principle on a bank loan. Its real cash money that changes from one hand to the next.

Can you clarify exactly what you mean? I found your post rather ambiguous.

I don't think you're looking at this at a macro level. I mean 30,000 feet in the air.

From the Cleveland Fed:

"The answer lies in the complexity of the market for the securities that were derived from subprime mortgages. Not only were the securities traded directly, they were also repackaged to create more complicated financial instruments (derivatives), such as collateralized debt obligations. The derivatives were again split into various tranches, repackaged, re-split and repackaged again many times over. This, most likely, was one of the mechanisms that amplified problems in the subprime securitized market, and the subsequent subprime-related losses. Each stage of the securitization process increased the leverage financial institutions were taking on (as they were purchasing the securities and derivatives with borrowed money) and made it more difficult to value their holdings of those financial instruments. With the growing leverage and inability to value the securities, uncertainty about the solvency of a number of large financial firms grew."

Source: http://www.clevelandfed.org/research/commentary/2009/0509.cfm

Your view only focuses on the two parties involved in a CDS type transaction. I'm taking the bigger view - who lent against the derivative, how many times was it traded, sliced and diced, how often was it leveraged, and how big is the entire web of derivatives, especially CDS.

And don't forget, we even have SYNTHETIC CDOs! I mean really, this market got a little out of hand.

If the top 5 banks imploded, they would have taken down countless hedge funds, private equity firms, municipalities, pension funds, and many many other banks.

The credit destruction would have been enormous.

Think it thru - there is a web of financial transactions between parties globally - tug on one string of a spiderweb, and the WHOLE thing moves.

Just my view, I could be wrong. The notional numbers of all derivatives are astronomical - and I understand that notional is taken frequently out of context. Nonetheless, the actual numbers have to be rather large as well - nobody knows the exact amount - but I think it's mind boggling.

 

[achilles28]

I'll write back tonight, Mithos.

Nap time