How can we de-risk the economy?

By Felix Salmon
May 5, 2009

The first panel at the New Yorker Summit featured Nassim Taleb and Bob Shiller. Shiller was placed, uncomfortably, in the role of defender of the status quo, saying that experts can be useful, that economics is a good thing, and that even the SEC has good people who are actually succeeding in making the world a better place.

Taleb, of course, has no time for such things: he said that economists crashed the economy, and that one shouldn’t give them the opportunity to crash it again. In a nutshell, Taleb says that we have far too much debt: “our level of debt is an indication of our faith in experts”, he said, adding for good measure that “debt creates instability and wars”.

Taleb’s solution is a massive conversion of debt to equity, not only in the corporate world but also in the world of housing. That, he says, “would restart the economy on a solid basis”, and he’s even weirdly hopeful that it wouldn’t make investment banks rich.

Shiller liked that idea, and said that there is a proposal out there that systemically important financial institutions issue regulatory convertible debt, which automatically converts to equity on a regulatory event. Is that related to Steve Waldman’s IACCPE? I think they’re close cousins, in any event, and that more thinking along these lines is a very good idea.

But Taleb goes much further. He said that bank runs are much more dangerous now than they were in 1980, because they’re much more instantaneous, and that therefore even 1980 levels of debt “are intolerable today”:

We have to be a lot more careful going forward, because we have globalization, the internet, and operational efficiency — which cannot accommodate debt.

It’s a compelling story, which has zero chance of being adopted by bankers, regulators, politicians, or CFOs. Taleb’s a very useful person to have around, taking a corner position, but the likes of Shiller and Waldman are better at being more constructive when it comes to sketching out how we can react in the real world.

8 comments

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Yes!!! Debt for equity, that is exactly what has to be done. How can economists and policy makers and corporate executives not see this? Too many businesses can not afford to service the debt they have with their current or future level of business.

Creditors who refuse to accept equity need a visit from the ghosts of Detoit future, where they see what happened to GM’s and Chrysler’s bondholders.

Posted by KenG | Report as abusive

But what if Taleb is right? Are “the likes of Shiller and Waldman…more constructive” if Taleb is right?

Posted by Daily Coase | Report as abusive

Taleb could be right, but the costs of implementing his plans are higher than just allowing financial crises to occur every so often. Restricting credit, and reducing the operational efficiencies of financial institutions (code for making them hold more money) will reduce growth in the economy.

The costs of reform cannot be ignored and should be the #1 factor, more accurately, cost/benefit analysis should. Put it this way, it is so expensive to buy earthquake insurance here in Los Angeles that most people don’t bother. It’s cheaper just to let the earthquake happen and then rebuild. I think people should realize that our economic system undergoes systemic shocks every so often. It’s like living in Los Angeles, earthquakes are part of the landscape and come along with the sunshine and lifestyle.

The “regulatory convertible debt” idea evolved from a paper “Rethinking Capital Regulation”, by Anil Kashyap and Raghuram Rajan at the University of Chicago and Jeremy Stein at Harvard, presented at the Jackson Hole conference last August.

Interesting. I would like to have been there for this. I think Taleb is onto something.

The most well-known “regulatory convertible debt” proposal actually came from Mark Flannery originally, in a 2005 book called Capital Adequacy Beyond Basel.

Here’s a copy of Flannery’s chapter proposing the RCD instrument: http://www.cba.ufl.edu/fire/docs/publish edpapers/Published_RCD_Chapter.pdf

Everyone who might be construed as being for the status quo should probably get smart and start sounding like Bob Shiller. The shrill nonsense (yeah, I am talking about you Cliffy the Clown) just makes your inanity more obvious. Bob kind of wants to save you all, so do be his friend.

Posted by Mean Mister Mustard | Report as abusive

You mean in the “real world” of too big or too connected to fail? Economists serve to rationalize the existing money flows to the top 1/2% of richest criminals. I’m sure Taleb knows railing against the stupid but highly remunerative status quo is pointless, but bless him for trying.

“Give me control of a nation’s money and I care not who makes her laws.”
Mayer Amschel Rothschild

Posted by Bigelow | Report as abusive