Black Swan wants debt swapped for equity

July 14, 2009

Nassim Taleb, the Black Swan, co-authors an op-ed in today’s Financial Times.  In it he proposes wide-scale debt for equity swaps in order to recapitalize the economy:

The core of the problem, the unavoidable truth, is that our economic system is laden with debt, about triple the amount relative to gross domestic product that we had in the 1980s. This does not sit well with globalisation. Our view is that government policies worldwide are causing more instability rather than curing the trouble in the system. The only solution is the immediate, forcible and systematic conversion of debt to equity. There is no other option.

He’s right about the core of the problem.  Goldman Sachs notwithstanding, the financial system is insolvent.  Remove government supports and it would collapse.  To properly recapitalize it, debt for equity swaps make fantastic sense.  But it’s a fantasy to believe this can be done from on high, by executive or legislative fiat.

Fortunately, we don’t need to do this.  We already have a tried and true legal method for dealing with overindebtedness.  We call it bankruptcy.  Bank creditors should be on the hook for the trillions of dollars of losses that have either been absorbed by taxpayers or completely ignored via accounting shenanigans.  Bankruptcy filings are the best way to achieve that.

Of course widespread bankruptcies will be exceedingly painful, which is why policy-makers have tried to forestall them with bailouts.  In our financial system, where credit is money, every unit of wealth is the mirror image of a unit of debt.*  Write off units of debt, which is what happens with debt for equity swaps, and you destroy units of wealth.  This is the essence of debt deflationary spirals.

Economists are very right to worry about such spirals.  But they are very wrong if they think their prescription–more debt, via fiscal and monetary “stimulus”–will avoid it.  It’s these prescriptions that got us here in the first place.  More of the same only compounds the problem.

Dealing with the debt is the only way out of this crisis.  There isn’t a painless way to do it.  The sooner we get to it, the better.


*Consider your bank statement.  The balance at the bottom is just a number on a piece of paper.  What does that number represent?  Money the bank promises to give you if you make a withdrawal.  But where is that money?  Only a fraction of it has been kept in reserves in the vault.  The lion’s share has been lent out to borrowers.  If borrowers stop paying their debts to the bank, your money is gone.  Debt is written off, wealth disappears.


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All this is just fine unless it’s YOUR money in the bank that is no longer there. Do you really think the FDIC is solvent and will cover the vanished money?

Posted by shelley | Report as abusive

The “vanished” money will be covered by printing. The FDIC is already a joke.

There’s going to be inflation one way or another.

Posted by Aaron Krowne | Report as abusive

For an economist you don’t seem very savvy with how the monetary system works. Bank’s DONT lend money. They extend credit. They also come good on the credit when requested – but that is them coming good on their debt – as is the same if you were a saver or ‘borrower’.

You have a quaint view on ‘reserves’. They dont keep a little back and lend the rest out. They keep ALL of it back. They use the reserves to settle THEIR debts. The reserves dont leave the central banking system except as benjys.

Posted by Joe Bloggs | Report as abusive