Nassim Nicholas Taleb wrote an open letter today to British Conservative leader David Cameron saying:
I despair of the Obama administration’s ability to fix this financial crisis and prevent future ones. I am appalled by the dangers it has been creating and its takeover by the same economic establishment responsible for this crisis…
Be careful, too, of the so-called science of economics. Economists have been no better in their predictions than cab drivers. We have an “expert” problem, in which the expert provides you with misplaced confidence, but no information. Because we think, correctly, that the dermatologist, the baker, the chemist are true experts (they know more about their respective subjects than the rest of us), we swallow the canard that the economists at the International Monetary Fund, the World Bank, the Bank of England and the US Federal Reserve are also experts, without checking their record. This reliance on faux experts is, for the most part, what got us here. Now it is continuing with the build-up of government deficit and an increased reliance on flimsy forecasts by the Obama administration.
This problem with experts was particularly acute when it came to the “risk models” on which bankers built those positions that turned sour. So it is that you are coming under pressure to provide more regulation. Alas, the need for more regulation is a myth. I have been fighting risk models both as a Wall Street trader and as a professor and my worst nightmares were the results of regulators. It was they who promoted the reliance on ratings by credit agencies. The “value-at-risk” models regulators promoted made us take more risks…
We replaced the heuristics of the elders with arrogant (and incompetent) beliefs, breaking, in the name of science, the chain of knowledge. Old, conservative bankers and traders have been replaced by keen young mathematical analysts, yet anyone who listened to a grandmother who survived the Depression would have been warned against debt and been better prepared than Ben Bernanke and Alan Greenspan, respectively chairman and former chairman of America’s Federal Reserve.
The solution is obvious: build an economy that increases the role of well-tested traditions. Ban financial derivatives that require advanced mathematics rather than trial and error. Look at mother nature. There is a complex system built around sound principles that has insured both evolution and survival. It does not let anything get too big to fail. It breaks things early. I don’t understand why people who stand against tampering with nature accept tampering with the economy that would have organically grown too. Work on building a “robust” society, capable of withstanding errors, in which the role of finance (hence debt) would be minimal. We want a society in which people can make mistakes without risk of total collapse. Silicon Valley offers a good example, where people have the chance to fail fast (and repeatedly).
The best blueprint is the very opposite of the Obama administration’s economic policies … It has been administering pain-killers without addressing the cause of disease. Obama is strengthening those who do the wrong thing. Take the “cash for clunkers” programme. It is a handout to those who bought the wrong – uneconomic – car. He is penalising people who did not make a mistake. The same applies to other “rescues”. By raising taxes after the crisis, the administration is hampering evolution. Those who do well in difficult times end up paying more tax and those who lost money in the crisis pay less. The rich who got us here are being rescued by regular Joes and being subsidised by the tax system.
Obama is giving the large institutions that failed us, like the IMF and the World Bank, even more powers. He is increasingly dependent on the visionary expert who failed us and does not understand the properties of complex systems and stifling long traditions of wisdom in understanding risk. Just consider the players: Larry Summers, director of the National Economic Council (who, among other things, made both Harvard University and the banking system more fragile), Bernanke (who increased reliance on the error-prone “models”) and Tim Geithner, secretary of the US Treasury (who failed to understand that property prices can take extreme deviations).
For background on why modern economists got it so wrong, see this.