How to Prevent Other Financial Crises [Taleb]
March 29, 2012 Leave a comment
By Nassim Nicholas Taleb and George A. Martin
This article argues that the crisis of 2007–2008 happened because of an explosive combination of agency problems, moral hazard, and “scientism”—the illusion that ostensibly scientiﬁc techniques would manage risks and predict rare events in spite of the stark empirical and theoretical realities that suggested otherwise. The authors analyze the varied behaviors, ideas and effects that in combination created a ﬁnancial
meltdown, and discuss the players responsible for the consequences. In formulating a set of expectations for future ﬁnancial management, they suggest that ﬁnancial agents need more “skin in the game” to prevent irresponsible risk-taking from continuing.
Let us start with our conclusion, which is also a simple policy recommendation, and one that is not just easy to implement but has been part of history until recent days. We believe that “less is more” in complex systems—
that simple heuristics and protocols are necessary for complex problems as elaborate rules often lead to “multiplicative branching” of side effects that cumulatively may have first order effects. So instead of relying on thousands of meandering pages of regulation, we should enforce a basic principle of “skin in the game” when it comes to ﬁnancial oversight: “The captain goes down with the ship; every captain and every ship.”
In other words, nobody should be in a position to have the upside without sharing the downside, particularly when others may be harmed. While this principle seems simple, we have moved away from it in the ﬁnance world, particularly when it comes to ﬁnancial organizations that have been deemed “too big to fail.”