Too Fucked to Bail

From Nassim Nicholas Taleb writing for the NYT:

I have a solution for the problem of bankers who take risks that threaten the general public: Eliminate bonuses.

More than three years since the global financial crisis started, financial institutions are still blowing themselves up. The latest, MF Global, filed for bankruptcy protection last week after its chief executive, Jon S. Corzine, made risky investments in European bonds. So far, lenders and shareholders have been paying the price, not taxpayers. But it is only a matter of time before private risk-taking leads to another giant bailout like the ones the United States was forced to provide in 2008.

The promise of “no more bailouts,” enshrined in last year’s Wall Street reform law, is just that — a promise. The financiers (and their lawyers) will always stay one step ahead of the regulators. No one really knows what will happen the next time a giant bank goes bust because of its misunderstanding of risk.

Instead, it’s time for a fundamental reform: Any person who works for a company that, regardless of its current financial health, would require a taxpayer-financed bailout if it failed, should not get a bonus, ever. In fact, all pay at systemically important financial institutions — big banks, but also some insurance companies and even huge hedge funds — should be strictly regulated.

What would banking look like if bonuses were eliminated? It would not be too different from what it was like when I was a bank intern in the 1980s, before the wave of deregulation that culminated in the 1999 repeal of the Glass-Steagall Act, the Depression-era law that had separated investment and commercial banking. Before then, bankers and lenders were boring “lifers.” Banking was bland and predictable; the chairman’s income was less than that of today’s junior trader. Investment banks, which paid bonuses and weren’t allowed to lend, were partnerships with skin in the game, not gamblers playing with other people’s money.

Hedge funds, which are loosely regulated, could take on some of the risks that banks would shed under my proposal. While we tend to hear about the successful ones, the great majority fail and their failures rarely make the front page. The principal-agent problem they have isn’t a problem for taxpayers: Typically their investors manage the governance of hedge funds by ensuring that the manager is hurt more than any of his investors in the event of a blowup.

I believe that “less is more” — simple heuristics are necessary for complex problems. So instead of thousands of pages of regulation, we should enforce a basic principle: Bonuses and bailouts should never mix.

The ramifications of the last crisis was that a failing and failed system was saved, pretty much intact. Yes — changes have been made around the fringes — the end of prop trading, the promise to later implement the Volcker rule.

But the big picture is that very few lessons were learned: the leverage stayed, the algorithmic trading stayed, the casino mentality stayed, and the huge web of interconnected derivatives stayed. state-owned and bailed-out banks have continued paying bonuses far in excess of anything payed to public servants. 2010 was a record year for Wall Street pay.

Is there anything that can address systemic fragility — the core problem — in a system wracked with the greatest debt burden in history? I don’t mean to be fatalistic — and I think we need to try Taleb’s measure — but I think that even a ban on bonuses would be gamed around by the vultures and vampires and cannibals.

I am concerned that the only thing that will really regulate this new hyper-leveraged, hyper-fragile global market is its self-destruction — where “too big to fail” metastasises into “too fucked to bail”, and the entire system collapses, the residual debt is erased, and the system has to be rebuilt from scratch.

8 thoughts on “Too Fucked to Bail

  1. I have a solution for the problem of bankers who take risks that threaten the general public: Eliminate bonuses.

    then we’ll have again this problem within another industry, like housing, and all others that got bailed out together with banks… it is central planning via interest rates that should be eliminated..

    • Mantrid: Taleb is aware of the Austrian school, but i think he is looking for something practical in this current environment. I agree that central planning and resulting malinvestment are the problem — they are what fuels all the interconnected debt superstructure which knocks the system into freefall if a “too big to fail” bank goes under.


      Simply the problem is not “bonuses” so much as it is systemic looting. Ban bonuses and the bonus junkies will simply skirt the issue by calling “bonuses” something else, delivering them through another mechanism. The financial world has become corrupted via addiction to gambling with other people’s money, and the only thing that can reliably stop a compulsive gambler is huge, painful , crippling losses.

      Further, banning bonuses won’t do anything to address the systemic fragility that I am convinced is the underlying problem here.

      I wrote last month:

      Not only did the bailouts disable creative destruction (the engine of innovation and social progress), they also created so much debt that they have already damaged the ability of future generations to save, invest and innovate.

      Worse, they did nothing to address the fundamental fragility of the system. All of that interconnected debt means the system is still fragile to a default cascade, which means that if the system is to be “saved” again, it will require more bailouts and more debt-acquisition, further eroding the ability of taxpayers to save and invest, as governments tax and inflate the currency to pay down the debt.

      I expect future generations to look back on this episode as a bizarre aberration. America — surely the greatest producer and innovator in the history of human civilisation — forgot how markets work and the notion of creative destruction, forgot that an empire dependent on hostile partners (i.e. China and the Arab world) is hugely fragile, and then forgot the fact that America emerged as a superpower as a direct result of its status as a great creditor and manufacturer, and that the old European empires lost their superpower status through loss of productivity and massive debt acquisition.

  2. Gee, you don’t even need to have gone to school to understand how incentives influence behaviour. Clean your room for 10 bucks? Make it twenty and its a deal. Bad incentives create bad behaviour. How could this possibly be difficult to comprehend?

    The problem as always is ‘other people’s money’. There’s less risk but greater reward in commissions for fund managers. The risk/reward balance is distorted in favour of risk, so its no wonder people get burnt.

    In a world of finite resources, stupidity is a bottomless glass.

  3. These bonuses are rightfully earned in this environment. What can a bank loose? Even complete bankruptcy is the loss of N in assets and M in potential gains from “normal” activity. With the kind of leverage banks live on now, if they gamble right – they win percentage not from N but 10N or more. With bailouts bankruptcy is not an option and losses are actually even smaller. It is most rational for every bank to employ best gamblers and pay them millions for even the smallest gains in win/loss ration they can provide.

    If you cut the money for top gamblers it has nothing to do with the problem. Well maybe some of these people are really talented and would be beneficial for some other undertaking than bank-gambling?
    Banks will still do it, just without pro-gamblers. They will have whoever they can get for the money do the same thing. Maybe slightly worse, say 2% more likely to bet wrong and put the bank down the drain… oh my bad, sorry. Not put the bank out of business – but have it loose some money and get bailed out.

    If govt wanted to fix the problem (it doesn’t – he’s co-inventor of this scheme) it can do it easily. Don’t reinstate Glass-Stangel but repeal fractional reserve banking! If a bank wants it’s credit to be labeled the same as money – it has to have 1:1 reserve and not a cent less. If they want leverage – no problem, but for all purposes credits they issue should be marked as what they are – promises from certain institution. If you get 1mln$ loan from a fractional reserve bank you DON’T get 1mln$. It’s polluted by risk of this bank going under. And it’s fine, maybe it’s worth it? At least you know what you bought. You know this bank is rated AA+ so you can assume 4% covers the risk and get to business. However now – all our money comes from fractional reserve banking and entire system is polluted. Not only this, but average consumer is oblivious to the problem and no preparations are made for VERY REAL risks associated with fractional reserve. We’ve built entire city in a depression near an ocean, because land there is more fertile than in highlands. Cool… but why there are no flood controls and everybody keeps saying that we actually live above sea level?

    • The problem with getting rid of fractional reserve banking is that there is such a massive web of debt already in existence that creditors just won’t accept it, because they won’t get the pound of flesh they are currently owed. I believe that changing the banking system requires some kind of systemic collapse, and the erasure of the debt.

      Even then, I think that the instant gratification of fractional reserve banking and Keynesian money printing (debtors get the debt cut by inflation, creditors usually get paid off in printed money) makes it very attractive to most participants in the economy, even if it weakens the system as a whole.

      • No need to quote yourself 😉 I read your blog for some time now and know your broader view of that issue.
        My point is – that cutting bonuses is pointless. Even if it’s done right and it really turns the screw on banks management it doesn’t change banks incentives. People may feel this, but institutions will still be in the same environment.

        As for entire Keynsian model being extremely seductive i can not agree more. In light of this school of thought govt’s expansion gets great justification and it is in fact encouraged to finance expanding with borrowing! More power now. Plain and simple. Whoever pays it will be in years and you may well not get elected at that point. Though in current climate I’m afraid we are not going to learn from this incoming crisis. How many people do you know that blame less strict regulations / or general greed of capitalists for those who see this as a problem in fundamental govt policy? When depression 2.0 hits and blame game begins we do get a chance, as people will be likely to study the problem at least a little deeper, but I wouldn’t hold my breath. I’d say there’s still equal chance for revival of nationalism/ or some kind of neo-communism as for a comeback of freedom.

        • How many people do you know that blame less strict regulations / or general greed of capitalists for those who see this as a problem in fundamental govt policy?


          I’d say there was significantly more chance of nationalism and neo-communism or dirigisme than the return of liberty. The Chinese/German statist modesl are gaining credit as something that “works” while Western corporatism (erroneously called the “free market”) fails.

          As you say and as I have said myself before we will get a chance when Depression 2.0 hits. I think our best chance is making the wider public aware that we live in a statist mess, and that we do not live under freedom or capitalism, and that in fact capitalism and freedom was the system that facilitated the growth of America, the greatest economy in the history of the world (before the statists took it over and abandoned freedom in the period from the crash of 1907 through the creation of the Fed, the Depression, Bretton Woods, and the abandonment of Bretton Woods).

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