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Why our financial decision-makers need ‘skin in the game’

Economic contrarian Nassim Taleb warned of a coming financial crisis more than a decade ago. Now he believes there’s a big con going on, and that the Federal Reserve’s response to the 2008 crash is part of it. Economics correspondent Paul Solman catches up with Taleb to discuss his new book, “Skin in the Game” and hear his latest concerns.

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  • Judy Woodruff:

    This year marks the ten years since the financial crash of 2008, which started with a demise of the investment bank Bear Stearns. Few people saw the crash coming, but economics correspondent Paul Solman did discuss the possibility, with, among others, writer and investor Nassim Taleb.

    Paul recently caught up with Taleb again to hear his latest concerns for our weekly series, "Making Sense".

    (BEGIN VIDEOTAPE)

  • Paul Solman:

    Back in 2006, when he was a hedge fund owner, economic contrarian Nassim Taleb warned of a coming financial crisis in his then soon-to-be- published book, "The Black Swan".

    As I understand it, your central insight is that people underestimate the likelihood of rare events.

  • Nassim Taleb:

    Exactly. And my idea is twofold. One, number one, that rare events happen more often. And, two, that, when they happen, they're far more devastating than we can imagine.

  • Paul Solman:

    More than a decade later, Taleb believes there's a big con going on right now, and that the Federal Reserve's response to the 2008 crisis is part of it.

    So what's the point of the new book?

  • Nassim Taleb:

    Unless a person owns his or her risk, the system will eventually collapse.

  • Paul Solman:

    The whole system?

  • Nassim Taleb:

    The whole system.

  • Paul Solman:

    The book is "Skin in the Game", which argues that a financial system works only if the people who are running it have a stake in the outcome.

  • Nassim Taleb:

    And you should build a society in which people who make decisions, all right, are eventually penalized if something goes wrong.

  • Paul Solman:

    Taleb's gripe with both big government and big business these days: that the decision makers pay no penalty.

  • Nassim Taleb:

    It's that rise of the class, the no-skin-in-the-game class in decision-making. People who intervene in Iraq and thinking, hey, we're going to bring democracy, or some abstract concept. The thing falls apart, and they walk away from it.

    In the financial world, we have the same class, a lot of bankers, for example, has not been reduced by the crisis. And as a matter of fact, they were compensated.

  • Paul Solman:

    What risk are they posing to us now?

  • Nassim Taleb:

    The system is loaded with debt that has benefited these bankers. The chairman of a certain bank now is making $23 million a year again in bonuses.

  • Paul Solman:

    That would be Jamie Dimon of JPMorgan Chase, and his 2017 bonus was actually $28 million, $5 million in cash and $23 million in restricted stock tied to performance.

    The CEOs of the other megabanks weren't far behind. Bank of America's Brian Moynihan and Citigroup's Michael Corbat each got $21 and a half million stock bonuses. And Tim Sloan of scandal- plagued Wells Fargo got a $15 million in stock.

    But the point is, says Taleb, none of them had skin in the game, and they continue to proceed risk-free.

    But if I'm a manager, CEO of a company and I have stock options, then I am punished if the stock goes down.

  • Nassim Taleb:

    No, not really, because you still have upside, net-net, you have upside.

  • Paul Solman:

    You mean I'm never going to be compensated. I'm never going to have money taken away from me.

  • Nassim Taleb:

    Exactly, whereas the taxpayer only has a downside. The taxpayer will never have the benefit of what's going on, but we pay the price as taxpayers, in case something goes wrong. Now —

  • Paul Solman:

    Because we're going to bail them out?

  • Nassim Taleb:

    Of course, so we are really — we are — the people who are owning the risk. If people can make money transferring risk to others and aren't penalized, then you will have — the system will blow up. It's very dangerous, and it's unfair, and it's immoral.

  • Paul Solman:

    But wait a second. Didn't the Federal Reserve — the institution charged with saving the banking system — actually save it, by creating new money through so-called quantitative easing?

  • Nassim Taleb:

    The Federal Reserve tried to cure debt with debt, transferring debt from one to the other, from the private to the public.

  • Paul Solman:

    What you mean is that that Federal Reserve has created several trillion dollars —

  • Nassim Taleb:

    Yes,

  • Paul Solman:

    — and that's money that eventually the American public, at least in concept, in theory, is going to have pay back?

  • Nassim Taleb:

    Exactly. Those who caused the crisis are rich today.

  • Paul Solman:

    But didn't the Federal Reserve pour money into the system and keep it going and prevent the very paralysis that you were worried about.

  • Nassim Taleb:

    No, that was Novocain.

  • Paul Solman:

    You told me in 2008, you said we could be back to barter. It could be worse, I could quote you. You said it could be worse than the Great Depression back to the American Revolution.

  • Nassim Taleb:

    Let me tell you, in 2008, what it should have done is immediately try to convert debt into equity, make sure those that caused the crisis were penalized, not regular people. I would like the Federal Reserve to understand that interest rates, very low interest rates, quantitative easing, drove people into higher end assets and stocks. Who benefited from it? People who owned a lot of stocks and people who owned real estate.

    We haven't really remedied what caused 2008. There's still a lot of debt in the system.

  • Paul Solman:

    So, how do we protect ourselves?

  • Nassim Taleb:

    I'm not telling you what to do. I'm going to tell you what I'm doing.

  • Paul Solman:

    Yes, what are you — that's what I want to know. What are you doing to protect yourself against the black swan?

  • Nassim Taleb:

    What I'm doing is I have a share of my money in currency.

  • Paul Solman:

    Foreign currency, that is.

  • Nassim Taleb:

    Maybe about 35 percent. Plus, I have some money that I spend to protect myself from crazy rise in interest rates. It may not happen, but, you know, I'm just paying that to sleep at night.

  • Paul Solman:

    And where is that?

  • Nassim Taleb:

    It's technical, like derivatives, OK? To protect myself from, you know, a rise in —

  • Paul Solman:

    So, if interest rates rise, you would–

  • Nassim Taleb:

    Dramatically. I don't think–

  • Paul Solman:

    You would — you would make money on these securities that you own.

  • Nassim Taleb:

    Exactly. And then the rest is I own stocks, I own some real estate, I own the usual things.

  • Paul Solman:

    I had one last question. Is the system today more fragile under President Trump?

    Were you in favor of Donald Trump?

  • Nassim Taleb:

    I was not against. Trump came, you know, with very simplistic ideas, but anybody with that same mindset, in other words, I'm not part of that group of people, would have been welcome. And there's some optimism. So, let's see. But we have to do things to clean up the system of —

  • Paul Solman:

    Or, what's going to happen?

  • Nassim Taleb:

    The system loaded — laden with debt and with pseudo experts will collapse eventually. Now, it may be that miraculously, under Trump, we may have a second wind and America may rise again, and pay the debt.

  • Paul Solman:

    You mean huge economic growth?

  • Nassim Taleb:

    That's my hope. But nevertheless, I'm a skeptic.

    He got the disease right. Now whether he's going to fix it, I don't know.

  • Paul Solman:

    And, of course, neither does anyone else.

    For the PBS "NewsHour", economics correspondent Paul Solman, reporting from New York.

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