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How Time and Uncertainty Can Make Us “Antifragile” – Article by David Howden

How Time and Uncertainty Can Make Us “Antifragile” – Article by David Howden

The New Renaissance Hat
David Howden
January 26, 2014
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Antifragile: Things that Gain from Disorder, Nassim Nicholas Taleb (New York: Random House, 2012).

No two buzzwords define the present crisis more than “contagion” and “robustness” in the world of economists and policy wonks. The current interrelated nature of the financial system has bred a fragile situation where the success of the greater economy supposedly hinges on its individual components, such as banks that are too big to fail. To combat this fragility, economists have increasingly sought to build robust institutions. Such institutions will remain strong in the face of adverse effects if an individual component of the economy fails — be it subprime mortgages, sovereign debt, deposit-taking institutions or investment banks. This approach to the crisis stresses that if we cannot battle contagion, we had better construct strong institutions to weather future storms.

Nassim Taleb takes great issue with this approach in his new book Antifragile. His view is that constructing such so-called robust institutions is not sufficient as they continually fight yesterday’s battles. Instead the focus should be in building “antifragile” insti­tutions. Although often confused with robustness or resilience, an antifragile institution is not only unharmed by adverse events, but is actually strengthened by them. Building antifragile institutions will not only strengthen the global economic arena, but also have wide-ranging social applications.

Taleb’s latest work builds on two of his previous books, Fooled by Randomness (2001) and The Black Swan (2007). The common theme underlying all three is that there are events which are fundamentally unknowable — true uncertainties — in distinction to merely risky outcomes. Since we cannot know in advance what these events are, or what their effects will be, we should not exert too much effort in constructing contingency plans.

It is at this point that my first quibble with the book arises, and one I had with its predecessor The Black Swan. Taleb bifurcates between two definitions of uncertain events. On the one hand he invokes random or fundamentally unknowable events. Readers of this journal will be sympathetic to this definition of uncertainty, bearing close resemblance to Mises’s own use of “case probabilities”[1] (1949, pp. 110–113), or Shackle’s (1949) use of “non-seriable, non-divisible” events.[2] On the other hand, it is also clear that Taleb also thinks of uncertain events as merely rare events. These are events located on the fat or long tails on a probability distribution. Even though he thinks that these represent true uncertainty, there is no doubt that he is referring to funda­mentally probabilistic events.

This quibble aside, one can apply much of the remaining work cognizant that Taleb’s terminology differs from that of the Austrian economists, and also that the domain of his theory is slightly different than he thinks.

Something is “antifragile” if it gets stronger from a negative event. What are some examples? Taleb applies the prefix of his book liberally to outline what choices we should be pursuing. Indeed, the body of the book gives a long list of antifragile actions that, at least on one level, boil down to doing the exact opposite of what you think you should be doing.

Authors should be shocked to learn that there is almost no news that can harm a writer’s credibility, and that any publicity is good publicity (pp. 51–52). Corporations and governments that try to “reinstill confidence” should not be trusted because they would do so only if they were ultimately doomed (p. 53). Children shouldn’t be on antidepressants as this removes a source of learning from the life experience and thus make individuals less capable of dealing with unwanted events later in life (p. 61). The sinking of the Titanic was a positive disaster as it put shipbuilders on their toes, and possibly avoided an even larger accident later (p. 72). The general theme is that those who make errors are stronger than those who don’t — reliability, or antifragility — only comes when something is regularly tested by an unwanted event.

The theory has merit. Consider this lesson applied to central bank policies. In the wake of the dot-com bust a concerted effort by the world’s central banks flooded the global financial system with liquidity. The liquidation of assets that should have happened never did, and as a result lenders and borrowers didn’t learn their lesson on prudential money management. The seeds were sown for the larger crisis starting in 2007–2008 because a simple lesson was not learned when the financial system’s problems were still in relative infancy.

There is much to learn from this book and much to be wary of. At the end of the day, Taleb reckons the best test of an anti-fragile institution is Mother Nature mixed with a healthy dose of time. In chapter 21 he criticizes the prevailing orthodoxy of “neomania,” the mistaken belief that newer is better. Those institutions that have existed the longest are, in all likelihood, those that will continue to exist into the future. As an example, imagine that the year is 1988 and answer the following: which structure will last the longest, the Berlin Wall or the Great Pyramid of Giza.

In this test, as in much of the book, Taleb asks too much and too little. He asks too much because those institutions with the most longevity were once upon a time also the ones with the least. There must be a better test than longevity, as it only pushes the problem back in time to identify the source of antifragility. It cannot be turtles all the way down.

An applied example relevant to the present financial crisis would involve looking for those institutions that have been strengthened by current affairs. The crisis has taken its toll on many aspects of the financial services industry, but some general types of products have proven surprising resilient, or antifragile. Governments with prudent fiscal policies — e.g., Germany, Switzerland and Singapore — have fared well and indeed been strengthened as finances deteriorate in more profligate countries. Investment funds capitalizing on what were once unorthodox strategies, such as gold and other precious metal holdings, have out-performed more traditional investments as the financial crisis worsens. Readers of this journal will also notice that their stock in Austrian economics has increased in value over the past decade. Question begging and failed policies developed through more mainstream theories have led many former outsiders to the ranks of Austrian economists. An unwanted event caused an offsetting positive outcome in all these scenarios. That is what being antifragile is about.

Taleb asks too little by not exploring the true sources of antifragility. He comes close, alluding in many places that market-based institutions better combat the false security that planned institutions create. Explaining and elaborating on this link would do much to take the fundamental merits of antifragility to the next level. It would be, however, fodder for another book.

References

[1] Mises, Ludwig von. 1949. Human Action: A Treatise on Economics. Auburn, Ala.: Mises Institute, 1998.

[2] Shackle, G. L. S. 1949. Expectations in Economics. Westport, Conn.: Gibson.

David Howden is Chair of the Department of Business and Economics and professor of economics at St. Louis University’s Madrid Campus, Academic Vice President of the Ludwig von Mises Institute of Canada, and winner of the Mises Institute’s Douglas E. French Prize. Send him mail. See David Howden’s article archives.

This article first appeared in the Fall 2013 edition of The Quarterly Journal of Austrian Economics.

Who Are the True “Deathists”? – Article by G. Stolyarov II

Who Are the True “Deathists”? – Article by G. Stolyarov II

The New Renaissance Hat
G. Stolyarov II
March 24, 2013
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On a recent Immortal Life debate/discussion thread, I was asked to participate in a conversation about whether advocates of indefinite life extension should call their opponents “deathists” or whether such a label is counterproductive. Another question on that thread concerned the use of the designation “immortalist” to refer to an advocate of indefinite longevity.

My view on this matter is a nuanced one. It is crucial to make a distinction between (i) people who simply hold the common “tragic worldview” – who accept their mortality as inevitable and try to “make peace” with it and (ii) people who actively work to stop life-extension technologies. The former are simply mistaken and can be reasoned with, persuaded, or at least led to gradually become more comfortable with life extension as it becomes ever more real. The latter, however, might not be open to persuasion and might pursue legislative action (or worse) to stop life-extension research. Every person’s arguments should be addressed civilly and intelligently. The label “deathist” is not uncivil per se, however, and has its place with regard to people who cannot be swayed by argument or evidence from a position that is actively hostile to life extension. These are not your rank-and-file skeptics of radical life extension, but rather people such as Leon Kass, Sherwin Nuland, Daniel Callahan, John Gray, and Nassim Taleb, who will not be shifted from their anti-life-extension views and who have made considerable amounts of money out of attacking pro-longevity ideas. Calling these people “deathists” is not aimed at persuading them, but rather at alerting possibly more objective third parties of the dangers of their views. If there is still the opportunity to persuade someone, then labels of this sort should not be directed at that person.

As for positive labels, I can proudly attribute the term “immortalist” to myself – not because I think that indefinite life extension will by itself bring immortality (it will not), but rather because I think that any condition that more closely approaches immortality is a desirable one. Thus, I support not only the lifting of upper limits on lifespans, but also major improvements in protection against asteroids, earthquakes, weather events, vehicle accidents, infectious diseases, and manmade conflicts. I oppose anything that can destroy an innocent human life.

Common Misconceptions about Transhumanism – Article by G. Stolyarov II

Common Misconceptions about Transhumanism – Article by G. Stolyarov II

The New Renaissance Hat
G. Stolyarov II
January 26, 2013
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After the publication of my review of Nassim Taleb’s latest book Antifragile, numerous comments were made by Taleb’s followers – many of them derisive – on Taleb’s Facebook page. (You can see a screenshot of these comments here.) While I will only delve into a few of the specific comments in this article, I consider it important to distill the common misconceptions that motivate them. Transhumanism is often misunderstood and maligned by who are ignorant of it – or those who were exposed solely to detractors such as John Gray, Leon Kass, and Taleb himself. This essay will serve to correct these misconceptions in a concise fashion. Those who still wish to criticize transhumanism should at least understand what they are criticizing and present arguments against the real ideas, rather than straw men constructed by the opponents of radical technological progress.

Misconception #1: Transhumanism is a religion.

Transhumanism does not posit the existence of any deity or other supernatural entity (though some transhumanists are religious independently of their transhumanism), nor does transhumanism hold a faith (belief without evidence) in any phenomenon, event, or outcome. Transhumanists certainly hope that technology will advance to radically improve human opportunities, abilities, and longevity – but this is a hope founded in the historical evidence of technological progress to date, and the logical extrapolation of such progress. Moreover, this is a contingent hope. Insofar as the future is unknowable, the exact trajectory of progress is difficult to predict, to say the least. Furthermore, the speed of progress depends on the skill, devotion, and liberty of the people involved in bringing it about. Some societal and political climates are more conducive to progress than others. Transhumanism does not rely on prophecy or mystical fiat. It merely posits a feasible and desirable future of radical technological progress and exhorts us to help achieve it. Some may claim that transhumanism is a religion that worships man – but that would distort the term “religion” so far from its original meaning as to render it vacuous and merely a pejorative used to label whatever system of thinking one dislikes. Besides, those who make that allegation would probably perceive a mere semantic quibble between seeking man’s advancement and worshipping him. But, irrespective of semantics, the facts do not support the view that transhumanism is a religion. After all, transhumanists do not spend their Sunday mornings singing songs and chanting praises to the Glory of Man.

Misconception #2: Transhumanism is a cult.

A cult, unlike a broader philosophy or religion, is characterized by extreme insularity and dependence on a closely controlling hierarchy of leaders. Transhumanism has neither element. Transhumanists are not urged to disassociate themselves from the wider world; indeed, they are frequently involved in advanced research, cutting-edge invention, and prominent activism. Furthermore, transhumanism does not have a hierarchy or leaders who demand obedience. Cosmopolitanism is a common trait among transhumanists. Respected thinkers, such as Ray Kurzweil, Max More, and Aubrey de Grey, are open to discussion and debate and have had interesting differences in their own views of the future. A still highly relevant conversation from 2002, “Max More and Ray Kurzweil on the Singularity“, highlights the sophisticated and tolerant way in which respected transhumanists compare and contrast their individual outlooks and attempt to make progress in their understanding. Any transhumanist is free to criticize any other transhumanist and to adopt some of another transhumanist’s ideas while rejecting others. Because transhumanism characterizes a loose network of thinkers and ideas, there is plenty of room for heterogeneity and intellectual evolution. As Max More put it in the “Principles of Extropy, v. 3.11”, “the world does not need another totalistic dogma.”  Transhumanism does not supplant all other aspects of an individual’s life and can coexist with numerous other interests, persuasions, personal relationships, and occupations.

Misconception #3: Transhumanists want to destroy humanity. Why else would they use terms such as “posthuman” and “postbiological”?

Transhumanists do not wish to destroy any human. In fact, we want to prolong the lives of as many people as possible, for as long as possible! The terms “transhuman” and “posthuman” refer to overcoming the historical limitations and failure modes of human beings – the precise vulnerabilities that have rendered life, in Thomas Hobbes’s words, “nasty, brutish, and short” for most of our species’ past. A species that transcends biology will continue to have biological elements. Indeed, my personal preference in such a future would be to retain all of my existing healthy biological capacities, but also to supplement them with other biological and non-biological enhancements that would greatly extend the length and quality of my life. No transhumanist wants human beings to die out and be replaced by intelligent machines, and every transhumanist wants today’s humans to survive to benefit from future technologies. Transhumanists who advocate the development of powerful artificial intelligence (AI) support either (i) integration of human beings with AI components or (ii) the harmonious coexistence of enhanced humans and autonomous AI entities. Even those transhumanists who advocate “mind backups” or “mind uploading” in an electronic medium (I am not one of them, as I explain here) do not wish for their biological existences to be intentionally destroyed. They conceive of mind uploads as contingency plans in case their biological bodies perish.

Even the “artilect war” anticipated by more pessimistic transhumanists such as Hugo de Garis is greatly misunderstood. Such a war, if it arises, would not come from advanced technology, but rather from reactionaries attempting to forcibly suppress technological advances and persecute their advocates. Most transhumanists do not consider this scenario to be likely in any event. More probable are lower-level protracted cultural disputes and clashes over particular technological developments.

Misconception #4: “A global theocracy envisioned by Moonies or the Taliban would be preferable to the kind of future these traitors to the human species have their hearts set on, because even the most joyless existence is preferable to oblivion.

The above was an actual comment on the Taleb Facebook thread. It is astonishing that anyone would consider theocratic oppression preferable to radical life extension, universal abundance, ever-expanding knowledge of macroscopic and microscopic realms, exploration of the universe, and the liberation of individuals from historical chains of oppression and parasitism. This misconception is fueled by the strange notion that transhumanists (or technological progress in general) will destroy us all – as exemplified by the “Terminator” scenario of hostile AI or the “gray goo” scenario of nanotechnology run amok. Yet all of the apocalyptic scenarios involving future technology lack the safeguards that elementary common sense would introduce. Furthermore, they lack the recognition that incentives generated by market forces, as well as the sheer numerical and intellectual superiority of the careful scientists over the rogues, would always tip the scales greatly in favor of the defenses against existential risk. As I explain in “Technology as the Solution to Existential Risk” and “Non-Apocalypse, Existential Risk, and Why Humanity Will Prevail”,  the greatest existential risks have either always been with us (e.g., the risk of an asteroid impact with Earth) or are in humanity’s past (e.g., the risk of a nuclear holocaust annihilating civilization). Technology is the solution to such existential risks. Indeed, the greatest existential risk is fear of technology, which can retard or outright thwart the solutions to the perils that may, in the status quo, doom us as a species. As an example, Mark Waser has written an excellent commentary on the “inconvenient fact that not developing AI (in a timely fashion) to help mitigate other existential risks is itself likely to lead to a substantially increased existential risk”.

Misconception #5: Transhumanists want to turn people into the Borg from Star Trek.

The Borg are the epitome of a collectivistic society, where each individual is a cog in the giant species machine. Most transhumanists are ethical individualists, and even those who have communitarian leanings still greatly respect individual differences and promote individual flourishing and opportunity. Whatever their positions on the proper role of government in society might be, all transhumanists agree that individuals should not be destroyed or absorbed into a collective where they lose their personality and unique intellectual attributes. Even those transhumanists who wish for direct sharing of perceptions and information among individual minds do not advocate the elimination of individuality. Rather, their view might better be thought of as multiple puzzle pieces being joined but remaining capable of full separation and autonomous, unimpaired function.

My own attraction to transhumanism is precisely due to its possibilities for preserving individuals qua individuals and avoiding the loss of the precious internal universe of each person. As I expressed in Part 1 of my “Eliminating Death” video series, death is a horrendous waste of irreplaceable human talents, ideas, memories, skills, and direct experiences of the world. Just as transhumanists would recoil at the absorption of humankind into the Borg, so they rightly denounce the dissolution of individuality that presently occurs with the oblivion known as death.

Misconception #6: Transhumanists usually portray themselves “like robotic, anime-like characters”.

That depends on the transhumanist in question. Personally, I portray myself as me, wearing a suit and tie (which Taleb and his followers dislike just as much – but that is their loss). Furthermore, I see nothing robotic or anime-like about the public personas of Ray Kurzweil, Aubrey de Grey, or Max More, either.

Misconception #7: “Transhumanism is attracting devotees of a frighteningly high scientific caliber, morally retarded geniuses who just might be able to develop the humanity-obliterating technology they now merely fantasize about. It’s a lot like a Heaven’s Gate cult, but with prestigious degrees in physics and engineering, many millions more in financial backing, a growing foothold in mainstream culture, a long view of implementing their plan, and a death wish that extends to the whole human race not just themselves.

This is another statement on the Taleb Facebook thread. Ironically, the commenter is asserting that the transhumanists, who support the indefinite lengthening of human life, have a “death wish” and are “morally retarded”, while he – who opposes the technological progress needed to preserve us from the abyss of oblivion – apparently considers himself a champion of morality and a supporter of life. If ever there was an inversion of characterizations, this is it. At least the commenter acknowledges the strong technical skills of many transhumanists – but calling them “morally retarded” presupposes a counter-morality of death that should rightly be overcome and challenged, lest it sentence each of us to death. The Orwellian mindset that “evil is good” and “death is life” should be called out for the destructive and dangerous morass of contradictions that it is. Moreover, the commenter provides no evidence that any transhumanist wants to develop “humanity-obliterating technologies” or that the obliteration of humanity is even a remote risk from the technologies that transhumanists do advocate.

Misconception #8: Transhumanism is wrong because life would have no meaning without death.

Asserting that only death can give life meaning is another bizarre contradiction, and, moreover, a claim that life can have no intrinsic value or meaning qua life. It is sad indeed to think that some people do not see how they could enjoy life, pursue goals, and accumulate values in the absence of the imminent threat of their own oblivion. Clearly, this is a sign of a lack of creativity and appreciation for the wonderful fact that we are alive. I delve into this matter extensively in my “Eliminating Death” video series. Part 3 discusses how indefinite life extension leaves no room for boredom because the possibilities for action and entertainment increase in an accelerating manner. Parts 8 and 9 refute the premise that death gives motivation and a “sense of urgency” and make the opposite case – that indefinite longevity spurs people to action by making it possible to attain vast benefits over longer timeframes. Indefinite life extension would enable people to consider the longer-term consequences of their actions. On the other hand, in the status quo, death serves as the great de-motivator of meaningful human endeavors.

Misconception #9: Removing death is like removing volatility, which “fragilizes the system”.

This sentiment was an extrapolation by a commenter on Taleb’s ideas in Antifragile. It is subject to fundamentally collectivistic premises – that the “volatility” of individual death can be justified if it somehow supports a “greater whole”. (Who is advocating the sacrifice of the individual to the collective now?)  The fallacy here is to presuppose that the “greater whole” has value in and of itself, apart from the individuals comprising it. An individualist view of ethics and of society holds the opposite – that societies are formed for the mutual benefit of participating individuals, and the moment a society turns away from that purpose and starts to damage its participants instead of benefiting them, it ceases to be desirable. Furthermore, Taleb’s premise that suppression of volatility is a cause of fragility is itself dubious in many instances. It may work to a point with an individual organism whose immune system and muscles use volatility to build adaptive responses to external threats. However, the possibility of such an adaptive response requires very specific structures that do not exist in all systems. In the case of human death, there is no way in which the destruction of a non-violent and fundamentally decent individual can provide external benefits of any kind worth having. How would the death of your grandparents fortify the mythic “society” against anything?

Misconception #10: Immortality is “a bit like staying awake 24/7”.

Presumably, those who make this comparison think that indefinite life would be too monotonous for their tastes. But, in fact, humans who live indefinitely can still choose to sleep (or take vacations) if they wish. Death, on the other hand, is irreversible. Once you die, you are dead 24/7 – and you are not even given the opportunity to change your mind. Besides, why would it be tedious or monotonous to live a life full of possibilities, where an individual can have complete discretion over his pursuits and can discover as much about existence as his unlimited lifespan allows? To claim that living indefinitely would be monotonous is to misunderstand life itself, with all of its variety and heterogeneity.

Misconception #11: Transhumanism is unacceptable because of the drain on natural resources that comes from living longer.

This argument presupposes that resources are finite and incapable of being augmented by human technology and creativity. In fact, one era’s waste is another era’s treasure (as occurred with oil since the mid-19th century). As Julian Simon recognized, the ultimate resource is the human mind and its ability to discover new ways to harness natural laws to human benefit. We have more resources known and accessible to us now – both in terms of food and the inanimate bounties of the Earth – than ever before in recorded history. This has occurred in spite – and perhaps because of – dramatic population growth, which has also introduced many new brilliant minds into the human species. In Part 4 of my “Eliminating Death” video series, I explain that doomsday fears of overpopulation do not hold, either historically or prospectively. Indeed, the progress of technology is precisely what helps us overcome strains on natural resources.

Conclusion

The opposition to transhumanism is generally limited to espousing some variations of the common fallacies I identified above (with perhaps a few others thrown in). To make real intellectual progress, it is necessary to move beyond these fallacies, which serve as mental roadblocks to further exploration of the subject – a justification for people to consider transhumanism too weird, too unrealistic, or too repugnant to even take seriously. Detractors of transhumanism appear to recycle these same hackneyed remarks as a way to avoid seriously delving into the actual and genuinely interesting philosophical questions raised by emerging technological innovations. These are questions on which many transhumanists themselves hold sincere differences of understanding and opinion. Fundamentally, though, my aim here is not to “convert” the detractors – many of whose opposition is beyond the reach of reason, for it is not motivated by reason. Rather, it is to speak to laypeople who are not yet swayed one way or the other, but who might not have otherwise learned of transhumanism except through the filter of those who distort and grossly misunderstand it. Even an elementary explication of what transhumanism actually stands for will reveal that we do, in fact, strongly advocate individual human life and flourishing, as well as technological progress that will uplift every person’s quality of life and range of opportunities. Those who disagree with any transhumanist about specific means for achieving these goals are welcome to engage in a conversation or debate about the merits of any given pathway. But an indispensable starting point for such interaction involves accepting that transhumanists are serious thinkers, friends of human life, and sincere advocates of improving the human condition.

Fragile Reasoning in Nassim Taleb’s “Antifragile”: An Enlightenment Transhumanist Critique – Article by G. Stolyarov II

Fragile Reasoning in Nassim Taleb’s “Antifragile”: An Enlightenment Transhumanist Critique – Article by G. Stolyarov II

The New Renaissance Hat
G. Stolyarov II
January 10, 2013
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Never before have I set out to read a book with such high expectations, only to encounter such severe disappointment. As an admirer of Nassim Taleb’s earlier books, Fooled by Randomness and The Black Swan, I expected to find insight and wisdom along similar lines in Antifragile. While Taleb’s latest book does contain some valid observations and a few intriguing general strategies for living, the overwhelming thrust of the book is one of bitter distaste for modernity (and, to a significant extent, technological progress), as well as an abundance of insults for anyone who would disagree with not just with Taleb’s ideas, but with his personal esthetic preferences. While sensible in the realms of finance and (mostly) economics, Taleb’s prescriptions in other fields venture outside of his realms of mastery and, if embraced, would result in a relapse of the barbarisms of premodernity. Perhaps as the outcome of his own phenomenal success, Taleb has become set in his ways and has transitioned from offering some controversial, revolutionary, and genuinely insightful ideas to constructing a static, intolerant, totalistic worldview that rejects deviations in any field of life – and the persons who so deviate.

I am saddened to write this, but I am convinced that Nassim Taleb would find me to be personally repulsive. Not only am I a technology-embracing transhumanist ( a “neomaniac” per Taleb’s vocabulary), and a person who embraces the “nerdification” of society – but I am also an explicit representative and promoter of the legacies of the 18th-century Enlightenment – and a proud suit-and-tie wearer besides. Taleb seethes with contempt for the very trappings of modernity – even for modern formal wear – and repeatedly asserts that nothing valuable can be gleaned from those who wear neckties. As in many other areas, his conclusion-jumping pronouncements exclude the possibility of the world not fitting into his invented categories (with their associated normative spin). On the necktie question, he seems to rule out the very existence of persons like me, who wear neckties not out of any compulsion (my office dress code does not require them), but rather as an esthetic statement arising from sheer personal choice – including, not infrequently, on weekends.

After reading Antifragile, and finding so much of the content in need of a thorough refutation, I have vacillated between writing a book review and a more comprehensive treatise. A short review, I realized, would not do this book justice – but I also did not wish to run the risk of writing a refutation as long as the book itself. The result is this – one of my longest book reviews to date, but written as concisely as the subject matter allows. Here, I seek to comment on many of Taleb’s areas of focus in Antifragile, highlighting both the book’s strengths and its egregious errors.

Antifragile was one of the very few books I ever pre-ordered, as Taleb, until about a month ago, held a place among my most admired contemporary thinkers – along with such luminaries as Steven Pinker, Ray Kurzweil, Aubrey de Grey, Max More, and Ron Paul. Taleb’s writings on the fragility of the contemporary financial system were simply brilliant and highlighted the systemic weaknesses of a “house of cards” built upon highly sophisticated but over-optimized models that relied on the unrealistic stability of the status quo and the absence of extremely disruptive “black swan” events. I expected that Antifragile would discuss ways to survive and prosper in a black-swan-dominated world – a question that has been at the forefront of my mind since at least 2006, when I personally observed some “six-sigma” events on the stock market and – after reducing my losses to manageable levels – have refused to participate in that particular economy-wide casino since.  While Antifragile does provide skeletal discussions of some valuable approaches (such as the “barbell” strategy, on which I will comment more below), the majority of the book’s focus is negative: a harsh criticism of the institutions, ideas, and people whom Taleb considers insufficiently antifragile or “fragilizing”. One of Taleb’s favorite terms throughout the book is “fragilista” – used to describe financial modelers, politicians, and intellectuals of a rationalist frame of mind. The term – aside from creating vague and completely irrelevant associations with left-wing Nicaraguan terrorists – also poisons the metaphorical well with regard to the people and approaches criticized by Taleb.

More generally, the book is pervaded by an undercurrent of anti-intellectualism, mocking those who use structured, explicit knowledge to interpret the world. This is rather odd, because Taleb himself is clearly an intellectual and a “nerd” of the sort he derides; his philosophical and historical allusions – and his expertise in mathematical finance (despite his criticisms thereof) – give away that fact. Fat Tony of Brooklyn, Taleb’s fictional representative of the non-intellectual person who relies on “empirical” heuristics and is able to become rich by occasionally betting against “suckers,” would not have kept the company of people like Taleb. No matter how much rhetorical contempt Taleb shows for those who engage in abstract reasoning, he cannot escape being one of them – and no amount of insults directed at his own kind will get him an iota of respect from those whose character traits he glorifies.

An antifragile system or entity, per Taleb’s definition, is one that benefits from volatility instead of succumbing to it. Beyond mere robustness, which withstands volatility intact, antifragility is the derivation of advantage from volatility. The concept itself is an intriguing one, but Taleb makes a crucial error in assuming that most antifragility is normatively preferable. He does make an exception for “antifragility at others’ expense” – but only in a limited context. For instance, he is outraged at career intellectuals who do not have “skin in the game” and do not suffer for making wrong predictions or recommendations (more on this later) – but he explicitly praises the antifragility of biological evolution, a process that has resulted in the brutal deaths of most organisms and the extinction of about 99.9% of all species in history. Even within his premise that modernity contains “fragilizing” elements, Taleb presupposes that fragility is necessarily undesirable. Yet a beautiful vase is fragile – as is, for that matter, an individual organism. Fragility is no justification for dismissing or opposing an area of existence that has other intrinsic merits. Perhaps the proper response to certain kinds of fragility is extra care in the preservation of the fragile – as shown, for example, in the raising of children and small animals.

When Taleb argues that post-Enlightenment civilization is fragile, he may be partly right – at least in the sense that such civilization requires the steady, conscious application of human intellect to maintain. Every generation must master the scientific, technological, and ethical accomplishments of the generations before it and amplify these accomplishments; this is the essence of progress. This mastery of civilization entails precisely the “nerdification” (i.e., sophisticated, refined, self-aware intellectualism) that Taleb scorns in favor of “empirical” heuristics that may have arisen out of premodern superstition in as great (or greater) a proportion as out of practical wisdom passed down throughout the ages. Steven Pinker, whose magnum opus The Better Angels of Our Nature I would glowingly recommend (and whose work Taleb has unfairly maligned, though Pinker’s response to Taleb is worth reading), illustrates convincingly that not only peacefulness but virtually every other characteristic of civilized human beings has improved dramatically over the past several centuries – and most remarkably over the past several decades. Nothing suggests that this improvement is an inexorable law of history, however; it is possible for anti-civilizing influences to take hold and for humanity to degenerate into the barbarism that characterized much of its past. In that sense, civilization may be considered fragile – but so eminently worth preserving and expanding, for it makes possible the good life for good individuals.

Unfortunately, Taleb has included himself among the influences that would undo many of the essential gains that humanity has achieved since the 18th-century Enlightenment. Taleb repeatedly references the “wisdom of the ancients” (the stoic Seneca is his favorite) and conflates the “natural” (a term from which he excludes human design and technology) with the desirable. Taleb praises the heuristics he sees in traditional religious systems (e.g., elaborate Greek Orthodox fasting rituals) while completely overlooking the massive horrors many traditional (i.e., premodern) religious systems perpetrated when persecuting dissenters, inspiring bloody wars of conquest, and establishing totalitarian regimes when combined with secular authority. The Enlightenment brought about a conscious questioning of religious (and all authority-based) traditions and commandments and resulted in the adoption of rigorous scientific inquiry in the pursuit of discovery and innovation. Taleb is wary of modern medicine because of possible “iatrogenic” effects (where the treatment itself causes most of the harm), and he even questions the genuineness and desirability of massive rises in life expectancy during the 20th and early 21st centuries. While there is some merit to balancing the anticipated benefits and possible side effects of medical treatments – and while Taleb may be right that certain fields may take treatment too far, especially as regards overprescription of psychotropic drugs to children – Taleb’s discussion of “iatrogenics” is mostly anecdotal and reliant on studies from much earlier periods in medicine (e.g., the death of George Washington in 1799 and a study on children in 1930).  The virtual eradication of smallpox, polio, tuberculosis, cholera, and the bubonic plague from the Western world by scientific medicine are utterly ignored by Taleb – as are the substantial declines in cancer death rates over the past 50 years, and the accomplishments of the Green Agricultural Revolution in averting the starvation of billions, which would have occurred if only “natural” agricultural techniques (i.e., techniques employed before some arbitrary historical cutoff date) had been utilized.

There may be some merit to Taleb’s advice of avoiding medical treatment for minor conditions (where the iatrogenic effects of treatment allegedly predominate) and letting the body heal itself, while being willing to undertake radical treatments for extreme, life-threatening conditions. However, context in medical care matters too greatly to make sweeping generalizations. A fairly small skin lesion, which does not interfere with day-to-day functioning, may, after all, be the beginning of a deadly cancer, for which no self-healing mechanism exists. In medicine especially, the “empirical” heuristics championed by Taleb must give way to careful and systematic scientific study. After all, most premodern cultures relied on “traditional” heuristics for millennia, with disastrous results; such reliance can be called folk medicine. One only needs to consider the “traditional” Eastern “remedies” based on the superstition that one will become like the creature one eats – or “traditional” Western Medieval bleeding and surgical practices – to realize how much progress modern scientific medicine has actually made.

While a reader of Fooled by Randomness and The Black Swan might have inferred libertarian and individualist tendencies in Taleb’s writing, Antifragile, unfortunately, sets the record straight: Taleb opposes “too much” individual flourishing and freedom. He reserves his bitterest venom for transhumanism, which is the logical outcome of a libertarian society in which technological progress is given free rein. Taleb’s reverence for “nature” and “the ancients” trumps his skepticism of centralized regimentation – as his ideas on life extension and freedom of speech illustrate. He writes, “I felt some deep disgust – as would any ancient – at the efforts of ‘singularity’ thinkers (such as Ray Kurzweil) who believe in humans’ potential to live forever. Note that if I had to find the anti-me, the person with diametrically opposite ideas and lifestyle on the planet, it would be that Ray Kurzweil fellow. It is not just neomania. While I propose removing offensive elements from people’s diets (and lives), he works by adding, popping close to two hundred pills daily. Beyond that, these attempts at immortality leave me with deep moral revulsion.” Taleb says little of substance to support this “deep moral revulsion” – beyond repeating the same tired, hackneyed old arguments about “making room for others” by dying – as if the life of the individual had no inherent value and could be justifiably expended for an alleged greater good. Taleb does not address Kurzweil’s arguments about the exponential progress of computing and other technologies, and the logical extrapolation of such progress within the coming decades. In short, he says nothing about why he would consider Kurzweil to be mistaken, or what about Kurzweil’s lifestyle and ambitions he considers destructive. Taleb’s rudely expressed opposition to transhumanism seems to be primarily driven by emotional revulsion or, to be more charitable, a conflict of values. Additionally, Taleb does not seem to understand the movement that he criticizes. He assumes that extended longevity would be accompanied by extended frailty and senescence, whereas true radical life extension would only be possible if biological youth could be prolonged through periodic rejuvenation of the organism. Moreover, Taleb is, at heart, a collectivist who embraces the sacrifice of the individual to the tribe. He writes, “I am not here to live forever, as a sick animal. Recall that the antifragility of a system comes from the mortality of its components – and I am part of that larger population called humans. I am here to die a heroic death for the sake of the collective, to produce offspring (and prepare them for life and provide for them), or eventually, books – my information, that is, my genes, the antifragile in me, should be the ones seeking immortality, not me.”

The biggest disappointment I experienced when reading Antifragile was the realization I came to upon reading the above-quoted passage. This book was never about helping make the individual antifragile. The preservation of a human being in a volatile and uncertain world – and the attempt to equip a human being to flourish in the face of such volatility and uncertainty – were never Taleb’s key aims. Taleb’s views on antifragility are, indeed, not particularly helpful to me in my goal to discover strategies that would preserve, fortify, and enrich the individual in an often hostile, and, in many ways, fundamentally unpredictable world which lacks any manner of built-in justice outside of what humans, through their ingenuity and will, can implement. Taleb would have both of us (and everyone else) be sacrificed for the sake of an unspecified “collective” – as if some abstraction, be it “nature”, evolution, or “the whole”, has value in and of itself, apart from its constituent individuals. Yet it is precisely this sort of collectivism that enables inhuman atrocities, from mass executions of “the other” to suicide bombings for a “greater cause”. Taleb does not intend to advocate armed violence, but his rhetoric on heroism, “dying heroically”, and self-sacrifice eerily resembles the pronouncements of many a totalitarian regime, inquisitorial sect, or band of nationalistic or religious terrorists. The good life – the comfortable life of peace, productive work, and self-fulfillment – does not seem to be his objective.

In several sections devoted to having “doxastic commitment” or “soul in the game”, Taleb glorifies the idea of leaving no way out in the event of one’s failure – forgetting that much true learning is iterative and often occurs through a trial-and-error process. If one is not allowed to recover from failure and change one’s approach (without crippling personal cost), then this learning will be preempted, and the individual will be destroyed instead. Taleb glorifies, for instance, the poet Almutanabbi, who died senselessly in the attempt to realize the ideals about which he wrote. But it is far more impressive to live in furtherance of one’s ideals than to die for them – particularly since living requires one to reevaluate one’s views in light of emerging evidence and continual reflection.

Taleb is no more a friend of individual liberty than of technological progress. As a consequence of his view that intellectuals should have “skin in the game”, he insists that they should personally suffer the adverse consequences of their recommendations. Indeed, he would implement his scheme of penalties to the detriment of legal protections for freedom of speech. While criticizing the financial rating agencies’ misclassification of toxic assets as “AAA” securities, he remarks that “they benefit from the protection of free speech – the ‘First Amendment’ so ingrained in American habits. My humble proposal: one should say whatever he wants, but one’s portfolio needs to line up with it.” Elsewhere, Taleb proposes that individuals be held legally liable for the damage that their predictions and recommendations result in if followed by others. He ignores that not all individuals have the assets to even invest in a portfolio. Are the poor and middle class to be deprived of the ability to express their opinions or speculate about the economic future (even if such speculation is without much basis), simply because they do not have much “skin” to put into the “game”? Furthermore, establishing any legal liability for expression of opinion would have a chilling effect on legitimate and valuable ideas – since the very threat or prospect of a lawsuit may serve as a deterrent to publishing or even verbal expression in front of someone who disagrees. For someone so insistent on individual moral responsibility, Taleb ignores the responsibility of the recipient of ideas to actively judge and interpret them. Just as there exist sleazy marketers, so there exist peddlers of philosophical falsehoods, and sometimes those falsehoods result in personal gains for their advocates. Yet the responsibility of the sensible, rational individual is to filter out truth from falsehood using his own mind. No prohibition, no regime of penalties, no prior restraint can protect people from themselves. Such restrictions can only prevent people from cultivating the habits of autonomous thought which are the surest safeguards against charlatans and demagogues of every stripe. Taleb is too concerned about punishing the false prophets, and insufficiently concerned about elevating the general level of reasoning and discourse by means of positive persuasion, dissemination of true information, and technological innovation that alters people’s incentives and the balance of power.

Taleb even departs from the libertarian advocacy of free trade and (genuine) globalization. While he acknowledges the theoretical validity of some specialization and the law of comparative advantage, he sees the global division of labor as vulnerable to volatility in the system. He argues that a change in conditions in one part of the world now has a far greater ability to adversely impact all other parts of the world – because the division of labor is so finely tuned. This is a fair argument for redundancy in economic systems – e.g., having “backup” institutions which could supply a good or service if the original supplier is unavailable due to an unexpected disruption. However, Taleb errs when assuming that businesses pursuing their rational self-interests under a truly free arrangement of global commerce would not already attempt to implement such redundancies. Supply-chain risk, for instance, is commonly discussed by representatives of multinational businesses and their insurers, who have a stake in preventing supply disruptions. Overreliance on any one economic partnership may indeed be imprudent – but does Taleb believe that businessmen with true “skin in the game” – billions of their own dollars – would be oblivious to the need for redundancy? Taleb makes no case for why free trade – in essence, the voluntary exchange of goods and services among individuals without regard for national origins or boundaries – would create a systemic lack of redundancy. A stronger argument could be made for how the current politicized environment of trade – a mixture of freedom and elaborate controls achieved by means of treaties and retaliatory protectionism – would produce insufficient redundancy and overdependence on those precious channels of international trade that remain permitted. But the solution to this problem would be more options – more channels for foreign trade – not fewer. Autarky certainly will not do, as it brings about its own massive vulnerabilities. One only need consider the consequences of a famine in a region which is not allowed to import food from abroad. Trade creates redundancy by allowing access to goods and services from all over the world, instead of just one minor segment thereof.

The nonlinear responses to volatility described in Antifragile are valid in principle. A system responds in a concave fashion if the harm to the system from a change in conditions is more than linear relative to that change (i.e., an accelerating harm). A system responds in a convex fashion if it is able to reap benefits from volatility in a more-than-linear accumulation. Taleb proposes that it is possible for certain systems to be concave or convex in both directions – being harmed by or benefiting from a shift in conditions either way. It is also possible for systems to be convex over some regions of inputs, and concave over others – e.g., a human immune system or a body engaging in exercise. Taleb does not, however, provide many tools to actually determine the inflection points within any particular system. Although he praises “empirical” heuristics for doing so – especially heuristics passed down through the ages – he provides absolutely no support to conclude that those heuristics do not overshoot the desirable levels of any given characteristics. To use the example he provides of religious fasting customs, even if one can be generous and suppose some benefit to the fasting (of which I am not altogether convinced), what evidence is there that the specific schedule and duration of fasts is optimal? Could not scientific investigation uncover a better way, and explain its workings in a rational, evidence-based manner, without recourse to superstition or ancestral hand-waving?  Furthermore, Taleb does not consider that the “wisdom of the ancients” may not have developed through the careful evolutionary process he describes – but rather comes to us as a warped reflection of some very recent generation’s interpretation of ancient practices – which themselves were altered by numerous political authorities, ideological movements, and idiosyncratic historical events in order to fulfill some very context-specific (and not necessarily virtuous or life-affirming) aim. To get a sense of how this has happened to distort prevailing conceptions of the past, one needs only to consider the early history of Christianity – where doctrine was often promoted or suppressed based on the temporal interest of Roman and Byzantine emperors and their officials – or the extensive revisionism performed by the 19th-century Romantics with regard to the Middle Ages. Taleb himself romanticizes antiquity (including the ancient Middle East), overlooking the incessant wars, disease, filth, vulgarity, persecution, and ideological totalism that characterized many pre-Enlightenment societies (e.g., the totalitarianism of Ancient Sparta or Calvin’s Geneva – which made even the USSR seem like a paragon of liberty and progress by comparison).

Taleb’s contempt for wealth, and praise for attitudes that part with wealth lightly, betray the fact that he has never been in danger of losing his material comfort. Growing up in a prosperous , respected, and intellectual Lebanese family, Taleb moved to the United States and made a fortune as a trader, which he later magnified by selling his books. If he expresses contempt for the material well-being he sees around him, and a nostalgic longing for an idealized past, it is because he cannot truly envision what premodernity was actually like. Perhaps, because he greatly underrates the transformative effects of technological progress, Taleb’s image of premodernity is of a slightly rustic incarnation of our present world – except one in which people mostly avoid doctors and editors, walk on rocky landscapes in foot-shaped shoes, eat “paleo” diets, quote from Seneca’s dialogues, and occasionally engage in bloody contests over fine points of poetry, philosophy, and theology – just to show how much “skin in the game” they have with regard to their beliefs. Taleb neglects the possibility that only recently has life become remotely comfortable and quasi-meritocratic, while premodernity was a mostly uninterrupted stretch of miseries, cruelties, superstitions, prejudicial hatreds, and filth (punctuated by a few refined characters like Aristotle – whom Taleb maligns – and Seneca – people who were remarkable for their time and are remembered precisely because they stood out so far above their contemporaries). A small elite has always been super-wealthy (by the standards of their time) in every era and in every society, but it is an all-too-common mistake to imagine oneself in the position of a historical member of the elite (e.g., someone who would have read Seneca, or Seneca himself) rather than a common peasant or slave – which is the far more probable fate for a randomly chosen premodern person. The casual dismissal of wealth as not particularly important would not have been articulated by people toiling from sunrise to sunset in order to grow crops for their feudal overlords and be given a small fraction of the resulting harvest in order not to starve. Nor is this attitude particularly helpful to people who might have been interested in cultivating personal antifragility so as to prevent themselves from becoming poor.

The most useful personal advice in Antifragile concerns the so-called “barbell strategy” for minimizing the downside of volatility while benefiting from the upside. The strategy involves putting most of one’s resources into an ultra-safe, ultra-conservative course of action, while devoting the rest to a diversified speculation, but in such a manner that the entire speculative amount can be lost without significant harm. An example of this approach would be keeping 90% of one’s money as cash or gold, and investing the remaining 10% into five different startup companies; each startup firm could fail – and many do – but it is also possible for a startup company to succeed tremendously and bring orders of magnitude of profit. If all the startup firms fail, then one has had a 10% loss – but this does not have to be ruinous if one is not hyper-leveraged. Taleb is also correct about the highly fragilizing effects of debt and recommends avoidance of indebtedness where possible. This is sound advice, greatly needed in a country where everything from everyday consumption to the purchase of big-ticket items to intangible “investments” such as formal education is often purchased on credit. Debt introduces fragility by amplifying the financial pain of volatility. A marginal drop in income could be endured by a debt-free person with savings, but would result in a leveraged person losing everything. Taleb’s advice here may not always be perfectly realizable – as not every person can afford to invest any percentage of his assets with the ability to continue living well if those assets were lost. Furthermore, mortgage debt is extremely difficult to avoid for a person without sizable initial wealth; other debt, however, is generally avoidable.

While Antifragile has some virtues, Taleb should not have dismissed or derided his editors. If carefully confined to the realms of finance and economics, Antifragile might have been an illuminating and positive book on net. As matters stand, however, Taleb has managed to gratuitously insult practically everybody who might have been sympathetic to his previously articulated views – including the libertarians, transhumanists, and rationalist natural-law thinkers who would have found much to agree with in Fooled by Randomness and The Black Swan. Taleb even classifies Friedrich Hayek among the rationalists whom he dismisses: “We may be drawn to think that Friedrich Hayek would be in that antifragile, antirationalist category. […] But Hayek missed the notion of optionality as a substitute for the social planner. In a way, he believed in intelligence, but as a distributed or collective intelligence – not in optionality as a replacement for intelligence. […] Finally, John Gray, the contemporary political philosopher and essayist who stands against human hubris and has been fighting the prevailing ideas that the Enlightenment is a panacea – treating a certain category of thinkers as Enlightenment fundamentalists. […] Gray worked in an office next to Hayek and told me that Hayek was quite a dull fellow, lacking playfulness – hence optionality.” And there was the gratuitous insult again. Very well. We Enlightenment rationalists and technoprogressives will be happy to accept Hayek as one of us – along with Socrates, Aristotle, and Ayn Rand (for whose fan Taleb should not be mistaken, as he tells us in a footnote). Taleb can have Seneca, Almutanabbi, John Gray, and Fat Tony. We remain in good company without them.

Wall Street Math – Article by Douglas French

Wall Street Math – Article by Douglas French

The New Renaissance Hat
Douglas French
April 11, 2012
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There’s plenty of blame for the financial crisis being spread around. Those on the left say Wall Street wasn’t regulated enough, while those on the right claim government mandates required lenders to make bad loans. The argument is made that the Federal Reserve was too loose, while the other side says Bernanke wasn’t loose enough. Some blame greed. Others blame Wall Street’s investment products. And then there’s mathematics.

Wall Street has become a numbers game played at high speed by powerful computers trading complex derivatives utilizing even more complex mathematical modeling. Writing for the Huffington Post, Théo Le Bret asks the reader to

Take the Black-Scholes equation, used to estimate the value of a derivative: it is actually no more than a partial differential equation of the financial derivative’s value, as a function of four variables, including time and “volatility” of the underlying asset (the derivative being a ‘bet’ on the future value of the asset). Differential equations are well-known to physicists, since such fundamental properties of nature as the wave equation or Schrodinger’s equation for quantum mechanics are given in the form of differential equations, and in physics their solutions seem to be very reliable: so why is this not always the case in finance?

Mr. Le Bret quotes Albert Einstein for his answer: “as far as the laws of mathematics refer to reality, they are not certain; and as far as they are certain, they do not refer to reality.”

Murray Rothbard put it another way:

In physics, the facts of nature are given to us. They may be broken down into their simple elements in the laboratory and their movements observed. On the other hand, we do not know the laws explaining the movements of physical particles; they are unmotivated.

Rothbard goes on to make the point that human action is motivated and thus economics is built on the basis of axioms. We can then deduce laws from these axioms, but, as Rothbard explains, “there are no simple elements of ‘facts’ in human action; the events of history are complex phenomena, which cannot ‘test’ anything.”

Using the models that work so well for physicists, mathematicians on Wall Street got it spectacularly wrong in the mortgage and derivatives markets, just as mathematical economists can never predict the future with any accuracy. Motivated human behavior cannot be modeled.

But the mathematicians or “quants” underscore all of Wall Street’s financial engineering, a process that takes a few pieces of paper and folds their attributes together to make new products, most times hoping to avoid taxes and regulation. Author Brendan Moynihan describes this engineering in his book Financial Origami: How the Wall Street Model Broke.

Origami is the traditional Japanese art of paper folding wherein amazing shapes and animals are created with just a few simple folds to a piece of paper. Moynihan cleverly extends the metaphor to the financial arena, pointing out that stocks, bonds, and insurance are pieces of paper simply folded by the Wall Street sales force into swaps, options, futures, derivatives of derivatives, and the like.

The author is adept at describing derivatives in terms a person can understand. Health-insurance premiums are a call option to have the insurance company pay for our medical care. Auto insurance premiums are like put options, allowing the insured to sell (put) his or her car, if it’s totaled, to the insurer at blue-book value.

Nobel Prize winners have played a big hand in the creation of derivatives. Milton Friedman’s paper on the need for futures markets in currencies paved the way for that market in 1971. But as Moynihan points out, it was Nixon’s shutting of the gold window that created the need to mitigate currency and inflation risk.

Nobel Laureate Myron Scholes was cocreator of the Black-Scholes-Merton option-pricing model. He and cowinner Robert Merton used their model to blow-up Long Term Capital Management.

But it was little-known economist David X. Li’s paper in the Journal of Fixed Income that would provide the intellectual foundation for Wall Street’s flurry into mortgages. “On Default Correlation: A Copula Function Approach” became “the academic study used to support Wall Street’s turning subprime mortgage pools into AAA-rated securities,” writes Moynihan. “By the time it was over, the Street would create 64,000 AAA-rated securities, even though only 12 companies in the world had that rating.”

Robert Stowe England, in his book Black Box Casino: How Wall Street’s Risky Shadow Banking Crashed Global Finance, says Li’s model “relied on the price history of credit default swaps against a given asset to determine the degree of correlation rather than rely on historical loan performance data.”

“People got very excited about the Gaussian copula because of its mathematical elegance,” says Nassim Nicholas Taleb, “but the thing never worked.” Taleb, the author of The Black Swan, claims any attempt to measure correlation based on past history to be “charlatanism.”

Subprime mortgages were bundled to become collateralized mortgage obligations (CMOs), which are a form of collateralized debt obligation(CDO). CDOs weren’t new; the first rated CDO was assembled by Michael Milken in 1987. But instead of a mixture of investment-grade and junk corporate bonds, in the housing bubble, CDOs were rated AAA based upon Li’s work.

Mr. England wryly points out, “A cynic might say that the CDO was invented to create a place to dump lower credit quality or junk bonds and hide them among better credits.”

England quotes Michael Lewis, author of The Big Short: “The CDO was, in effect, a credit laundering service for the residents of Lower Middle Class America.” For Wall Street it was a machine that “turned lead into gold.”

Wall Street’s CDO mania served to pump up investment-bank leverage. England explains that if level-3 securities were included (level-3 assets, which include CDOs, cannot be valued by using observable measures, such as market prices and models) then Bear Stearns sported leverage of 262 to 1 just before the crash. Lehman was close behind at 225, Morgan Stanley at 222, Citigroup at 212, and Goldman Sachs was levered at 200 to 1.

Leverage like that requires either perfection or eventual government bailout for survival.

The CDO market created the need for a way to bet against the CDOs and the credit-default-swap (CDS) market was born. Bundling the CDS together created synthetic CDOs. “With synthetic CDOs, Wall Street crossed over to The Matrix,” writes England, “a world where reality is simulated by computers.”

It’s England’s view that the CDO market “was the casino where the bets were placed. Wall Street became bigger and chancier than Las Vegas and Atlantic City combined — and more.” According to Richard Zabel, the total notional value of the entire CDS market was $45 trillion by the end of 2007, at the same time the bond and structured vehicle markets totaled only $25 trillion.

So the speculative portion of the CDS market was at least $20 trillion with speculators betting on the possibility of a credit event for securities not owned by either party. England does not see this as a good thing. It’s Mr. England’s view that credit default swaps concentrated risk in certain financial institutions, instead of disbursing risk.

In “Credit Default Swaps from the Viewpoint of Libertarian Property Rights and Contract Credit Default Swaps Theory,” published in Libertarian Papers, authors Thorsten Polleit and Jonathan Mariano contend, “The truth is that CDS provide investors with an efficient and effective instrument for exposing economically unsound and unsustainable fiat money regimes and the economic production structure it creates.”

Polleit and Mariano explain that credit default swaps make a borrower’s credit risk tradable. CDS is like an insurance policy written against the potential of a negative credit event. These derivatives, while being demonized by many observers, serve to increase “the disciplinary pressure on borrowers who are about to build up unsustainable debt levels to consolidate; or it makes borrowers who have become financially overstretched go into default.”

Mr. England concludes his book saying, “We need a way forward to a safer, sounder financial system where the power of sunlight on financial institutions and markets helps enable free market discipline to work its invisible hand for the good of all.”

Polleit and Mariano explain that it is the CDS market that provides that sunlight.

The panic of 2008 was the inevitable collapse of an increasingly rickety fiat-money and banking system — a system where the central bank attempts to direct and manipulate the nation’s investment and production with an eye to maximize employment. In a speech delivered to the Federal Reserve Bank of New York, Jim Grant told the central bankers that interest rates should convey information. “But the only information conveyed in a manipulated yield curve is what the Fed wants.”

Wall Street’s math wizards convinced the Masters of the Universe that their numbers don’t lie, believing they could model the Federal Reserve’s house-of-mirrors market. Maybe the numbers don’t lie, but the assumptions do.

Advising about mathematical economics, Rothbard wrote, “ignore the fancy welter of equations and look for the assumptions underneath. Invariably they are few in number, simple, and wrong.” The same could be said for Dr. Li’s model and Scholes’s model before him.

Until the era of unstable fiat-money regimes ends, the search for scapegoats will continue — because the crashes will never end.

Douglas French is president of the Mises Institute and author of Early Speculative Bubbles & Increases in the Money Supply and Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master’s degree in economics from the University of Nevada, Las Vegas, under Murray Rothbard with Professor Hans-Hermann Hoppe serving on his thesis committee. French teaches in the Mises Academy. See his tribute to Murray Rothbard. Send him mail. See Doug French’s article archives.

This article was published on Mises.org and may be freely distributed, subject to a Creative Commons Attribution United States License, which requires that credit be given to the author.