Russ Roberts

Rebonato on Risk Management and the Crisis

EconTalk Episode with Riccardo Rebonato
Hosted by Russ Roberts
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Riccardo Rebonato of the Royal Bank of Scotland and author of Plight of the Fortune Tellers talks with EconTalk host Russ Roberts about the challenges of measuring risk and making decisions and creating regulation in the face of risk and uncertainty. Rebonato's book, written before the crisis, argues that risk managers often overestimate the reliability of the measures they use to assess risk. In this conversation, Rebonato applies these ideas to the crisis and to the challenges of designing effective regulation.

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0:36Intro. [Recording date: May 22, 2009.] Book, risk and uncertain, decisions in an uncertain world; written beforehand but prescient about the economic crisis. History of finance and housing in the United States, how banking changed. In 1990s, up to end of 2006; hiccup of 1998, after the fact purely contained to financial sector; within 6-9 months a blip. Regulators who look after soundness of banking system came to rely on quantitative models and the banking system being the forefront by making use of these quantitative models. Two steps back from technicalities, philosophy of faith in self-regulating properties of the system, managed by enlightened self-interested mangers and CEOs; skilled. Quants came from background in mathematical finance, not deep thinkers, not deep knowledge of the banking system. Supposed to guarantee that sufficient capital would be set aside to act as safeguard against unlikely events. We know now that that didn't happen. Book: we are not in a position of saying anything about extremely rare events. Might collect daily, monthly, quarterly data, spanning a few years--information about the last few years. Even with data going back to the 1950s or 1940s, leap of faith to say they are relevant to present market conditions. What about events every 100, 1000, or 4000 years? A 99.975 percentile one year horizon corresponds to one event that should not happen more frequently than once every 4000 years. Quants might have sophisticated theory, but how do we know the data are sufficiently homogeneous--belong to the same patch of history--to be giving information relevant today as opposed to 3 years ago. Similar point made on EconTalk, talking about the Great Depression: no consensus about how we got into it or how we got out of it because it's a one-time event. Easy to have a theory, hard to be confident that it applies today. Humility rather than hubris.
7:59Little more technical: one technique that came to be popular in the banking is Value at Risk. What is idea behind it and why did it become popular? Measure of risk with some nice features: expressed in units of money. If your value at risk one day, 95th percentile, is $20 million, it means you should exceed a loss of $20 million only 5 days out of 100, so basically one day in 20. Won't be a perfect measure, but gives idea of day-to-day volatility when nothing extraordinary happens. For a trader or for a bank as a whole. Look carefully at the time-frames we are talking about. Can I infer the type of losses I might typically incur over that period, one month or a few months? Yes. Supposed to be used to determine capital; but capital should be there to absorb losses that occur not just once every 20 days, but once every hundreds of years; any time to protect the solvency of the institution. Before the regulators slapped on a multiplier; didn't ask for more remote percentiles; just take a safety factor. Safety factors have illustrious pedigree. Physics, engineering: use same formula calculate the thickness of steel ropes (cables) in elevators; but at the end of the day, they multiply by 10. Calculations for landing gear of aircraft multiply by 1.1; always a safety factor. Sensible because it allowed the bank to calculate a statistical number that was meaningful; but then a multiplier. Goal of regulator: to prevent insolvency or disaster because if it spreads the entire financial system could be at risk, systemic problems, runs on the bank, recent problems. What nest egg, what buffer do you have to keep so that in the worst case scenario, your firm still survives?
13:40Complicated question: inherent tension between bondholders and stockholders in a bank, and between regulators and owners. How big would the buffer be without regulation? How much economic capital--the buffer--should a bank keep to entice its investors, both equity and bond, to be comfortable? Not precise; what are some of the conflicts? Lot of thinking after the crisis about the alignment of interests even of any enlightened owner and the interests of society. Economic capital: the nest egg, but how severe an event? Folklore came up with a number: the 99.975 percentile--events that should happen not more frequently than once every 4000 years. Really bad luck, recent crisis! How did that number come up? Example: I am a bank with a certain rating. How many AA-rated institutions went from double-A to default in one year? Probably a handful. Divide that over total number of companies, get approximately one in 4000. So to convince bondholder that I am a AA company I should set aside enough capital in order to convince them I will only go bust once every 4000 years. Align capital I am holding with observed frequency of default of a AA company within one year. Signaling device to tell regulators: I am double-A. Regulators shouldn't be asking for a great spread, because I am AA. In case of a bondholder, the only thing of interest is solvency--just want their money back. Why not go for triple-A? Because the shareholders care about the return on capital? So to convince bondholder that I am AAA, I'd have to hold so much capital that the shareholder would not get a great return for each dollar of that capital. Compromise. For most banks, the equilibrium is around AA level. Bondholder, short a put, only loses money if the bank defaults; but if things go extremely well, he doesn't share in the upside. Shareholder likes volatility, long a call. Recent crisis has made very clear that a shareholder can be perfectly rational but willing to accept a level of risk that a regulator may not like. June or July 2007, shareholder of one of the banks that eventually got in trouble looks at his portfolio: would have to need a repeat of the 1930s to take a big loss; to insure himself against that possibility he'd have to lock in losses that most likely he won't have to bear. Perfectly acceptable to take that risk. Regulators' view: in that calculus you haven't taken into account the systemic risk. Regulators' view is to step in to not allow taking on that level of risk. Those investors had extremely high rates of return during 2003-2006. If someone had said this is getting a bit out of hand, your competitors wouldn't have been doing the same. In 2006, plenty of signs, liquidity was too abundant, risk premia compressed too much, asset prices too high. Fracture line of an earthquake; people knew it had to give, not sustainable for a long period of time; but where and when the crack would occur. Stepping out too early is disastrous. Greenspan, irrational exuberance, uttered around 1994, 1996. Pulling out would mean having to explain to the shareholders what you are doing when everybody else is becoming rich.
23:35Competitive market issue, also a social issue. Small world, investment banks; events and parties where your colleague is doing very well, you look the fool in the short run if you pull out. Central question, heard that story before: that's the music that's playing, so if you are there to dance, you have to dance to the music. Everyone's investing in these mortgage-backed securities, etc., but it's the only game in town. Yet, there were people who did not play along. Range across institutions of how much exposure. Any speculative thoughts on why institutions differed? Bear Sterns vs. J.P. Morgan. Some institutions big in this area for a long period of time. Late-comers fared less well. Goldman Sachs, JP Morgan. Different levels of inventory reflected different stages of getting into this business. Could have been emerging markets, which were extremely resilient. Summer 2007, wobble in emerging markets; head trader described it as a week of panic buying of emerging market paper! For same amount of risk, less and less compensation being paid. Some have said this wouldn't have happened had the investment houses never gone public. Asymmetry of incentives facing traders, executives on one hand and investors on the other; not playing with their own money. From point of view of a private firm, it would have been a reasonable risk to take. Regulators different, system; level playing field. If I step off the bandwagon, disadvantage to a more reckless person or institution who remains on; people will have withdrawn their funds from me. Asset fund manager in the United Kingdom stepped out of the dot-com bubble a bit too early and got fired three weeks before the bubble burst. Difficult to swim against the tide; regulator should intervene to level the playing field, you will all be inhibited from taking this kind of risk.
30:15Two questions. One: amount of leverage in play here is one reason these gambles were so large. One thing to say you had a bad quarter or bad year; but why did you take such a roll of the dice that these losses in the U.S. housing market destroyed your legendary company? Simple answer: they were so leveraged--they had borrowed so much to finance that gamble that losing the gamble didn't just mean a bad quarter, but death. Point number two: People who swim against the tide, standard argument is investor psychology is such that no one really cares about risk. But in current environment, psychology might thus go the other way. Akerlof and Shiller book, Animal Spirits, talks about the importance of sentiment; reversals of sentiment affect markets and real economy. How do we get out of the current environment--v or double-v as shape of the downturn? Very uncertain, unstable state. A week ago, stock prices were going up, people saying we'd get out very quickly; a week later, a bit of negative information. Might become more cautious if protracted period of decline. If plan A works and we get out with a v-shaped recovery, expect risk aversion will disappear much more quickly than we think possible today. Good that we get out quickly, but same behavior will result again in the same risks and problems. Where will that liquidity come from?
34:51Basel II, regulatory arbitrage. Basel II was trying to make the capital a bank has to set aside more in line with the risk. Basel I, formulaic, simple rules for capital that did not reflect the risk taken by banks. Credit-worthiness of the bonds you hold--government of OECD countries considered very, very safe; banks of those countries considered very safe; little differentiation between lending to a double-A company and lending to a corner shop. Set aside $1000 to either the latter has higher return for apparently same risk. Basel II was attempt to remedy that. Overconfidence in statistical techniques' abilities to quantify risk. How did the ratings agencies come into this regulatory arbitrage issue? Set-up was role of the ratings agencies with securitization--process whereby banks accumulate assets, e.g., mortgages, package them, and by virtue of the diversification create a portfolio less risky than any of the individual items. Tranche the portfolio in different sections: first section bears risk of first losses, so gets more return if things go well; all the way up AAA. Ratings agencies were to check amount of diversification to be sure it was up to the right level. Human nature, and conflict of interest--rating agencies only got paid if the securitization went through. Agencies worked with the investment houses to meet the criteria for AA, AAA, and A ratings. Teacher sets test but goes over questions with the students the day before. Portfolios met the specific requirements, but not the best way to set up system. But someone who goes to hire a student from that kind of school knows to be skeptical. Everyone knew this about the ratings agencies. Value of franchise: only 18-24 months ago, enlightened self-interest of market players was viewed as best safeguard for financial system. If the ratings agency debase the currency of their name, they will lose credibility by giving away AAA for nothing. Self-regulating efficient market.
41:10Mark to market: what role did it play in the crisis? Whole problem or irrelevant? Controversial topic. Not fair to point to that. Like saying if I didn't have a thermometer this patient wouldn't have a fever. Dynamics of mark-to-market forcing certain actions. Nexus where it got things into trouble was that when securities got downgraded, certain institutions had to sell them. This caused forced unwinding, Special Interest Vehicles (SIVs), nobody talks about it today. Mark-to-market is good where there is a willing buyer and a willing seller. Equilibrium is good information about the fundamental value of what is bought and sold. If unbalanced selling or buying, mark to market ceases to have the same information content. Why are buyers no longer there? Could be that liquidity disappears. Pseudo-arbitrageurs, agents who bring things back to fundamentals don't have the firing power to deploy their money. Two sides, some information still there. Loss of trust may simply reflect vagaries of today's supply and demand. Mark-to-market requirement and regulatory capital buffer: If I'm holding an asset, will hold for 5 years. Mortgages will be paying out over time. Some will go into default, some will be prepaid, etc. I'm not going to resell. Meanwhile, if there is an increase in the default rate, the market value of this goes down. I may not be in compliance with my capital requirements today but over time I may be fine on a cash-flow basis. Somewhat compelling argument--forced to sell it because of the capital requirement, though I wouldn't ordinarily sell it. When creating a security, you have a choice to place it on the banking book or the trading book. Trading book attracts less capital but forces you to mark to market on a daily basis. Perhaps people have been placing into the trading book when the sky was blue, price high, prices almost for everything, a lot of things whose prices disappeared when liquidity was withdrawn. Traded loan on trading book; but if you plan to hold it to maturity, place it on your banking book, in which case you get a different capital and a different recognition of a value. Unless impairment, value of 100. Choices that were made through 2006-2007 was to place in trading book--less capital, abundant liquidity, blue sky days.
47:53Too big to fail. Enlightened self-interest, or maybe just self-interest. Some have argued that too much risk was taken because at the end of the day, "too big to fail" or U.S. Central Bank behavior would bail out these bad decisions. In the United States we have banks that are regulated by the Federal Deposit Insurance Corporation (FDIC). Also shadow banking system, investment banks not guaranteed, but it turned out that they kind of were--erratic decision: Lehman Brothers died, Bear Sterns sold at discount, Merrill Lynch sold to Bank of America, AIG made whole all the way through. How much was there a socialization of losses and a private set of gains? Fannie Mae and Freddie Mac turned out to be a catastrophic institutional structure that turned out to be implicitly guaranteed; many investment banks were not guaranteed at all. Was that rational? Instead of thinking of an institution in the abstract, think of the decision-makers. Perhaps institution might survive, but the individuals who made those bad choices don't. Deterrence from rolling the dice. Could argue it goes the other way: a lot of traders made a great deal of money along the way, and though some CEOs were both humiliated or financially destroyed, others turned out fine. CEO of AIG announced his resignation today, saying he was leaving the most horrible job in the world. Before the event, cannot know if you are going to be one of the survivors or not. If you are rescued by the government you have lost control.
51:58Systemic risk. There is a negative externality, so when you take a risk you are careful, but you are not as careful as you would be if you had to bear the other social costs of the other firms that will be called into question. Back to March of 2008, turning point when U.S. Federal Reserve became active in the financial system to a degree that had been unimaginable previously. Weekend in March, Bear Sterns informed Fed and Treasury that it was not going to be able to meet its obligations. Failure of democracy that Fed and Treasury never explained the urgency other than saying it was urgent and that it had to be done. Meltzer podcast, few cases where firms were allowed to fail, failure of incentives. Claim was that if they had failed so much would have cascaded down. A few months later they let Lehman Brothers fail, which people have debated. We now have information about their assets--they've gone through bankruptcy. Claim was that if Bear Sterns had been allowed to go through that, whole system would have frozen up. But whole system froze up anyway. Was that Bear Sterns an unsustainable event? What if it had been allowed to go through bankruptcy? Intense debates. Should we let the market work out its own problems or should we intervene? Records of different central bankers, they were more averse to interventions. Some central banks said rescue of Bear Sterns was a mistake. When Lehman came around, people who favored the open market had the upper hand. When they saw what happened, the central banks said that's it, no more. We would have had a preview of Lehman in March. John Taylor has a claim that the spike in the spreads occurred after the Lehman failure, not concurrent; and it was really the TARP bailout that spiked interest rates. Don't agree; there was real panic after Lehman was allowed to fail. Noise prompting depositors to take their money out. Pure speculation, counterfactual. Regulators in the dark--face their own set of incentives. In the United States, Ben Bernanke, an expert on the Great Depression was eager to not have another one under his watch.
57:09European perspective: tendency to blame much of the crisis on various U.S. policy decisions behind the housing crisis. In 1990s, and can even trace it back to the 1930s under Roosevelt, United States eagerly subsidized price of housing, inflating housing prices. Blames tax policy, Fannie and Freddie, but was it large enough? Those sympathetic to that argument often ignore similar housing price appreciations in Europe: Spain, Ireland, South Africa, Australia around the world. John Taylor argument: excess of liquidity searching for yield as central banks pushed out money. When something of the recent magnitude occurs, there is no single cause. Perfect storm, confluence. China prompts them to invest in Treasuries, depressing the yields and Fannie and Freddie, pumping them into housing in particular. Why housing? Environment with pretty low return on lots of assets in 2006, for many investors the most solid thing to invest in was houses. Home refinancing in the United States; houses looked at not as place to live but a place to invest. Magnitude and complexity and leverage of the instruments attached to mortgage securities. Government aiding and abetting increase in housing, but not the only cause. Money chasing places to go. But why Ireland and Spain and not England and France? Have to look at data; suggest looking at availability of mortgages.

COMMENTS (10 to date)

I haven't read Rebonato's book. His opinions expressed in this podcast were both unassailable and obvious. The cause of the crisis was: well... all of the causes mentioned on this podcast and on any other blog: herd behavior, low interest rates, high liquidity, rating agencies, asymmetric information... when everything is a cause, nothing is.

I would have been happier if Rebonato could have shed some light on the colossal risk mismanagement of RBS, which in some respects mimics and surpasses that of Citi and Merrill. Was it caused by blind ambition? Regulatory changes in the UK? New competitive environment? Rebonato seems to suggest that the latecomers (Merrill, UBS, Citi, RBS) were also greedier than the rest. As explanations go, this one seems too much ad hoc.

Also, it was painfully obvious that VaR and Conditional VaR are ineffective. As evidence, read the Jorion-Taleb 1998 debate, in which Taleb, usually a chaotic writer and speaker, methodically vanquishes his opponent. And yet I understand Rebonato went along. Why?

Quasi-final note: I understand from Rebonato that we (risk managers) should do things differently. But putting aside any cosmic questions about the future of banking regulations, what guiding principles should a good risk manager follow?

Final note: On the herd behavior I would recommend the article by DeLong, Summers, Schleifer and Waldmann on noise traders, which at least tells a story about the risk introduced by traders (in this case, the banks themselves) taking positions disjointed from fundamentals. Summers is out of reach, maybe Schleifer too. But it would be fun to have DeLong or Waldmann on EconTalk. They are formidable, intelligent debaters of a very different persuasion from Roberts and that is a good thing. Shakespeare didn't read only Shakespeare. Roberts should not talk only to libertarians.

Russ Roberts writes:

Giuseppe Paleologo,

I guess it depends on what you mean by "went along." My understanding (and you may know better than I do) is that some suits ignored their geeks.

I was curious too about the dynamics there. Maybe we can discover them if and when he leaves the bank.

I will check out the noise trader article.

Always eager to have non-libertarians (see Rebonato, Acemoglu, Wolfe, for example.) Alas, not all non-libertarians are eager to be on EconTalk.

But I appreciate the prod and will continue to work on it.

William Love writes:

I like this Podcast (as I do so many others at Econtalk). It provides a nice intersection of different fields of thought and a good practical application at times.

Perhaps though could someone answer a question for me about the financial crisis/economists that seems to pervade even some of this podcast at times?

I do not really get why people adopt flawed logic as a basis or their economic forecasting/studies. Perhaps I misheard, but it seems that people discussing this almost have to adopt the flawed logic then step back to speak about its flaws, thus perpetuating the flaw as the status quo.

It struck me while listening to this that the forecasters were just plain wrong in their logic in how they used/analyzed their studies, even before Rebonato pointed out less obviously other concerns.

For instance:

It is evident in the "problem" of the assumed once in 4000 years chance. That just does not make any sense and falls into the Gambler's Fallacy (The Doctrine of the Maturity of Chances). There is a fundamental failure to understand statistical independence. (see Colin Bruce, "The Case of the Gambling Nobleman", in Conned Again, Watson! Cautionary Tales of Logic, Math, and Probability (Perseus, 2002))

Moreover, there is an essential problem of Cum Hoc, Ergo Propter Hoc - That things happening at the same time mean that one caused the other. There really is no proof that policy caused anything with the financial crises. There is no foundation to make such a claim and it is illogical to do so since there are many possible logical explanations other than causation.

The problem of Post Hoc, Ergo Propter Hoc applies in the same way (that if a thing comes after in time, the former event is the cause). This seems to be bolstered by fake precision and appeal to misleading authority.

Obviously there is more, but it severely seems that the story is the only important thing for most people, not the understanding or critical analysis behind it. Of course this could be said about almost any field today, and of course this flaw being common does not make it right.

So again, why would anyone listen to flawed logic and obvious con jobs? Most investors depend upon signaling, biases, or intellectual shortcuts for advice and thus are susceptible to games that provide temporary minor gains and long term major losses. While I do get the "lemming" point - where everyone else is having fun and ignoring the consequences, there is a more basic point.

If you are investing and expecting to be informed, how can you rationally trust the authority when you cannot evaluate his logic/claims/argument, you do not have the same position to gather information, and he has a motivation to not provide full disclosure?

How is this not fraud?

Russ,

without doubt Rebonato must have cleared this interview with his employer. He carefully avoided controversial statements. In my experience, risk managers are often employed as useful idiots (the suits play the role of Lenin, obviously). The following article from The Economist is in accord with my rather limited experience (http://www.economist.com/finance/displaystory.cfm?story_id=11897037).

To all the listeners of this podcast I recommend the two podcasts of Russ and Nassim Taleb. In Taleb's own words, they are among his favorite interviews.

It's too bad that modern liberals don't want to be guests, because EconTalk is the only web forum for substantive and urbane economic discussion.

Darren writes:

Giuseppe:

Thank you for the tip on the Jorion-Taleb debate, which is easily accessible on the website derivativesstrategy.com.

I take it from your comments that you believe Rebonato is more of a "Dr. John" than a "Fat Tony?" I agree that he must have cleared this with the higher-ups at RBS. No way they'd allow him to speak candidly about events that went so horribly wrong for the bank.

Humility is certainly in scarce supply among the market participants who were at the center of this financial crisis.

Floccina writes:

I do not think that CEO's think I am too big to fail so the Government will save me so I will take more risk.

I think though that had we let them fail the smell of the rotting corpse of LTCM in the nostrils of Wall street players might have reduced their willingness to take on risk.

Maybe you need to execute someone now and then to keep the inmates in line. (I am speaking figuratively here of course).

vimothy writes:

VaR is ineffective WRT what, exactly?

And Taleb is a walking contradiction: warning the world about events that cannot be predicted, only narrativised after the fact, and talking about the incredible prescience he displayed when predicting the financial crisis. The financial crisis is the worst thing that could have happened to him. Previously he was an egomaniac, but rather charming. Now, convinced that he is right, he is insufferable.

Jonathan writes:

I was disappointed Mr Rebanato did not speak about central bank policy or fractional reserve banking in the interview except to mention that central bankers were smart guys with the observation that the ones he knows flip flopped on how to handle the crisis, i.e. they differed over whether to support more or less reliance on the market to solve things. Sounds to me a bit like a priest deciding to be more or less of an atheist.

Central banks are not free market institutions but price fixers. They also oversee and guarantee a fractional reserve banking system, itself the only example in law where multiple claims on the same assets are upheld. Mr Rebanato expects too much from regulation and I would suggest rather than pointing to many simultaneous 'weather fronts' colliding at once (quant models, asymmetric information, short termism of investors, behavioural finance, regulatory lapse, rating agencies/incentive problems etc etc), is it not more likely there is a single systemic problem? i.e. he is addressing many symptoms but not the cause.

Central banks/regulators are not likely to have any Austrians in their midst in the same way, to use the earlier analogy, atheists wouldnt have many members from the clergy. Yet is it not surprising (amazing?) that one school of thought that bangs on about the consequences of excessively low interest rates married with fractional reserve banking leads to unsustainable booms and busts,distortion of capital structure etc is completely ignored/unknown/not taught in graduate level economics except as a footnote anymore? We listen to the exact same people that took us into these crises, indeed, have the same individuals that profited from it most now running the various departments in government that tell us they will now 'fix' it?!

I run a trading floor for a major N American bank and came late to the Austrian school having been an economics quant (which I liken to Sudoku - fun as long as you dont take it too seriously) and I find it distressing that such a wonderful body of work is completely unknown by generations of economists and it seems Mr Rebanato.

Brian writes:

I need to preface my remarks as follows: I am not an Economist by training and I have not read Mr. Rebonato's book. I am just a liberal arts graduate with some knowledge of economic theory and "markets". I have become hooked on the EconTalk podcasts, which I listen to while driving.

I am surprised to hear the Global Head of Market Risk and Global Head of the Quantitative Research Team at RBS say he needs government regulators to step in and save him from systemic risks. Exactly what "market risk" does Mr. Rebonato manage? With all the resources at his disposal, and the substantial incentives that exist for RBS to identify and plan for any risk, how is it that he cannot foresee systemic risk and plan accordingly? Moreover, if he cannot, then why would he expect regulators to effectively do so with lesser resources? One can assert in theory any role for a regulator, but the real question is whether the regulator can actually execute that role in practice. It seems to me the record of regulators and regulation is rather dismal.

Can we safely rely on regulators to take appropriate actions? Regulators are appointed/hired by elected officials who have been, and always will be, influenced by those who help them hold on to their elected offices. That being the case, regulation is not executed in an independent manner which strives to serve the public good, rather it is a political process which is heavily influenced by the ever-changing political climate. Lawmakers, who are primarily concerned about holding on to their elected office, serve as proxies for campaign contributors and other allies. The end result is regulators do not serve the public interest, but political interests instead. In this way, lawmakers and regulators encouraged and permitted activities which led to the recent financial crisis.

Whether you are an individual or an institution, you always have to manage internal and external risks. So, as an individual, I not only have to manage my personal finances (income, expenses, savings and investments, insurance, etc.) but I must also monitor potential external threats to my personal financial situation which are out of my control. The latter, I would argue, is the equivalent of Rebonato's "systemic risk". I rely on others to intervene on my behalf at my own risk.

The systemic risk here was not unforeseeable. There are asset managers and bankers who recognized it and planned accordingly. Some of them actually benefited substantially from the crisis by making appropriate bets. They did not need "sufficiently homogeneous data" to accurately assess the risks and identify market imbalances.


Seth writes:

I enjoyed this podcast, probably because I agree with most of the premises.

Thanks for giving the words to describe what I've now witnessed twice: "you have to dance to the music they're playing at the party."

I saw it in the 90s while working for an electric utility company doing financial transactions similar to Enron because, "that's what was expected of us by the Senior Leaders to add value," and again while working for a company that dabbled in subprime lending.

I think this was touched on in the podcast, but not said explicitly, another reason for the mess was that those in control, on Wall Street, at the rating agencies, at Fannie and Freddie and in government, weren't nearly as smart as they thought they were.

Our society still puts a lot of credence into so-called experts in fields that are prone to fool those experts, as Taleb points out in his books. When will we learn? The new government powers to regulate away systemic financial risk sounds too good to be true. Wait. That's because it is.

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