Thursday, May 04, 2017

Risk Transferring Interventionists and Their Mental and Moral Defects

medium |  Skin in the Game is necessary to reduce the effects of the following divergences that arose mainly as a side effect of civilization: action and cheap talk (tawk), consequence and intention, practice and theory, honor and reputation, expertise and pseudoexpertise, concrete and abstract, ethical and legal, genuine and cosmetic, entrepreneur and bureaucrat, entrepreneur and chief executive, strength and display, love and gold-digging, Coventry and Brussels, Omaha and Washington, D.C., economists and human beings, authors and editors, scholarship and academia, democracy and governance, science and scientism, politics and politicians, love and money, the spirit and the letter, Cato the Elder and Barack Obama, quality and advertising, commitment and signaling, and, centrally, collective and individual.

This idea is weaved into history: all warlords and warmongers were warriors themselves and, with few exceptions societies were run by risk takers not risk transferors. They took risks –more risks than ordinary citizens. Julian the Apostate, the hero of many, died on the battlefield fighting in the never-ending war on the Persian frontier. One of predecessors, Valerian, after he was captured was said to have been used as a human footstool by the Persian Shahpur when mounting his horse. Less than a third of Roman emperors died in their bed –and one can argue that, had they lived longer, they would have fallen prey to either a coup or a battlefield.

And, one may ask, what can we do since a centralized system will necessarily need people who are not directly exposed to the cost of errors? Well, we have no choice, but decentralize; have fewer of these. But not to worry, if we don’t do it, it will be done by itself, the hard way: a system that doesn’t have a mechanism of skin in the game will eventually blow up and fix itself that way. We will see numerous such examples.

For instance, bank blowups came in 2008 because of the hidden risks in the system: bankers could make steady bonuses from a certain class of concealed explosive risks, use academic risk models that don’t work (because academics know practically nothing about risk), then invoke uncertainty after a blowup, some unseen and unforecastable Black Swan, and keep past bonuses, what I have called the Bob Rubin trade. Robert Rubin collected one hundred million dollar in bonuses from Citibank, but when the latter was rescued by the taxpayer, he didn’t write any check. The good news is that in spite of the efforts of a complicit Obama administration that wanted to protect the game and the rent-seeking of bankers, the risk-taking business moved away to hedge funds. The move took place because of the overbureaucratization of the system. In the hedge fund space, owners have at least half of their net worth in the funds, making them more exposed than any of their customers, and they personally go down with the ship.

The interventionistas case is central to our story because it shows how absence of skin in the game has both ethical and epistemological effects (i.e., related to knowledge). Interventionistas don’t learn because they they are not the victims to their mistakes. Interventionistas don’t learn because they they are not the victims of their mistakes, and, as we saw with pathemata mathemata :