NEVERMORE

In Edgar Allen Poe's "The Raven" he mentions nepenthe, a pain killer, the drug of forgetfulness in Greek mythology. Versed might be the modern-day version. But the problem with pain killers, God bless 'em!, is they mask the real problem.

This weekend's edition of the WSJ runs a piece about 2016 and what 12 critical thinkers think. One of them is Nassim  Nickolas Taleb, the well-known author and former Wall Street trader, "The Real Risks to Worry About."

 How should we think about financial risks in 2016?

First, worry less about the banking system. Financial institutions today are less fragile than they were a few years ago. This isn’t because they got better at understanding risk (they didn’t) but because, since 2009, banks have been shedding their exposures to extreme events. Hedge funds, which are much more adept at risk-taking, now function as reinsurers of sorts. Because hedge-fund owners have skin in the game, they are less prone to hiding risks than are bankers. 

The point about hedge funds being less prone to "hiding risks" is questionable for many reasons, not withstanding their performance the past few years (See a companion article in the same edition:  "Wasted Opportunity:Hedge Funds Falter) and the well-publicized corruption issues over the years.

The comment about banks is also suspect if for no other reason than their history of selective amnesia, a point Taleb concedes with banks "have not gotten better" in measuring risks. One could easily argue that tax-payer financed bail-outs are the public version of nepenthe.They mask the real problem.

This isn’t to say that the financial system has healed: Monetary policy made itself ineffective with low interest rates, which were seen as a cure rather than a transitory painkiller. Zero interest rates turn monetary policy into a massive weapon that has no ammunition. There’s no evidence that “zero” interest rates are better than, say, 2% or 3%, as the Federal Reserve may be realizing.

I worry about asset values that have swelled in response to easy money. Low interest rates invite speculation in assets such as junk bonds, real estate and emerging market securities. The effect of tightening in 1994 was disproportionately felt with Italian, Mexican and Thai securities. The rule is: Investments with micro-Ponzi attributes (i.e., a need to borrow to repay) will be hit. 

Though “another Lehman Brothers” isn’t likely to happen with banks, it is very likely to happen with commodity firms and countries that depend directly or indirectly on commodity prices. Dubai is more threatened by oil prices than Islamic State. Commodity people have been shouting, “We’ve hit bottom,” which leads me to believe that they still have inventory to liquidate. Long-term agricultural commodity prices might be threatened by improvement in the storage of solar energy, which could prompt some governments to cancel ethanol programs as a mandatory use of land for “clean” energy. 


His comment about Dubai might well be true until the recent "divine vengeance" uprising.

We also need to focus on risks in the physical world. Terrorism is a problem we’re managing, but epidemics such as Ebola are patently not. The most worrisome fact of 2015 was the reaction to the threat of Ebola, with the media confusing a multiplicative disease with an ordinary one and shaming people for overreacting. Cancer rates cannot quadruple from one month to the next; epidemics can. We are clearly unprepared to deal with such threats. 

It's just a difference of opinion, but we would also take issue with Mr. Taleb's scolding of those who scolded others for over-reacting. We're not virologists, but we've been around more than one viral rodeo, probably in a  much more assembly line way than he, irrespective who and what his sources are. Over-reaction mostly from the media is part of the DNA of these outbreaks.

This is not to say it can't happen, but the probabilities are quite small, a subject we suspect Taleb is quite familiar with. In fact, we would argue that the last point in his piece the blackout and what is to come buttresses our point more than his.

Finally, climate volatility will produce some nonlinear effects, and these will be compounded in our interconnected world, in which disruptions are more acute. The East Coast blackout of August 2003 was nothing compared with what may come. 

What we do agree with is his comment about the Fed, no cure just a transitory pain killer. So we will leave you with two stanzas from Poe's masterpiece.

Then, methought, the air grew denser, perfumed from an unseen censer
Swung by seraphim whose foot-falls tinkled on the tufted floor.
"Wretch," I cried, "thy God hath lent thee—by these angels he hath sent thee
Respite—respite and nepenthe, from thy memories of Lenore;
Quaff, oh quaff this kind nepenthe and forget this lost Lenore!"
            Quoth the Raven "Nevermore."

"Prophet!" said I, "thing of evil!—prophet still, if bird or devil!—
Whether Tempter sent, or whether tempest tossed thee here ashore,
Desolate yet all undaunted, on this desert land enchanted—
On this home by Horror haunted—tell me truly, I implore—
Is there—is there balm in Gilead?—tell me—tell me, I implore!"
            Quoth the Raven "Nevermore."