The problem is not leverage by itself. A highly-leveraged ES trader does not cause systemic risk because if his account goes below required margin he's just kicked out of the casino. The problem is when traders are allowed to make bets they cannot cover if wrong. The banking system leverage is not desirable because if all banks fail together no one can cover lending or trading losses. You insist on ignoring the fact that quantitative Nobel Prize winning risk models were introduced explicitly with the purpose of increasing leverage, while telling their naive users that their positions were not risky. In fact, the whole Federal Reserve System has been created so banks can leverage more and more. Leverage is the essence of Fractional Reserve and Central Banking. Closing down the Fed means banks cannot leverage thus banking crises cannot happen.
This is idiotic. They crisis was caused by reckless banks who lent money to unqualified borrowers because the banks could get the garbage off their books by packaging and selling it as Triple-A investments. Take FNM, FRE, and mortgage securitization out of the equation and this never happens. Banks had the ability to shift risk to someone else so they didn't care about the risk involved in the reckless lending. No Nobel Prize Economist's theory caused this mess. Taleb's position is laughable.
taleb overestimates the importance of academics. If the Academics had never existed, some other rationale would have been used to justify bad behavior. The particular rationale that was used is consequently of limited significance.
Yes, but when you go to sell that steaming crapload, you have to have something to hide the smell. That something would be the kind of thing these Nobelistas were coming up with. I mean, there's a model out there, Modigliani-Miller (yes, the same Miller), that I swear to freakin gawd states* that it makes no difference if a company funds itself via debt or equity. Who even thinks of this kind of stoopid crapola? And even better, what kind of fool believes it? The kind of fool who'd buy a triple-A CDO, I guess. *[size=-2]Here's the fine print with all the assumptions. Might as well be on Mars when you're done: The ModiglianiâMiller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. The basic theorem states that, under a certain market price process (the classical random walk), in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed.[1] It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the Modigliani-Miller theorem is also often called the capital structure irrelevance principle. But who the freak reads footnotes anyway?[/size]
"in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market" In other words in ivory tower tenured idiot professor land. Does anybody who operates in the real world pay any attention to finance professors? There was this man called Greenspan who acted on accepted but unproven academic theories.............. There was also this guy called Merton Scholes who advised a company called LTCM. Seems his model failed to account for the fact that bids get pulled in a falling market.
Well....all I can say is the position Miller takes on equity v debt financing is even more laughable than Taleb's assertion that these types of theories caused the crisis. Boy, this guy really said that?
The scary part is this stuff is what's actually taught in Economics and Finance classes, routinely. This is why Taleb gets so .... exercised. I'm pretty sure a lot of those guys who were selling that crap on believed this stuff, because its' what they got taught in school. Well, except for the guys at GS. I'm sure they were the ones in the back of the class suppressing their laughs...
From my first class in Finance 101 I learned there is a big difference between equity and debt financing for a variety of reasons. I guess the professor I had didn't subscribe to Miller's theory.
I got this model as a retort on another forum, where the person stated in all seriousness how these guys demonstrated that debt was no different than equity. So, some guys are taught this, and it looks like the assumptions either aren't emphasized or are mentioned and then tossed aside.
Seems the professors also forgot about this little real world inconvenience of debt called bank covenants.