Federal regulators need to help insure the economy against catastrophes, not just the optimize it to do well under ordinary conditions.
Nassim Taleb, a risk engineering professor at the New York University Polytechnic Institute, made that argument today at a hearing organized by the oversight and investigations subcommittee at the House Financial Services Committee.
The panel organized at the hearing to look at the progress of the Office of Financial Research (OFR) and the Financial Stability Oversight Council (FSOC), two agencies created by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Dodd-Frank Act calls for the OFR to help the FSOC get the data the FSOC needs to identify and track potential threats to the U.S. financial system.
Taleb, a former derivatives trader, is known for promoting “tail risk hedging,” or the need to protect against potentially catastrophic “Black Swan” events.
The OFR section of the Dodd-Frank Act “aims at the creation of an omniscient Soviet-style central risk manager,” Taleb said, according to a written version of his testimony provided by the subcommittee. “It makes us fall into the naive illusion of risk management that got us here –the same illusion has led in the past to the blind accumulation of Black Swan risks.”
Society can prepare for Black Swan events, but it cannot predict them,Taleb said.
“There have been tens of thousands of scientific papers on prediction that have not been been replicated outside the papers,” Taleb said. “Had the last crisis been predictable within these quantitative methods, then central banks with access to all manner of information, and thousands of PhDs on their staff, would have been able to see it. They failed. So please ask yourselves why you believe that the next attempt will succeed.”
Taleb suggested that policymakers should take a “less is more” approach to managing financial system risk.