What is Nassim Taleb suggesting…?

July 14, 2009

In an FT op-ed Nassim Taleb and co-author Mark Spitznagel suggest the following:

“The only solution is to transform debt into equity across all sectors, in an organised and systematic way. Instead of sending hate mail to near-insolvent homeowners, banks should reach out to borrowers and offer lower interest payments in exchange for equity. Instead of debt becoming “binary” – in default or not – it could take smoothly-varying prices and banks would not need to wait for foreclosures to take action.”

Can anyone explain what they mean by this…?

5 Responses to “What is Nassim Taleb suggesting…?”

  1. p Says:

    Good question. I was wondering the same thing when I read the op-ed. On some fundamental level, Taleb hates debt and loves equity — he may be right, but I am not quite sure how you can convert mortgage debt into equity without going through foreclosures. It looks like Taleb wants banks to become landlords, and home owners on the brink of defaulting on their mortgages to become renters. Everybody may be better off indeed: you’d get rid of a binary risk (default or not) and turn it into some kind of continuum (higher or lower returns, i.e. rents); equity bubbles seem less problematic than credit bubbles so a financial system based on more equity and less debt may be more robust overall… The argument makes sense. But practically, turning debt into equity is exactly what foreclosures are about, and the process does not seem that smooth… Maybe Taleb is arguing for legal reform, but the argument is not quite clear.

    • Julian Cochran Says:

      >but I am not quite sure how you can convert mortgage debt into equity
      > without going through foreclosures

      Mortgage debt can be converted to equity by giving a partial
      ownership of the house to the bank to cover the mortgage, and
      then start form a new basis where you don’t have any debt any
      only own equity within the house and can from there gradually
      pay off the rest of the equity. This strategy would reduce
      the fragility of having debt against a changing house price.

      – Julian

  2. marthapoon Says:

    Thanks this interesting interpretation!

    My own initial confusion stemmed from the fact that many of the properties are underwater, which means that the value of the debt instruments financing the purchase of the asset, currently exceeds the value of the asset.

    I wasn’t sure how they could suggest conversion debt into equity so easily, when precisely, there seems to be a fundamental misalignment in the relationship between the debts and the equity.


  3. [Rob’s lengthy comment has been made into a new post.]

  4. Scott Locklin Says:

    Obviously you don’t understand Nassim Taleb. That’s OK, I don’t think anybody else does either, because he’s generally just passing wind, and there is very little signal in his noise:

    http://scottlocklin.wordpress.com/2009/07/17/nassim-taleb-clown-of-quantitative-finance/


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