Where Leverage Is Bubbling Up

I use to think the next debt crisis was going to be a sovereign debt crisis, but I think it may be much bigger and much worse - a combination sovereign, corporate, consumer debt crisis. Sovereign balance sheets have exploded in a countercyclical move to cover for reduced aggregate demand in the wake of the GFC. Now corporate balance sheets are exploding as the false veneer of higher profits and higher share prices allows companies to gorge themselves at the trough of low interest rates and an eager demand for higher yielding paper. This will come back to bite when the economy experiences its next cyclical downturn. The poor consumer, overstuffed as he is but hanging on, will simply be collateral damage as everything goes to hell in a handbasket.

The margin for error is diminishing.

More Great Insights from Taleb

The rule - what you don't do is more important than what you do. In natural systems, you need redundancy to make the system work better. People think that redundancies are inefficient. I think they're the most efficient thing in the world, if you do them right.

Redundancy is bad if you buy the same morning newspaper twice or if you have two subscriptions to the same website. But redundancy is fine if you have a stock of cash in the bank or if you're a company that needs oil and you have extra oil.

Let's assume that you have cash in the bank and there's a big crisis. You have dry powder. It will make you antifragile to have the extra dry powder if nobody else has money. You can buy anything you want. Cash is the opposite of leverage.

In fact, the number one indicator of fragility is leverage. It can be operational or financial. Leverage corresponds to people's overconfidence about the future.

Most people who have leverage will be completely squeezed in a crisis, and you will have cash.

Where did we get our stomach for risk

It amazes me the gutsiness of the guys who sit on prop desks, or at hedge funds making market bets with 20x-30x-40x-50x leverage. I don't know how they do it! One wrong move and it all goes poof.

Is it ego? Is it hubris? Is it bravado? Is it incentives? Is it stupidity? Is it madness? Is it skill? Is it luck? Is it greed? Is it insecurity? Is it peer pressure? Is it culture? Is it ambition? Is it hope? Is it faith? Is it the will-to-power? Is it immaturity?

The one thing they invariably have in common is that it is someone else's money.

This penchant for risk among our financial superstars has slowly, but insipidly made its way through the system. To the point where modern Anglo-Saxon economies are a mere shell of their former financial selves.

One way or another change is coming. It may be through enlightened cultural norms (don't count on it), more likely it will be through enlightened self-interest brought on by economic necessity.

The choice is ours (if only there was leadership to help navigate the waters). We can either take our medicine now (manifest in a deep recession) or we will experience something a lot less savory later.