The risk-reward philosophy
Most people see the world as it is and believe what they see. It takes a special class of people to arrive at insights not apparent to ordinary minds. Nassim Nicholas Taleb belongs to that rare rank of thinkers who can illumine any subject they choose to focus on.
In The Black Swan, he told us about low-probability but high-impact events that we ignore at our own peril. It is such events that alter the course of history. Being impossible to foresee, they make a mockery of all those in the prediction business, who claim to be able to foretell the future.
In Fooled by Randomness, Mr Taleb dwelt on the role that luck plays in our lives. Most people attribute their success to their own talents and abilities, and are unwilling to concede that chance may have played a part. In that book, Mr Taleb’s portrayal of people he labelled “lucky fools” was interesting, and humorous. These are the people that Lady Luck has smiled on, way beyond what they deserve. But are they willing to concede that they have been fortunate? You bet not. As they grow more successful, their hubris grows and they turn increasingly reckless. Sometimes — though not always — the day of reckoning arrives out of the blue and their ill-deserved fortune gets wiped out. Success, says the author, that is achieved owing to luck is also more vulnerable to changes in fortune.
The idea of Skin in the Game, which Mr Taleb dwells on in his latest book, is essentially simple. If you enjoy the rewards, you must also share some of the risks, and not let others pay the price for your mistakes. The principle was enshrined in the code of Hammurabi, which says: “If a builder builds a house and the house collapses and causes the death of the owner, the builder shall be put to death.”
The idea is also interwoven in history. Traditionally, society was run by risk-takers. Emperors often died fighting in wars. Even today, monarchs derive their legitimacy from a social contract that requires risk taking. The British royal family, for instance, made sure that one of its scions, Prince Andrew, took more risks than commoners in the Falklands War, his helicopter being in the front line. Why? Because nobility derives its position from protecting others. It barters personal risk for power and prominence.
But the bane of modern society, says Mr Taleb, is the rise of people who enjoy the power to make decisions, but are not affected by their consequences. Academicians espouse theories that gain wide currency but fail the test of reality. Bureaucrats, in their role as regulators, frame convoluted rules. When they retire from government, they take up sinecures and help the same companies they had once regulated circumvent those very regulations.
Many top bankers in the US took massive risks and were rewarded with outsized salaries and bonuses in the 2000s. When the blow-up occurred in 2008, it was the taxpayer’s money that bailed out these banks. The government did not claw back any of these bankers’ ill-gotten earnings.
Another class on whom the author directs his fire is the “interventionistas”. These are intellectuals who advocate the overthrow of dictatorships around the world, such as in Iraq and Libya. The question they don’t address is: Once you have removed the dictator, whom do you supplant him with? In reality, the alternatives have often proven to be worse. In the turmoil that has followed such regime changes, millions have lost their lives, homes and families in West Asia. The “interventionistas”, meanwhile, continue to live cushy lives in the US and keep advocating interventions in new countries.
In the financial world, a sales person may sell you a toxic product (ULIPs sold in India in the past, for instance). Their harmful effects become apparent only in the distant future. By the time the buyer realises he has been sold a lemon, the seller has collected his upfront commissions and is long gone. Next time someone tries to sell you a financial product, take the author’s advice and ask: “Don’t tell me what you think, just tell me what is in your portfolio.” In other words, do you have skin in the game? Many Indian mutual funds urge their staff to invest in their own funds. Those are the financial products in which you should feel comfortable investing.
Although the examples in this book are mostly American or global, the patterns of exploitation the author elaborates are rampant in our own society as well. Read this book to recognise such patterns and circumvent them when someone attempts to victimise you.
As with all of Mr Taleb’s writings, this book is not an easy read. But those who stay the course will be rewarded with illuminating, and all too rare, insights.
SKIN IN THE GAME
Hidden asymmetries in daily life Nassim Nicholas Taleb
Allen Lane
279 pages; ~699