“The physicist-run Prediction Company is an example of a company that has apparently extracted unusual profits from the market for over a decade. In contrast, economist-run companies like LTCM and Enron have gone belly-up. Being a physicist certainly doesn’t guarantee success … but if you are going to look for correlations in (market or any other) data then being a physicist might help.”

Joseph L. McCauley, writing in
Dynamics of markets: econophysics and finance

As a trader turned philosopher, Taleb has railed against Wall Street risk managers who attempt to predict market movements. Even so, Taleb said he saw the banking crisis coming.

“The financial ecology is swelling into gigantic, incestuous, bureaucratic banks — when one fails, they all fall,” Taleb wrote in “The Black Swan: The Impact of the Highly Improbable,” which was published in 2007. “The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup.”

…

Taleb is angry that Wall Street is continuing to use traditional tools such as value at risk, which banks use to decide how much to wager in the markets.

“We would like to society to lock up quantitative risk managers before they cause more damage,” Taleb said.

This being recruiting season, there was a guy from the risk management division of a certain big bank here talking up his job and company. (The week after that, their stock was halved and last week it was even in the single digits. That’s another story.)

He wasn’t very specific but I got an impression of the very crude and non-rigorous method of “value at risk”, something like the 90th percentile loss value based on some unverifiable model, but not an actual hard bound. So what do you get? Obviously everybody builds up their portfolio right up against the 90th percentile and a digital waterfall effect at the boundary becomes that much more likely. There is nothing wrong with quantitative risk management. There is something wrong with bad ideas even if they are “quantitative”… Probably worse, because it gives the layman a false sense of invincibility.

Who is the Federal Reserve, who owns the Federal Reserve

and this,

Where does the Federal Reserve get the money to fund its operations?

If that’s the case, then the Federal Reserve doesn’t really “creates money” when it uses open market operations to buy bonds. To presume that would put the Federal Reserve outside the economy.

Money is “created” at the moment that a newly originiated debt IOU (or any non-money, really) is accepted as money for the first time, that is, in exchange for actual money — e.g., individuals obtaining a new loan, companies or governments selling newly issued bonds, selling of newly created stock, etc.; and if I were a stickler, this should really only apply to the portion of the debt that is unsecured, as the exchange of money for the secured collateral is like a purchase by the lender who has rights on it. When the bond or debt is repaid, the reverse happens as money is destroyed. Interestingly, money expansion like this is only pseudo-permanent to the extent that the debt is either permanently revolving or replaced with new issues (Treasury notes in practice) or has an infinite time horizon (stocks).

In fact, bank loans can go a step further and continually (permanently) expand the money supply through fractional reserve lending, where new loans given out faster than the pace that old ones are repaid — if I get a loan today, I can put it into a savings account, but before I pay it back, it will be loaned out again. This is okay as long as banks have a reasonable value proposition for their loan, i.e. an expectation that whatever the loan is used for has or will have underlying value in the economy and hence an expectation of repayment. (If that’s not the case, then fractional reserve lending becomes but a pyramid scheme.)

In none of these cases is the money supply expanded top-down by the government. The money supply expands organically with the new value created in the economy (actually keeping slightly ahead of it, as they are tied to the expected value to be created from a capital venture — temporary asset bubbles excepted). The Federal Reserve is just a bank in this ecosystem with the objective not of profit but of being a sane participant (indeed to define “sane” through its market behavior); but it is still just a bank, and it has to balance its own checkbook, too.

(See here for another discussion. Interestingly, the Fed doesn’t have nearly sufficient net equity to conduct its operations, but it doesn’t matter because when the bonds it buys mature, the government, i.e. taxpayers, pays the Fed; or if the bonds roll over, then taxpayers in the indefinite future presumably will. If we look at this situation on a grand scale, if money supply in the economy grows in any permanent way it must be entirely due to growing private debt lent by banks plus growing debt incurred by the government, which of course is implicitly borne by the public as well. If that growth is in step with the economic productivity, meaning people will be increasingly able to pay their private debt, and government will get increasing tax revenue to pay bonds, then everything is okay.)