Nassim Nicholas Taleb & Scott Patterson — How Traders Make Billions in The New Age of Crisis

Scott Patterson and Nassim Taleb discuss their shared history and connection through their work in finance, particularly focusing on Taleb's influence with his books "Fooled by Randomness" and "The Black Swan." Taleb explains his transition from active trading to a more scholarly pursuit, emphasizing his preference for intellectual endeavors over financial identity. They explore the concept of tail risk and how Universa Investments, co-founded by Mark Spitznagel, employs strategies to manage extreme market events. The conversation also delves into the precautionary principle, emphasizing the importance of mitigating systemic risks such as pandemics and climate change by understanding and preparing for fat-tail events.

• Scott was a reporter at the Wall Street Journal in the mid-2000s, covering hedge funds.
• A book called "Fooled by Randomness" by Nasim Taleb was popular among hedge fund managers.
• Scott investigated rumors about Nasim's hedge fund shutting down and got in touch with him.
• Nasim revealed his hedge fund had shut down, but a new one was starting by his former colleague, Mark Spitznagel.
• Scott wrote a story in 2007 about the shutdown and the launch of the new hedge fund, Universa, and mentioned Nasim's upcoming book, "The Black Swan."

"I was covering hedge funds and there was among the hedge fund community this book that a lot of hedge fund managers liked to talk about... It was called 'Fooled by Randomness.' So I read that book, I thought it was amazing."

• Scott was intrigued by the mystery surrounding Nasim's hedge fund and decided to investigate further.

• Nasim decided to step out of active trading in his late 30s, early 40s.
• He preferred focusing on concepts and ideas rather than the stress of trading.
• Mark Spitznagel took over the trading responsibilities as Nasim transitioned to scholarly work.

"I realized that I'd like to be a scholar who eats well who trades once in a while with a sense of it was like a military person who you know has an honorary discharge to do other things."

• Nasim wanted to be known as a scholar rather than a trader and felt Mark was more capable of handling the trading responsibilities.

• Nasim and Scott first met around 2001-2002 after corresponding about hacking ideas.
• They shared a memorable meal on Madison Avenue, eating all the eggs the restaurant had.
• They became friends and shared significant moments, such as the collapse of Lehman Brothers.

"We went to a restaurant on Madison Avenue and ate every single egg they had in the store."

• Their friendship deepened over shared interests and significant financial events.

• The concept of betting on tail events involves preparing for rare, extreme events that can have massive impacts.
• Universa's strategy is not about predicting these events but constantly taking positions that will pay off during such events.
• This strategy involves buying far out-of-the-money put options to protect clients' portfolios.

"The whole idea of the Black Swan... is to bet on disruption, on the unforeseen, to not be harmed by silent risk."

• The primary goal is to avoid harm from unforeseen risks and capitalize on the systemic risks that others ignore.

• Universa differentiates itself by focusing solely on tail risk management, not making predictions.
• Mark Spitznagel emphasizes that their strategy is about risk management, not betting.
• Universa's approach allows clients to increase their market exposure while being protected against extreme downturns.

"What Universa does is they are constantly taking on positions that will pay off massively in a tail event so that their clients are constantly protected."

• The strategy is designed to provide constant protection without the need for accurate market predictions.

• The strategy can go years without making money, which is stressful and requires patience.
• Universa's genius lies in packaging their product as insurance, allowing investors to take larger market positions.
• The firm’s focus on a single strategy for decades has honed their expertise, making them highly proficient.

"Mark is always bearish on the market but he provides people a product that couples very well with a very long stock position."

• Universa’s specialization in tail risk management is both their main criticism and their greatest strength.

• Nasim and his team had been working on pandemic preparedness since 2007, emphasizing the importance of early action.
• The interconnectedness of today’s world makes it crucial to be prepared for pandemics and financial crises.
• Historical lessons, such as quarantine practices, are vital for managing modern-day risks.

"We were all obsessed with a great pandemic that would come and we thought it was going to be Ebola."

• The importance of early action and learning from history is emphasized in managing systemic risks.

• The concept of "skin in the game" highlights the need for personal accountability in decision-making.
• Financial leaders often lack personal risk, leading to decisions that favor short-term gains over long-term stability.
• The bonus system in finance encourages risky behavior without personal consequences.

"If you have skin in the game, you're going to worry about blow up because it's your money. If you don't have skin in the game... your incentive is to print good numbers because you don't pay for the downside."

• Ensuring personal accountability can mitigate the risks of catastrophic financial failures.

• Scott’s book on Universa and Nasim’s strategies serves to document and fact-check the importance of tail risk management.
• The book aims to provide a narrative around the concept of precaution and tail risk for society.
• Rigorous documentation and fact-checking help separate myths from reality.

"It was very good that he wrote that book for one reason: to put some story and narrative around the idea of precaution and tail risk for society in general."

• Accurate documentation is crucial for understanding and appreciating the value of tail risk strategies.

• The conversation highlights the importance of preparing for extreme events, both in finance and broader societal contexts.
• Universa's unique approach to tail risk management sets it apart from other hedge funds.
• The principles of early action, personal accountability, and historical lessons are emphasized as crucial for managing systemic risks.

• Robustness is valuing the opinions of a few who appreciate your work over the multitude who criticize it.
• Fragility is when you care more about the few who criticize your work than the many who appreciate it.
• Reputation should be valued in circles of knowledgeable people rather than the general public.

"Robustness is when you care more about the few who like your work than the multitude who hate it. Artists' fragility is when you care more about the few who hate your work than the multitude who loves it. Politicians."

• This quote illustrates the difference between robustness and fragility in terms of caring about opinions.

"If you have to go defend your reputation and you're doing the right thing, it's too much energy wasted, and it's not gonna help. Haters are gonna hate."

• Defending one's reputation against widespread criticism is often futile and energy-consuming.

• Many hedge fund managers are driven by a strong desire to make money.
• There is often a contrast between personal backgrounds and professional motivations.
• Successful traders often come from varied educational backgrounds but apply their expertise to finance.

"Many are very focused on making a lot of money. That's a very common trait."

• A common trait among hedge fund managers is the strong drive to accumulate wealth.

"A lot of them are mathematicians, scientists. They come out of university with different expertise and apply that on Wall Street to making money."

• Successful traders often leverage their academic backgrounds in fields like mathematics and science to excel in finance.

• Independent thinking is often mistaken for contrarianism.
• True contrarianism is an expertise, not merely an attribute.
• Envy can be a driving force but should be directed towards intellectual pursuits rather than material wealth.

"Contrarian is an expertise rather than an attribute."

• Being contrarian is a specialized skill rather than just a personality trait.

"I was always envious that people had more erudition than me."

• Envy can be directed towards intellectual achievements rather than material gains.

• Philosophical ideas, especially from Stoicism and Skepticism, have significantly influenced thinking.
• Historical scholars often had similar ideas, and their works can provide valuable insights.
• Fundamental skepticism should be applied to significant matters rather than trivial ones.

"I started liking the Stoics and all those people I've talked about much earlier in my life."

• Philosophical influences like Stoicism were embraced early in life.

"I wanted to find people who were fundamentally skeptical about important things, not about small things."

• The focus should be on skepticism about significant issues rather than minor ones.

• The precautionary principle advises against taking risks with potentially catastrophic outcomes.
• It is particularly relevant for systemic risks like climate change and pandemics.
• The principle emphasizes avoiding actions with uncertain but potentially severe consequences.

"If you have uncertainty about the climate, stop these models. Just don't pollute."

• The precautionary principle suggests avoiding actions that could worsen climate change due to uncertainty.

"There's no evidence that GMOs are harmful, but there's no evidence that they're not harmful."

• The precautionary principle is about erring on the side of caution in the face of uncertainty.

• Fat tails describe extreme events that have a disproportionate impact.
• These events require different risk management strategies compared to more predictable, thin-tailed events.
• Identifying fat-tailed risks is crucial for applying the precautionary principle effectively.

"Fat tails mean that you have the greatest contribution comes from the smallest number of events."

• Fat tails indicate that a few extreme events can have a significant impact.

"Practically everything in socio-economic life is fat-tailed."

• Most socio-economic phenomena exhibit fat-tailed characteristics.

• Personal identity should not be confined to professional roles like finance.
• Intellectual pursuits and contributions can be more fulfilling and meaningful.
• Avoiding an identity crisis involves aligning one's work with personal values and interests.

"I don't want to be someone who produces intellectual work and who happens to have had contact with reality thanks to trading."

• Intellectual work can be more fulfilling than being solely identified with a profession like finance.

"George Soros missed his career; he wanted to be a philosopher and thinker."

• Even successful financiers like George Soros have struggled with identity crises, wanting to be known for intellectual contributions.

• The concept of polycrisis describes multiple, overlapping global crises that exacerbate each other.
• Addressing these crises requires a holistic approach to risk mitigation.
• Applying risk management strategies from finance to global issues can provide valuable insights.

"We are seeing a magnification of extreme events accelerating and overlapping."

• The polycrisis concept highlights the interconnectedness and amplification of global crises.

"Can you take ideas that were created on Wall Street for risk mitigation and apply those to other forms of risk management?"

• Risk management strategies from finance can be adapted to address broader global risks.

• The precautionary principle can be applied to various domains, including climate change and public health.
• It involves identifying and prioritizing risks that have the potential for catastrophic outcomes.
• Practical examples include avoiding actions with uncertain but potentially severe consequences.

"If you hear that a billion people died, which one is more likely to be the cause: Ebola or car accidents?"

• This illustrates how fat-tailed events (like pandemics) have a disproportionate impact compared to more common risks (like car accidents).

"You need fat tails to apply the precautionary principle effectively."

• Identifying fat-tailed risks is crucial for prioritizing precautionary measures.

• The risk of COVID-19 is thin-tailed, meaning it spreads and affects populations widely.
• Vaccines are essential in mitigating the spread and impact of COVID-19.
• The comparison between the risks of COVID-19 and vaccines shows that the risk of the virus is significantly higher.

"If I die of COVID, the odds of my neighbor dying of COVID has increased."

• COVID-19 has a transmission mechanism that increases the risk for the entire population.

"I am in favor of vaccines; the risk is thin-tailed, and I'm against GMOs because they spread in the environment."

• Vaccines help control thin-tailed risks, unlike GMOs which can have uncontrolled environmental spread.

"We know a lot more about genetic stuff in an individual than we know about how genes spread in a population."

• Individual genetic risks are better understood compared to population-level genetic risks.

"COVID raised the risk of death, your multiple of deaths across, you know, beyond the age of 30."

• COVID-19 increased mortality rates significantly, particularly for those over 30 years old.

"By then we had eight billion jabs... we had the answer."

• The widespread administration of vaccines provided clear evidence of their effectiveness and safety.

• GMOs pose a risk due to their potential for uncontrolled environmental spread.
• Selective breeding is a slower, more controlled process compared to genetic modification.
• There is a lack of proper risk studies on GMOs, particularly regarding environmental impact.

"The GMO, the way it would spread through the environment, it's like an uncontrolled spread."

• GMOs can spread uncontrollably, posing significant environmental risks.

"They have never done a proper risk study on GMOs in the environment."

• There is insufficient scientific evidence on the long-term environmental impacts of GMOs.

"Monsanto... they really wrecked science because they had groups of people who would go and intimidate scientists."

• Monsanto has been accused of undermining scientific research and intimidating scientists who criticize GMOs.

• The precautionary principle is widely adopted in Europe but not as much in the United States.
• It provides a framework for assessing and mitigating risks, particularly when there is uncertainty.
• The principle can be applied more broadly to regulatory policies to enhance safety and reduce risks.

"In Europe, the precautionary principle is widely adapted among international agencies and regulatory agencies."

• Europe actively uses the precautionary principle to regulate risks, such as those posed by GMOs.

"The more uncertainty there is in a model, the more you have to be cautious."

• Greater uncertainty in risk models necessitates more precautionary measures.

"Uncertainty is actually a reason for precaution rather than just throwing caution to the wind."

• Uncertainty should lead to more cautious and preventive actions, not less.

• Uncertainty in climate models should lead to more precautionary measures, not less.
• The precautionary principle can be applied to mitigate the risks associated with climate change.
• The principle highlights the importance of taking action even when the full extent of risks is not known.

"If you are uncertain about the potential future destruction... maybe you should stop doing that."

• Uncertainty about climate change impacts should prompt preventive actions to reduce risks.

"The more uncertainty there is in a model, the more cautious you should be."

• Greater uncertainty in climate models calls for more cautious and preventive measures.

"Dosing the atmosphere with carbon dioxide... you're going to end up with a very bad outcome eventually."

• Continuous pollution increases the risk of severe negative outcomes for the environment.

• Convexity refers to the non-linear relationship between risk and reward.
• Understanding convexity is crucial for managing financial risks and identifying potential gains.
• Historical financial crises illustrate the importance of recognizing and managing convex risks.

"If the market goes down 10, you make a million dollars; if it goes down 20, you make 10 million dollars."

• Convexity can lead to exponential gains or losses based on market movements.

"The risk of Fannie Mae... if the markets increase by 100 basis points, they lost X; 200 basis points, 20 times X."

• Convexity in financial risks can lead to disproportionately large losses or gains.

"You had maximum risk all you could lose is say X thousand dollars, and that exploded."

• Convexity can result in significant returns even with a relatively small initial risk.

• Globalization has increased interconnectedness, reducing the effectiveness of traditional diversification strategies.
• Financial markets and supply chains are now more susceptible to global shocks and crises.
• The interconnected nature of the modern world requires new approaches to risk management.

"International diversification was no longer a diversification... because of that integration."

• Global interconnectedness has diminished the effectiveness of international diversification.

"The world's getting bigger and bigger... but it's like a large movie theater with the same door."

• The global economy is more interconnected, but the capacity to manage crises remains limited.

"People would not understand that this is why people like to sell tail events because it costs money to diversify."

• Diversification and hedging against tail risks are often perceived as costly but are essential for managing global risks.

• Discussion on various countries and their approaches to risk management.
• Analysis of traditional societies and their resistance to certain technologies.
• Effects of propaganda on public perception and policy.

"Traditional societies are traditional communities like Italy where there's this paranoia about GMOs."

• Italy's traditional resistance to GMOs is highlighted.

"The KGB was not very good at spying but was very good at disinformation."

• The KGB's effectiveness in spreading disinformation is noted.

• Comparison of nuclear energy risks in different countries.
• Impact of Fukushima disaster on Germany's energy policy.
• Convexity in risk management of nuclear reactors.

"Germany freaked out over something that actually didn't kill people, shut down their entire nuclear program, and in its place opened up a bunch of coal-fired power plants."

• Germany's reaction to Fukushima led to a shift from nuclear to coal energy, increasing direct risk.

"Because of convexity, one reactor is vastly more dangerous than ten small ones."

• Convexity suggests smaller reactors are safer than one large reactor.

• The banking sector is considered safe due to its utility status.
• Migration of risk from banks to hedge funds post-2008.
• Hedge funds and private equity as new risk centers.

"The banking sector is very safe for one reason: it's a utility with high-paid bankers."

• Banks are seen as utilities, making them safer.

"The risk has migrated from banks to hedge funds."

• Post-2008, financial risk has shifted to hedge funds.

• Shift in investment focus from cash flow to selling companies.
• Low interest rates have impacted investment behaviors.
• The fragility of startups and the potential for failures.

"The game now is who you're going to sell your company to."

• Modern investment focuses on selling companies rather than generating cash flow.

"There are going to be tremendous fatalities in the next probably three quarters in the startup world."

• Predicting significant failures in the startup sector due to funding contractions.

• Importance of convexity in risk management and other fields.
• Convexity effects in medicine, nutrition, and volatility.
• Application of convexity in scientific research.

"Convexity means your life likes volatility where you're convex."

• Convexity implies systems thrive on variability.

"This is what I'm focusing on now: these convex responses applied to fields like medicine."

• Current research focuses on convexity in medicine and other fields.

• Risks associated with options trading for ordinary investors.
• Importance of understanding optionality in business.
• Advice for individuals to focus on their primary business rather than financial speculation.

"It's not trading options that will help you; it's looking at optionality in business."

• Emphasizing the importance of understanding optionality in business contexts.

"Ordinary people should stay away from these derivative contracts."

• Warning against the risks of options trading for non-professionals.

• Impact of the Inflation Reduction Act on climate technology.
• Conversations with lawmakers about renewable energy.
• Strategies to engage different parties in climate discussions.

"The Inflation Reduction Act is sending shock waves through the climate technology world."

• The act is significantly influencing climate technology development.

"You can have perfectly rational conversations with them and they love it when you talk about energy."

• Productive discussions can be had by focusing on energy rather than climate change.

• New book projects focusing on scientific papers and ancient wisdom.
• Exploration of non-BS criteria in scientific and casual contexts.
• Reflections on historical judgments and the passage of time.

"I'm working now on a book that is structured like an ancient Roman treatise."

• Upcoming book will be structured as a traditional treatise.

"The main difference between BS and non-BS is the rigidity of meaning."

• Rigidity of meaning is a key criterion for distinguishing BS from non-BS.

"It is improper to blame someone retrospectively for values we have today that were not present then."

• Discussing the importance of context in historical judgments.