Tail Risk Killers: How Math, Indeterminacy, and Hubris Distort Markets

CHAPTER 23The Fed Is a Two-Faced Mutant Pig

The problem with risk is that we manage it with what we know best, even when events outside our experience happen. For this reason, investors work under the assumption that the future is not appreciably different from the past. When radically different conditions arise, all bets are off. The Federal Reserve manages risk with what it knows best—easy liquidity. This will create a greater problem than it resolves.

THE PROBLEM IS INSOLVENCY, NOT ILLIQUIDITY

Insolvency is the real tail risk now, not illiquidity.

The Policy Premise

The prices for bank assets became “artificially” depressed by banks and other investors trying to unload their holdings in an illiquid market. As a result, they no longer reflect ...