Preventing and Rethinking Black Swans
On my recent travels to eastern Australia I was lucky enough to see a black swan. This got me thinking of the other type of black swan—specifically, two items I’ve read in the recent past:
Nassim Nicholas Taleb’s ten principles for a Black Swan-proof world (via Kottke, pdf):
- What is fragile should break early while it is still small.
- No socialisation of losses and privatisation of gains.
- People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
- No incentives without disincentives: capitalism is about rewards and punishments, not just rewards.
- Counter-balance complexity with simplicity.
- Citizens must be protected from themselves, from bankers selling them “hedging” products, and from gullible regulators who listen to economic theorists.
- Governments should never need to “restore confidence”. Cascading rumours are a product of complex systems. Governments cannot stop the rumours. Simply, we need to be in a position to shrug off rumours, be robust in the face of them.
- Using leverage to cure the problems of too much leverage is [denial]. The debt crisis is not a temporary problem, it is a structural one. We need rehab.
- Citizens should not depend on financial assets or fallible “expert” advice for their retirement. Economic life should be definancialised.
- This crisis cannot be fixed with makeshift repairs. […] We need to rebuild […] with new (stronger) materials; we will have to remake the system before it does so itself. Let us move voluntarily into Capitalism 2.0 by helping what needs to be broken break on its own, converting debt into equity, marginalising the economics and business school establishments, shutting down the “Nobel” in economics, banning leveraged buyouts, putting bankers where they belong, clawing back the bonuses of those who got us here, and teaching people to navigate a world with fewer certainties.
and Dr. Doug McGruff stating that (previously) “many Black Swans only appear unpredictable because of a blindness that can be removed when viewed from a different perspective”.
I believe that this quote epitomises the crux of the Black Swan theory. Of the three criteria for identifying a Black Swan event, the parenthisised part of the first is surely the most important:
- The event is a surprise (to the observer).
- The event has a major impact.
- After the fact, the event is rationalized by hindsight, as if it had been expected.
1 Comment
I’ve said it before but I think there’s no harm in repeating it.
Dressing the economic crisis up as an Act of God or an unforseeable natural disaster exonerates the disaster’s creators from blame. Taleb’s theory and book only became popular because they are being used as a flag of convenience for the creators of the credit crunch — i.e. the creators and main beneficiaries of the credit bubble.
Consequently, the three criteria you’ve given for identifying a black swan event are axiomatic, inviolable and self-referential (the third criteria requires acceptance of the first to be valid and the second is merely a get-out clause because if the impact is minor, no-one cares). Most importantly though, they are a distraction from the real issue that risks cannot be transferred and spread from the player without incurring a higher degree of systemic risk on the casino.
Which economists have known for a long, long time.
On a related note, the UK and US public have been sold and bought the idea that there is no such thing as a long term investment with reasonable returns for the provision of a pension. This too is bunkum. Banks regularly manage to provide their own senior employees confortable pensions in protected funds. The difference is that they don’t make as much money on them as they do from selling the higher risk, attractive margin products they sell to the rest of us.