The financial meltdown that started last autumn could have been avoided. That’s the view of Nassim Nicholas Taleb, author of the book, The Black Swan. Des Dearlove traces the evolution of Taleb’s thinking and shows that the success of his book was quite probably no accident.
“An extraordinary, almost unimaginable sequence of events.”
That is how Mervyn King, Governor of the Bank of England, described the circumstances that plunged the world banking system into crisis following the collapse of Lehman Brothers on September 15, 2008. “It is difficult to exaggerate the severity and importance of those events,” he added. “Not since the beginning of the First World War has our banking system been so close to collapse.”
What King was describing is known as a “black swan”, a term made famous by Nassim Nicholas Taleb in his book, The Black Swan: The Impact of the Highly Improbable (Random House, 2007). In it, Taleb refers to “large-impact, hard-to-predict and rare events beyond the realm of normal expectations”. As examples, he points to the creation of the Internet as well as the terrorist attacks of September 11 as prime examples of recent black swans. Indeed, he argues that most big moments in history are caused by black swans.
But it is Taleb’s views on the banking crisis that have been catching the most attention in business circles since the financial meltdown last autumn. “In the breakdown of our current financial system, which many deemed impossible or at least highly improbable,” wrote Gregory Skidmore in a SeekingAlpha.com column last October 6, “I believe we have witnessed the appearance of a black swan.” The term has been used so often in connection to current financial travails that it has almost achieved cliché status. Yet the impact of negative financial black swans (just check your own retirement savings account) is hardly a cliché.
The philosophy of swans
The phrase “black swan” originally comes from the belief for centuries that all swans were white – an assumption based on the fact that no one in the West had ever seen a black swan. Western philosophers, including Aristotle, used the idea of a black swan to illustrate the improbable, in much the same way that we might refer to those other rare animals, flying pigs or pink elephants. Yet, ironically, this changed in the 17th century with the discovery of black swans in Australia. As a result, the phrase came to mean the exception to the rule.
For Taleb, “black swan”, with its dual meaning, was an irresistible concept to use in discussing world affairs. In Taleb’s case, he didn’t need another person to debate the reality of black swans: on the one hand, he argues that flawed assumptions blind us to the possibility of black swans – for example, that a long-time, upward progression of stocks or home prices can never reverse course and fall. On the other hand, he notes our tendency to imagine there are rules and patterns – for example, that the inevitable reduction in the supply of oil means prices will spike ever higher – even when such rules do not really exist. Think on this awhile and it will help to explain your own current economic dizziness. Everyone assumed that the financial world was being rigorously managed when, in fact, it now appears that bankers were operating laissezfaire. Everyone imagined that the appearance of understandable and predictable rules and patterns in the economic system implied that it operated according to rules and patterns. As we now know, nothing could be further from the truth.
Taleb’s book was an instant success; it spent 17 weeks on The New York Times bestseller list and was translated into 27 languages around the globe. By April 2008, UK and US print runs had already exceeded 370,000 copies. Since then, Taleb’s reputation, and book sales, have been further boosted by the predictions he made about the looming bank crisis. The words at the top of his website home page last November probably capture why he’s been so popular: “My major hobby is teasing people who take themselves and the quality of their knowledge too seriously and those who don’t have the courage to sometimes say: I don’t know....” (www.fooledbyrandomness.com).
Taleb was onto the mirage of the financial mess far earlier than most. “The financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall,” Taleb wrote in 2006. He also pointed presciently at a familiar name: “The government-sponsored institution Fannie Mae, when I look at risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup.” How right he was. That hiccup nearly blew the world’s financial system to pieces.
The Black Swan cemented Taleb’s place as Wall Street’s dissenter-in-chief. Taleb’s criticism of the workings of Wall Street and other financial centres is a recurring theme in his work. His previous book, Fooled by Randomness (Texere Publishing, 2001) had already challenged the Wall Street orthodoxy that making money was the result of superior analysis. In Taleb’s view, most investment decisions involve little more than placing bets and hoping for the best.
In The Black Swan, he extended that criticism to the wider banking system. “Banks hire dull people and train them to be even more dull,” he wrote. “If they look conservative it is only because their loans go bust on rare, very rare occasions. But . . . bankers are not conservative at all. They are just phenomenally skilled at self-deception by burying the possibility of a large, devastating loss under the rug.”
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