Black swans, an oil spill, hubris and debt

Black_swan_family_2If there is one thing we can learn from the headlines of the past week or so – Market Plunge Baffles Wall Street, Size of Spill in Gulf of Mexico is Larger Than Thought, ‘Amateurish’ Bomb Defused in Times Square—it is that we cannot reliably forecast the future, that the world is bound to surprise us, frequently in unpleasant ways, and that, as the poet Robert Burns wrote, the best laid schemes of mice and men oft go awry.

Shit, as they say, happens.

And yet we keep on devising those well-laid schemes, don’t we? We extrapolate the future based on the past. We imagine that we can make useful economic forecasts (because now we have more data than we did before). We imagine that regulation will protect use from the meltdowns of markets (as well as off-shore oil drilling platforms and nuclear power plants). We imagine that the Department of Energy can lead us to a clean energy future, or that scientists can make geo-engineering safe. We imagine that we understand things better than we do. And we forget the words of that other poet, John Lennon, who wrote that “life is what happens to you while you’re busy making other plans.”

So the timing is excellent for this week’s updated version of The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb, which includes a new essay called “On Robustness and Fragility.”  I’ve haven’t read the essay yet, but Taleb discussed the book and much more with my friend Russ Roberts, the Hayekian economics professor, at EconTalk. Their 67-minute conversation is never dull.

For those of you who aren’t familiar with The Black Swan, the title refers to the fact that the phrase “black swan” was used for hundreds of years in Europe to describe the impossible or near-impossible–until, that is, a Dutch explorer discovered black swans in western Australia in 1697, at which point the term morphed into the idea that the impossible sometimes happens. In Taleb’s account black swan events are rare, extreme, impossible to foresee and often world-changing. “History does not crawl, it jumps,” he writes. Brilliant and egotistical,  Taleb worried in the book, which was published in 2007, that

Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall.  The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ….I shiver at the thought.

You know what happened next.

CharlieRose_NassimTalebAnd yet, as he tells Russ, Taleb recently spoke on a panel with a top official of the International Monetary Fund, who began his remarks by offering his economic forecast for the years 2011 through 2014–infuriating Taleb, who thought

Anyone in this room who’s listening to this forecast without asking what his forecasts for 2008 and 2009 were in 2001, 2, 3, 4, 5, 6 and 7 needs to blow up again…

How can people still listen to the No. 2 man of the IMF talking about his forecasts for the future when he never got anything right in the past?

And why are we building systems based on these forecasts?

Some people say having an imperfect forecast is better than having no forecast at all. But of course that’s not so, at least not if we make big decisions based on that imperfect forecast that can impact all of our lives. The banks, remember, bet their future on complex computer models saying that housing prices could never decline by 15 to 20% in a year. Their formulas, they said, reduced the amount of value at risk. Unhappily, the fact that they were so tragically mistaken does not seem to have diminished the supply of hubris at, say, Goldman Sachs.

Now, the problem with wrong-headed forecasts is not that they are wrong-headed; that’s inevitable. The problem comes when our collective well-being depends on them. This, Taleb says in his essay, is why we need to build robust systems and not fragile ones. The global banking system was and is fragile. So was BP’s oil-rig. So, we were reminded last Friday, are stock markets when a “glitch” can cause a 1,000 point drop. So is the economy of Greece, which in an interconnected world, has global repercussions.

Taleb says:

I want to live in a society in which human error doesn’t penalize the multitudes. This is pretty much my mission. To try to figure out how to build a society in which people can make mistakes and mistakes are inconsequential.

One way to do that is to reduce debt. Personal debt, corporate debt and government debt all make borrowers more fragile. Surplus cash makes us more resilient, better able to withstand the unforeseen. (Recall the pre-recession balance sheets of GM and Ford.) Debt is driven, at least in part, by hubris. The shoppers who flock to the mall despite their negative balance sheets, GM, Chrysler, Sam Zell when he bought the Chicago Tribune, Greece or the people in charge at the U.S. Treasury grow overconfident about the future; they make their plans, borrow money and then life gets in the way and the rest of us get stuck with the bill. This can’t go on forever. As Russ put it during the podcast: “We’ll bail out Greece” — he could as easily have said Citi or AIG — “and then we’ll get bailed out by Mars or Neptune.”

Interestingly, western religions have understood hubris and debt for a long time. “All Mediterranean religions had either an explicit or implicit ban on debt,” Taleb notes. “We’ve known about how debt fragilizes systems since the Babylonians.”

So beware of economists bearing forecasts, bankers offering teaser rates and governments when they take on obligations that our children and grandchildren will have to repay. In a fragile and interconnected world, we all pay for their mistakes.


  1. says

    Tom, thanks, Taleb is an amazing guy. One of the oddities is that he is so sure of himself while explaining that the world is filled with uncertainty.

    There’s a great bit at the end of the podcast where he talks about running on uneven surfaces, falling and breaking his nose and refusing to put ice on it. I won’t spoil it by saying any more but it’s priceless.

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