The Reverse Black Swan, Part I

Posted by: Michael Mandel on April 01

I recently reread The Black Swan and came to a surprising conclusion: Once I looked beneath the snarkiness, Nassim Nicholas Taleb’s book is brilliant—and I don’t use that term lightly. Yes, it is still true that Taleb is a confirmed pessimist and I am a confirmed technological optimist. But he’s gotten hold of fundamental truths which have changed some of my views about innovation and growth.

In particular, Taleb has a persuasive argument for why the economy, the financial markets and technology are fundamentally unpredictable in both directions—up and down—and why we should care.

Let’s start with the small reasons to like Taleb. First, he does a great job of nailing the bankers. He writes that the bankers:

are not conservative; just phenomenally skilled at self-deception by burying the possibility of a large, devastating loss under the rug.

(Remember that the book was published in 2007, before the crisis really took hold). In the same vein, Taleb writes that

people are often ashamed of losses, so they engage in strategies that produce very little volatility but contain the risk of a large loss—like collecting nickels in front of steamrollers.

Bingo—that’s exactly what the banks did.

But prescience about the crisis is not the only or even the most important reason to take Taleb seriously. His big innovation is that he has the best approach that I’ve seen for thinking about “fundamental unpredictability.”

The question of economic and technological unpredictability has been a top concern of mine for many years. In my 1996 book, The High Risk Society, I argued that “economic growth is disruptive and unpredictable”. In my 2000 book, The Coming Internet Depression, I stressed the increasingly violent nature of the lurches in the economy:

…the process of technological and business innovation amplifies the normal rhythms of the overall economy….The result is that the Old Economy business cycle has been replaced by the New Economy tech cycle: longer expansions, followed by deeper and harsher recessions.

Since then, I’ve repeatedly made the point that technological progress is fundamentally unpredictable (see here and here)

But Taleb has gone far beyond anything that I did—I’m envious and appreciative. His main point is that the world is consistently capable of generating “Black Swans”—outlier events which have an extreme impact, and “retrospective (though not prospective) predictability.” Obviously the current financial crisis is a Black Swan from the perspective of many people.

There are several important implications. First, Black Swans don’t have to be purely negative events—we can have positive or what I would call ‘reverse’ Black Swans as well. The invention of the Internet was a reverse Black Swan—unexpected, extreme impact, and inevitable in retrospect. More generally, the positive Black Swans are the technological innovations which could not have been anticipated ahead of time, and which work so well that we have experienced 200 years of rising living standards, despite the downward Malthusian pressure.

Taleb acknowledges the possibility of positive or reverse Black Swans, though he doesn’t spend much time on them. On the subject of technology, Taleb writes:

Prediction requires knowing about technologies that will be discovered in the future. But that very knowledge would almost automatically allow us to start developing those technologies right away. Ergo, we do not know what we will know.

As a result, going forward, we can view the world as able to produce unexpected positive technological innovations. There is no potential ceiling for growth. In addition, we could easily see a reverse Black Swan—a technological breakthrough that helps pull us out of the downturn.

However—and this is an enormous however—a Taleb-type analysis tells us something else. Because technological innovation really is fundamentally unpredictable, increasing the amount spent on R&D and innovation does not lead to diversification and a reduction of uncertainty. Taleb writes:

In spite of our progress and the growth in knowledge, or perhaps because of such progress and growth, the future will be increasingly less predictable.

This is especially true in the U.S. The way that the global economy developed in recent years, the U.S. has outsourced production to other countries, and kept the high-end task of design and innovation. As Taleb puts it:

The American economy has leveraged itself heavily on the idea generation.

This is precisely the point that I missed in my 2004 book, Rational Exuberance. In that book, I argued that a “hot” financial system—one with lots of highly mobile capital —would boost growth by seeking out and funding the development of the most promising innovations. I also argued that this growth-enhancing effect was worth the added possibility of financial crises. This is what I wrote then:

During boom times, the U.S. is able to fund innovative and growing new businesses with financial instruments--venture capital and junk bonds--that barely exist anywhere else. And then when the inevitable bust comes, the U.S. financial system is highly liquid and far more diversified than elsewhere, able to cope with sharp plunges without freezing up.

Har de har har. How stupid could I have been...

In my (weak) defense, I acknowledged in that book the possibility that the pace of innovation would slow, leading to lower real wages for college-educated workers. What's more, I pointed out that in the absence of innovation:

...it will become a lot harder to service all the debt that companies and people took on during the 1990s. Housing prices will slump and perhaps even plummet.

But despite this nod to the potential Black Swan of the financial crisis, I didn't really wrap my mind around the possibility that all this money out there might not get results. The fundamental unpredictability of technology means exactly that--we could summon up all this capital, and not get the big innovation. The big potential innovations such as biotech didn't take off in the post-2000 era, as was expected. As a result, that big pot of hungry money had no outlet except for housing. The innovations didn't happen.

What did happen was a big negative Black Swan--the financial crisis. And a Taleb-type analysis tells us that such negative unexpected events--a sudden acceleration of global warming, global war, a breakdown of the Internet, you name it--are almost guaranteed over a long enough time span.

So here's the thing. What reading Taleb tells me is that as a technological optimist, I need to accept three statements.

1) Unexpected technological breakthroughs are possible. That's good

2) The timing and nature of the breakthroughs cannot be controlled. That's bad

3) Unexpected large bad events are possible as well. That's bad. In fact, we can get bad events which have as big an impact, in the negative direction, as the technological innovations.

Whew. That's it for this post. In my next post on Taleb, I will talk about the implications of these three statements for financial and innovation policy.

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Reader Comments

Keith G

April 1, 2009 01:58 PM

I see this crisis as very bad both for from a financial perspective and an economic perspective. However, look at the interaction between the financial, governement, and economic sectors. A very severe financial "black swan" has had, so far, less impact on the economy than it would have had in the past.

Unemployment is at 8.1% and lots of wealth has been lost. Nevertheless, inflation is reasonable and interest rates are low - unlike the early 80's. It could also be said that it is terrible that the world has lost (unrealized losses) $50 trillion dollars! I say, "Wow, we can loose $50 trillion dollars and not all be starving?"

The entire system is more robust today than in the past. The lessons learned in this crisis will promote further strength for the future.

FstEde

April 1, 2009 02:22 PM

As for the Black Swan effect, the economy & financial markets are chaotic systems, what do you expect.

Alberto Luyando

April 1, 2009 02:25 PM

“What everyone knows is what has already happened or become obvious. What the aware individual knows
is what has not yet taken shape, what has not yet occurred”.

— Sun Tzu
The Art of War

We're in a state of desequilibrium where anything can happen.

Chuck Brooks

April 1, 2009 02:27 PM

The whole convoluted system, with the government in the middle, was ready for a fall, a consequence of the 'cheap revolution', not unlike Craig's List being the major instrument driving the general circulation newspapers to the wall. The tranching of subprime loans was an opening wedge that will make financial capital more efficiently deployed, in spite of government actions, not because of them.
Chuck Brooks
FutureWare SCG

Mark G

April 1, 2009 03:28 PM

Taleb is correct about unpredictable events of large (magnified impact). Innovation is not well correlated to investment. Malcom Gladwell's book "Outliers" illustrates (through anecdote) that we need a culture of innovation rather than just investment. It is good to read the two books in succession.

The invention of dynamite was a kind of leverage. With financial leverage we blew up the system (or at least a big part of it). Technology has cut both ways, also. But mostly it has been very beneficial.

John T

April 1, 2009 04:20 PM

Taleb is one of the thought leaders who should have a central role in helping design an improved and sustainable global financial system. His understanding of complex system properties effectively argues against trying to resuscitate the fragile, leveraged system that has collapsed. Just as complex systems gain robustness (improve) by increasing levels of variety and simplicity, innovation theory suggests that maximizing the number of efforts is a better approach than a few targeted mega-efforts. Taleb and Mandel correctly note the inherent uncertainty involved in reverse black swan events. In other words the limited ability to predict the success of innovation efforts.
John T

Ducky

April 1, 2009 04:40 PM

Keith, actually the economy was far more "robust" in the 1930s.

Unemployment was only 8.7 percent at the very start of 1931... Our current system is far more complex; far more black swan prone, and the cascade has most likely merely begun.

Unlike the 1930s, western countries and their citizens have far more debt and don't have the manufacturing base that was so FUNDAMENTAL to survival when the depression hit.

That 50 trillion was nothing. Wait til' hedge funds truly deleverage.

Sure, interest rates are artificially low. Inflation is also very low. Yes, these short term trends would be good if it looked likely to define the near future. If these had any appearance or likelihood of stability - it would be a good thing.

But the interest rates have been artificially chopped down - ala 2001 - and what is going on with the monetary supply is UNPRECEDENTED in U.S. history.

Things are collapsing from a higher precipice than in 1930.

I believe we are going to see things over the next couple of years that are just unbelievable... It is possible we are seeing a true systemic collapse, and will see record gains and drops like never before.

Kartik

April 1, 2009 04:44 PM

Michael,

Bad, unpredictable events actually cause technological innovations to accelerate around them. Two examples :

1) 9/11 caused great innovations in security, bio-metrics, battlefield technologies like military robotics, etcs. As a result of 9/11, the NYPD has advanced their counter-terror technology and tactics to such a degree that common criminals just don't have a chance to conduct routine muggings and robberies. As a result, mundane crime in NYC is very, very low by historical standards.

2) The SARS outbreak pushed genome sequencing of superviruses forward so fast that that the SARS virus was decoded in just 31 days. That was in 2003, and now it is even more advanced. Our ability to decode the genomes of new superbugs is very advanced.

So a disaster causes a massive swarm of innovation to develop around it, making it very hard for the same disaster to happen twice.

Kartik

April 1, 2009 04:50 PM

Michael,

As I mentioned before, I don't think your 2004 book was too far off. The gains through technology that you predicted did happen. Except that they manifested in driving mature technologies (cellphones, netbooks) to ultralow prices to boost India/China growth.

Which makes sense - that is where the biggest percentage gain can happen in the shortest time, so capital will support that type of innovation, and it has.

US living standards, in the meantime, don't rise. But where the US has seen 0% real wage growth for college-educated people in the last decade, India and China have seen 100% real wage growth over the same period.

So the weighted world average real wage growth for college-educated people might be about 20%. Not bad, overall.

This also means that US wages will not rise until China's per capita GDP becomes about half of the OECD average (about 2017). Only after 2017 will US wages rise.

Kartik

April 1, 2009 04:59 PM

In general, one should view technology's impact on economics as :

A $1 Trillion industry gets destroyed, and a new $2 Trillion industry forms in its place (or whatever number you want to assign).

That is how wealth rises, but many people are displaced in the process, and the losers are not the same people as the winners.

The thing is, this process is accelerating on many fronts at once, and so the $1T destroyed/$2T created happens faster and faster. The rate of this is becoming to rapid for many people to comprehend.

Ajay

April 1, 2009 05:37 PM

Lots of stuff in this post, Mike, I'll take it one at a time. I don't think Taleb is as much a pessimist as that he tends to focus on the negative black swans and how many institutions don't account for them in their risk assessments. I'm not sure the notion that technological progress is fundamentally unpredictable is any great insight, most would have said that. I'm also not sure that the current crisis qualifies as a black swan. Is it a black swan just because a lot of people took stupid risks? You need to have a more precise definition of black swan than any greatly negative event. I have been claiming that we will see a positive black swan, or just boom if you don't want to call it a black swan, when the internet takes off again because of micropayments. I think that is the bottleneck that has held back the internet, once it's removed the internet takes off like a rocket. I think Greenspan held rates down for a decade or so anticipating such a boom, but unfortunately the techies were too dumb to implement the best way to monetize the internet. For all their claims to innovation, techies are as conventional as anybody else, simply taking the long-existing concept of advertising online rather than thinking about the best way to monetize this new technology. As for R&D and mobile capital, it all depends on the institutions doing it. Microsoft wastes billions every year, unsurprisingly as they have never been an innovative company, and venture capital just dumps money down the latest useless fad like social video or social networking. Mobile capital is not enough, you need institutions that put in charge people who are best equipped to decide where that money should go. I believe that I'm one of those people and I hope to form such institutions one day. As for biotech, I don't think anybody seriously expected it to take off this decade. I disagree that the money had to go into housing instead, the problem was idiot financiers who dumped it there regardless and dumb investors who let them. It could have been spent many other ways, if we just had better investors and financial institutions handling that money. For example, I believe that the best institution for investing in internet tech is seed investing, where an investor sticks a whole bunch of $50-150k sums with a lot more companies than VCs do and figures out who and what works best. However, tech investing is still stuck in the old-fashioned VC model, where millions are invested in individual startups, an artifact of a time when startups like Intel had to buy millions in capital equipment, which internet startups don't have to do. Naturally, idiot VCs still follow the old model because it's less work and allows them to control more money, despite being totally unsuited to internet startups and having had consistently negative returns this decade. I hope to someday get into seed investing and I believe it will produce the best results. However, first the bottleneck to an internet boom needs to be removed and that's micropayments.

CompEng

April 1, 2009 05:53 PM

There are a lot of interesting ideas here to tackle:

1. Although there are many examples of technology that could not be predicted, there are many examples where some level of predictability did exist. For example: the transistor and the integrated circuit (they didn't know how transformative it would be, but they knew there was something there). The Manhattan project is another oft-cited example, or magnetic memory. There are many cases where we did and do know where to look. There is a level of unpredictability in most research, but most technological progress from very basic research to pure application is not of the (reverse) black swan variety.

2. Science is a field of survey and categorization. Technology is looking at the survey results for potential gold mines and then going after them. Progress in survey is very measurable, but there's huge amounts of ground to cover. One of the reason we end up with so many "black swans" is that we try only try to survey where we think there's gold (because that's how grants, etc. are given out). That's just backwards. Basic science should be funded collectively as a survey effort, and then technologists should raise capital to do the mining.

3. Black swan events != black swan technology. Life comes at you fast. Sure. But the effects of technology can generally be modeled and predicted as desired, because they are small relative to the rest of the system. The negative effects of financial "innovations" weren't predicted largely because no one had a real incentive to predict them. There are a class of events that you simply don't have the information or compute/brain power to predict, but that isn't one of them.

Finally,
4. "Malthusian pressure". The worthwhile insights of Malthus resolve around sustainability. Planned sustainability is certainly possible if we have the will for it: we have all the modeling tools necessary. There will always be winners and losers, but there is no real excuse for humanity not to continually improve the lot of even the losers. I maintain that while technology plays a role in this, the fundamental limiter is our ability to govern ourselves, which is where Malthus seemed to be headed. The future is not fundamentally grim, even without a breakneck technology pace. That's a cop-out.


empedos

April 1, 2009 05:58 PM

I believe that the US still has a unique capacity to produce technological innovation unlike any other country. Why? Because of its unparalleled ability to generate new ideas, test them and commercialize them very fast.
I used to render tribute to the system of values and the open structures of the US which, in my view, are the key ingredients of its unprecedented capabilities to create technological breakthroughs.
All these suddenly changed during the last few years. The US produced an unjustified war based on a lie (Saddam's chemical and nuclear weaponry is still invisible) accompanied by the requisite internal propaganda which was driven by the oil cartel and was designed to induce fear to the population to get its consent. This very same cartel has intervened to stop the development of green technologies and is responsible for putting the taxpayers' money into wars rather than research on biotech, nanotech and so on. I saw this pattern repeatedly over the last few years in other occasions.
A fearful society that acts based on lies and has allowed special interests to take so much power in their hands, is not anymore capable to produce innovation. This is exactly the situation in my country : fear, lies and powerful special interests that serve the preservation of the status quo which, if changed, may shift power to other hands.
To conclude, I do agree that innovation is a matter of probabilities but the equation is "more money brings higher probabilities" rather than "more money does not affect probabilities". What is most important though, are the following propositions :
1. immorality is contagious and very soon infects the entire society including the financial sector and the rest of the business community (and may be even the research community)
2. Fear makes people less open to fresh ideas, their mindset is more attuned to preserving rather than changing and testing new things.
3. Concentration of power in few hands is not supportive of innovation.
To tie the above with Mike's arguments, I think that the probabilities of a major innovation happening may be controlled (in a qualitative manner of course) as long as people are dedicated to this goal. Having said that, I suggest that the current negative Black Swan's name should be "lack of dedication to what we can best do, housing is something anyone can do"

Kartik

April 1, 2009 06:01 PM

Ajay,

I agree with you on seed investing. I know a couple of people who have done this successfully for two decades.

But the general Angel investor rule of thumb is :

1) Never put more than 1% of your net worth in any 1 company.
2) Never put more than 5% in any 1 sector (Web 2.0, solar, wireless, etc.)

Thus, to do $100K seed investments, one should have a net worth of $10M, as per point 1). Any less, and the investor is too small to do the necessary diversification.

Actually, your micro-payment paradigm could work for certain types of fund-raising. Just like Obama got large numbers of donors to donate $10-$20 each, thereby accumulating hundreds of millions in donations, startups seeking funding could put their business plans online (after taking patent and IP protections, of course), accrue small investments from donors who buy 'shares', and thus acquire seed funding not from 1 source, but many. They are effectively accessing the public market very early in their lives.

Much has to be worked out before this can be a viable funding strategy for startups, but political campaigns have done this successfully.

Thomas

April 1, 2009 06:20 PM

America's invasion of Iraq in 2003 (to enforce UN resolution 1441) is the reason we still don't have innovation in 2009 (despite the Iraq War being successfully won at this point)? Will it continue to stop innovation for decades to come?

Sheesh, some people are quite fanatical.

Ajay

April 1, 2009 06:40 PM

Kartik, rules of thumb are only good for people who can't use their brain to figure out something better. Internet tech is where a lot more money needs to be invested, so I don't think it's worthwhile to diversify just for the sake of it, particularly if you don't know much about solar or other markets. I actually wasn't really talking about seed investing of one person's money, I was talking about funds like VC funds that then follow a seed investment model instead. I think the prosper.com model that you bring up is the future of all investing, the only part you're missing is that you will need brokers, dedicated seed investors like myself to decide where to actually put the money. Unlike a political campaign, where people invest in Obama because they think he speaks well or because they can't stand Bush, you need real expertise with seed investing. I don't see the similarity to micropayments but micropayments will be used for the information monetization aspects, just like everywhere else online. I do think it doesn't make sense to go full bore into internet tech till micropayments are deployed, but once they are it will be so lucrative everybody will be jumping in.

CompEng, Buffett predicted the current mess in his 2002 annual report, pages 13-15, and got out early:

http://www.berkshirehathaway.com/letters/2002pdf.pdf

It is not that the incentives to avoid the current mess weren't there, it's that human delusion and short-sightedness prevailed for most as it does during every bubble, not just from the financiers but homeowners and foreign investors. We may have to think creatively to properly rebuild the financial sector quickly and allocate the losses but further regulation is unlikely to accomplish anything.

Joe Cushing

April 1, 2009 09:02 PM

I was listening to a podcast while driving. After arriving at my destination, I paused the podcast went online. What am in in the middle of listening too? ...an interview with Taleb. This is barely a coincidence though. The Black Swan is in.

What seems to be missing from this discussion of the black swan is, what do you do to protect yourself and still grow?

CompEng

April 1, 2009 11:05 PM

Ajay,

excellent spot. Thanks for the link. I intended my comments more to apply to the folks within Lehman, Bear, AIG, etc. that were nominally supposed to watch out for their investors and shareholders. But I suppose you are ultimately responsible for your own money, no matter how you attempt to outsource the decision.

It's true that regulation does bear the risk of not only closing the barn door after the cow has left but nailing it shut. But that doesn't mean that any new regulation is necessarily wrong, just that we should be wary of it.

Lord

April 2, 2009 02:36 AM

Breakthroughs can occur and large ones are rare and unpredictable. Once they occur, less significant ones are much more common and predictable. A first set of innovations capture the most growth and are then followed by a second set that refine the first.

There may not be a ceiling for growth, but there well may be a ceiling for the rate of growth. Too much growth can lead to self limiting instability. Necessity is the mother of invention so our troubled times may lead to more but is unknown. It is possible to drive investment, for example in green technologies, but the greatest innovations may occur indirectly through solving problems in it that apply to disparate unrelated areas. We are well suited to capitalizing on innovation that does occur, though it cannot be forced, it can be encouraged.

beezer

April 2, 2009 09:29 AM

Taleb's in the process of becoming a terrific philosopher. I hope he continues this development because the world's breakneck pace needs some updated philosophical guidelines.

As for innovation, big breakthroughs are often a case of "look here, find there." Serendipity, in other words. Which would argue, at minimum, for a consistent application of money to pure research. Private capital won't do that.

The internet was an invention resulting from DOD funding. Two guys trying to clean a dish off, to get rid of background noise, resulted in the big bang theory. Bessemer was washing dishes. An anthropologist digging in the lower midwest discovered 8 feet of ash that led to the super volcano 1,300 miles away that's underneath Yellowstone National Park. Now there's a Black Swan in somebody's future.

Now if only some economist would start publishing graphs and charts using Mandelbrotian math instead of Gaussian.

John

April 2, 2009 02:04 PM

I love articles like this. It shows life is unpredictable and you should not count on a nice 12% gain in the stock market every year. Invest in bank money market accounts (list at http://www.money-rates.com/mmarket.htm) and CDs and be happy with 3%.

Tom E.

April 2, 2009 05:01 PM

How much innovation is lost by not having a hand in on day-to-day production? Some of the top innovative countries, Germany and Japan tend to keep production at home even though they have labor costs similar to the US.


Can innovative ideas be thought up in a vacuum? If we outsource our production of software will we lose our ability to innovate in that area?


Can we think of ideas in an ivory tower without having a foothold in the real world?

Greg

April 2, 2009 09:29 PM

I loved "The Black Swan" and his "Fooled By Randomness" as well. Both should be required reading for any one who will be in a position of authority. The world is too fragile and one ignorant mistake can cost too much these days. Understanding the limits of our understanding is crucial.

Regarding the statement that 'innovation is not well correlated to investment'. I think it because of the diverging mindsets of the practitioners. Innovators plug along for long periods of time fiddling and pondering. Modern investment is about returns.........NOW! Now the financial engineers are doing the pondering and fiddling (and wreaking havoc) while true society changing innovation cant be funded adequately. Its a numbers game I think. We need more guys just sitting around tinkering and keeping their minds open to discovery. Its kind of like archaeology, you need to be out digging up alot of ground, to make the new discovery.

Someone asked about Talebs investment strategy. He recommends 80-85% safe as cash, 15-20% super risky out of the money options. If one or two of your really risky options hit.......BINGO. I heard him describe this strategy on a podcast once.

Dave

April 3, 2009 05:16 AM

The last couple of significant periods of positive technological innovation that come to mind are the space progam and world war II. Both were motivated by war (threat in one case, and actual in the other). Both involved pouring large amounts of financial and intellectual "stimulus" into solving challenging and difficult problems. In both, a bunch of non-military applications were the result. WW-II gave us: radar, sonar, the jet engine (thanks, Frank), primitive GNC (guidance, navigation and control), primitive rocketry, better understanding of transonic aerodynamics, and so on. The "space race" gave us: advanced GNC, advanced rocketry, microcomputing / silicon chips, teflon, kalman filtering, strap-down IMUs, satellite and microwave communications and the basis for the internet (packet switched systems and telemetry downlinks).

What other periods can compare against these in terms of positive technical innovation and resultant positive economic externality?

The only sad thing is that the way we are headed globally at present (into another "depression" era) may result in a cracker of a war over natural resources which will be bloody and horrid but may spur new advances and a new future. Perhaps this is the cycle of history?

Raul

April 3, 2009 06:51 AM

"The timing and nature of the breakthroughs cannot be controlled"

That is not bad - it simply the way the world evolves: not a straight line.

The more freedom you have, the more innovation you ll get. Sometimes they are bad - as proven by the recent financial debacle, most of the times they ll be great.

Innovation is a natural result of a chaotic system. Organized or planned innovation doesnt exist.

WM

April 3, 2009 09:10 AM

But Taleb just doesn't know what he is talking about with respect to this crisis. The Black Swan was the mark-to-market rule. His view that bankers "hide" losses, adding a hidden risk to the entire system, may be emotionally satisfying, but the numbers show otherwise. One common example is a bank in Atlanta which had only $44,000 in losses or projected losses from their mortgage products. Yet, they had to take an $87 million write-down due to the mark-to-market rule. Look through all the big banks, and you see the same story--billions in write-downs, few actual losses. There is no evidence for Taleb's interpretation of the downside, not in the context of an economy. The "Black Swan" on the downside is always government interference.

Adam

April 3, 2009 09:23 AM

These outlier events are obvious and common knowledge to all statisticians and economists. Whether in a normal distribution or log-normal or some other skewed model of possible outcomes.
I believe it is much more a psychological phenomenon of human consciousness. People are loss-averse.. will lie to cover losses, will over-glorify good news and data and in general have the mindset that "things will get better", that "this is only temporary", that "the stock market will always rise/real estate will all rise- over time"
Our collective mindset for generations which is now instilled in most of us is just that.. optimistic by default and thus our interpretation of stuff is also skewed. Even when we have computer models try to adjust for this, our interpretation of the results is also skewed! And for those of us without the benefit of such models even more so.

So it is not surprising at all that we find massive losses, severe recessions, sudden market drops, and the like appear to be more unexpected and the masses more unprepared.

Your so-called reverse black swans are not anything new either. Before the internet exploded there was the PC itself.. before that telephony.. before that the transistor.. before that the automobile and assembly line process.. before that the oil.. before that railroads.. before that the steam engine.. before that horses.. and on and on and on -- technological innovation is indeed the stuff that propels society and economies forward, creating jobs and prosperity through innovation. Each building upon the last.

Likewise negative black swans too build upon the past events (in this current case: low rates led to- increased borrowing/leveraging led to- greedy lenders and bankers who saw opportunity which led to- subprime lending / creation of MBS, CDS and other complex derivatives which led to- a rise in housing prices and speculation in all asset markets which led to- consumer borrowing and leveraging which increased the bubbles and reduced savings rate which led to- well we all know how this ended.)

So now let's look forward if we will to the gov'ts of the world and their attempt to rectify the situation....
Bear, Lehman, Merrill et. al. go under which leads to- stock market collapse from all time highs which leads to- massive realization of bubble and rush to deleverage- which leads to massive decline in other asset markets (oil, metals, foreign currency etc) which leads to- TARP and gov't rescue of AIG, Citi, BofA et. al. which leads to- Further market declines, instability of financial system and seizing of credit markets/lack of liquidity for 'toxic' assets which leads to- Obama's TALF and TARP part II (aka stimulus) and Geithner/Bernanke increasing money supply and lowering interest rates which leads to- (hyper-)INFLATION?, GREATER RICH/POOR DISPARITY, 20% UNEMPLOYMENT? XXXXXXX?

u fill in the XXXXs... can we see where this is heading?

-AH

Ted

April 3, 2009 09:29 AM

Taleb's hedge fund has consistently lost money over the years (with the exception of 2008 into '09).. his strategy is basically buying lottery tickets. Duh! If u win the lottery you will win A LOT of money and is extremely UNLIKELY... sounds like his strategy...
Sure he buys teenie puts but theres so much more you can do with options (and other things) to take advantage of small-probability events...

kenkovaly

April 3, 2009 03:27 PM

Innovation is seldom a single eye-poping event or discovery. Innovation is the somewhat systematic accumulation of knowledge that is applied to solve a real or perceived problem.

I'm writing about innovation in science and technology.

Sometimes--many times, the innovation has no immediate commercial use. So it sits there.

Over time it, along with other innovations is combined, interwoven, and integrated in various ways to produce a commerical product or service of great value.

Our "fund" of knowledge grows at a nearly exponential rate. Thus, you would think innovations may occur more frequently. In some cases, microprocessors, that has happened. But certainly not in all areas.

The point of all this. True commercial innovations are the result of some need. And, the truth is, we already have more than we need--as far as things.

There are still vital health needs--cure cancer, for example, But beyond that it is difficult to find many needs that are vital to our well being and happiness.

Add to that the growing movement to spend less than you make and you have a country and a world and many individuals who will start to look "within themselves" for a satisfying life.

That is not a bad thing to happen.

Greg

April 3, 2009 09:23 PM

WM

You're just wrong. A banks "44,000 in projected losses from their mortgage products" is pure fantasy. Don't you see, thats the problem.... the projections. I'll bet Bear Stearns had much smaller projected losses on their books too.

By your comment in your last sentence, I assume you are a market purist. Yet you dont like that the market prices for the mortgage products is too low, "forcing" the bank to write down 87 million. Well you cant like the market when it says what you like to hear and ignore it when you don't like what it says. The mark to market losses ARE the actual losses at present.

Sorry, but avoiding mark to market rules is wrong and the buyers know what they are up to so it won't work.

LAO

April 7, 2009 10:27 PM

Michael,

Thanks much for diving into this intriguing book. It is remarkable how many different, but related, takeaways people find, and how much of it rings true, at least for me and others of a mathematical nature. If I attempted to neatly oversimplify and sum it up, the message would be the overwhelming importance of humility -- recognition that you cannot have all the definitive data, that key variables may well lie outside your analysis, that you could be wrong. Rather than paralyzing, it suggests to me that contingency planning and endlessly scanning the universe for the mistaken assumption ought to be the norm for the individual and the culture, so that the implausible enters the public discourse, and shifting gears and getting on with it in the face of a changed reality become second nature and merely another hallmark of successful functioning. I should add the caveat that I have not quite finished reading the book.

Both you and Taleb hint that one man’s Black Swan shock is often another man’s expectation. I am told that Taleb, in an interview, said that the current crisis was not a Black Swan because it was predictable. While pinpointing the expert problem – the propensity of experts to be absolutely wrong with great precision and confidence – he also suggests that those with a valid and correct reading are too easily ignored, and those who do not claim expertise are more often humbly correct, just not as precisely. I followed up on some of the research he referenced and found the Society of Safety and Reliability Engineers very seriously pondering the repercussion of their new understanding of this human deficiency. I am led to a couple of conclusions.

There is a professor in Michigan who studies why fish can swim much faster than they “should”. Being taken by the idea that global warming could threaten civilization without cheap alternative energy, and having access to machinists who proved his concept, he now has a full-scale hydroelectric generator going into a Michigan river to prove that his simple, scalable, fish-inspired mechanism can deliver cheap, environmentally harmless, power wherever there is moving water. He is not exactly an energy expert. This professor was lucky that the press finally gave enough credence to the energy problem that he started thinking in ways that only a non-expert can think; even if that premise should prove faulty, it could be a boon. I think it is a nice example of what innovation can emerge when the information filters are not too constraining. It may well be the case that unfettered journalism was key – journalists may not just be critical to democracy, but perhaps also to innovation.

Secondly, I think that the lack of humility in the limited way we measure our economy represents a haughty certainty that we know what we’re doing – I would measure the economy in all kinds of new ways, leaving GDP and CPI for those who think they matter. It’s a complex beast, and its every corner ought to be constantly open to analysis as well as retroactive study of the reasons why it can suddenly prove so fragile.

I'm looking forward to Part II.

Thank you for your interest. This blog is no longer active.

 

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Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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