Insights & Advice


Why is a “Black Swan” such an ugly duckling?

You may have heard the term or even read the book “Black Swan” by Nassin Taleb sometime over the last few years. Most people mistakenly believe that a so-called “Black Swan Event” was all about the inability of Wall Street to manage risk leading up to the financial crisis of 2008 but that’s only partially true.

The on-going Gulf Oil Spill makes it abundantly clear that Black Swan Events encompass much more than simply finance. These rare, seemingly unpredictable events that lie beyond the realm of our normal expectations can impact all of us communally as a nation or individually in our every day life. I suggest you take these ugly ducklings seriously.

The title of the book is derived from an old philosophical saying that when most people see only flocks of white swans, we tend to conclude that all swans are white. All it takes is one black swan to upset the applecart. A black swan event is, by definition, a surprise.

Pearl Harbor was just such a surprise. So was the attack on the World Trade Center and for a twenty-year veteran roofer, falling off a ladder could also be considered a black swan event. The question you might ask is how can we possibly prepare for such events in our daily lives?

One could argue that there were clues that could have alerted us to an imminent attack on Pearl Harbor but this information were buried under a pile of U.S. intelligence gathering data. 09/11 was also a surprise, although terrorist’s threats, including the prior bombing of the very same building, gave us hints of the disaster to come.

The point is that while we can’t foresee the event that could take us down, we can do quite a bit to remove ourselves from harm’s way.

Take the roofer, for example. Given his occupation, it would make sense that he carries life and disability insurance as well as a good health insurance policy. That way, if the fall does critical damage to his ability to work or even survive, he and his family might be protected from the economic impact of that fall.

Could we, as a nation, have prevented the Gulf oil spill? The answer is yes. There were certainly enough warnings that just such a spill could happen. There could have been a much larger (and costlier) safety net surrounding oil drilling activities, more stringent inspections, thorough vetting of environmental impacts on a ‘what if’ basis. Yet, we allowed oil companies to drill anyway.

Why, because we are human and our brains are geared to thinking along the same patterns when it comes to risk. In our minds, risk assumes a bell curve of fairly predictable outcomes. Since we had never had such a spill, why plan (and spend) for what may never happen. It is the same thought process that the roofer goes through in deciding to forgo buying insurance, since in twenty years on the ladder; he has never so much as slipped.

Taleb in his book predicted the financial melt down in 2008-2009. At that time it was the explosion in derivatives that almost sank the global economy. Plenty of people on Wall Street might have seen it coming but once again refused to accept the possibility that such an event could occur. It was left to the government to pick up the pieces with a price tag that will set us back decades.

In hindsight, our government is now planning for the ‘next time’ both in their financial reform bill as well as in the on-going changes in energy policies. However, the problem with black swan events is that by definition the ‘next time’ won’t happen in the same way or in the same area and our failure to accept that these events actually occur magnifies their impact.

Take our debt for example. As our national and personal debt continues to explode, we are setting ourselves up for the next big crisis event. As a nation and as individuals, we all carry too much debt. We have been living way beyond our means for way too long. How often have you heard that? Our recent efforts to pare that debt have been minimal. You know it, I know it and the government knows it, but what are we doing about it?

If ever there were clear signals for an upcoming black swan event this is it. Yet despite the warning shots of the last two years we continue to ignore it. So when this particular swan happens to hit the fan, you heard it here first.

Posted in Macroeconomics, Portfolio Advice, The Retired Advisor