Black Swan Free World (3)

On April 7 2009, the Financial Times published an article written by Nassim Taleb called Ten Principles for a Black Swan Free World. Let’s look at them one at a time…

3. People who were driving a school bus blindfolded (and crashed it) should never be given a new bus. The economics establishment (universities, regulators, central bankers, government officials, various organisations staffed with economists) lost its legitimacy with the failure of the system. It is irresponsible and foolish to put our trust in the ability of such experts to get us out of this mess. Instead, find the smart people whose hands are clean.

Since I cannot claim to have completely clean hands, I will simply point to the writings of Hyman Minsky.  His Financial Instability Hypothesis describes how a financial system goes to the extremes of leverage that creates a crash like what we just experienced.  He wrote this in the 1980’s and early 1990’s and then did not feel that there was much chance of the extreme part of that cycle happening any time soon.  He thought that the Fed had enough of a handle on the financial system to keep things from getting to a blow up state.

However, he did mention that with the advent of sources of debt and leverage and money outside of the traditional financial system, that if those elements grew enough then they could be the source of a severe problem.

How prescient.

In addition to reading what Minsky wrote, we should also be studying the thinking of those who totally avoided the sub prime securities that caused so much problems for so many very large financial institutions or who were in but got out in time to avoid fatal damages.

Those are often the people with the common sense that we should be using as the basis for the way forward.

Risk management programs need to have a deliberate risk learning function, where insights are developed from the firm’s losses and near misses as well as from others losses and near misses.

In this crisis, we should all seek to learn from those who were not enticed into the web of false knowledge about the riskiness of the sub prime securities.   One of the most interesting that I hear at the time when the markets were seizing up was that those who had escaped were too unsophisticated to have gotten into that market.

I spoke to one of those severely unsophisticated people on the buy side and he said that he never did spend too much time looking into the CDOs.  He said that he knew what the spreads were on straight mortgage backed securities.  And he had some idea of how many additional people were getting a slice in the creation of the CDOs.  And then he knew that the CDOs were promising higher yields for the same credit rating as the straight mortgage backed securities.   At that point, he was sure that something did not add up and he moved on to look at other things where the numbers did add up.  I guess he was just too unsophisticated to understand the stochastic calculus needed to explain how 2-1-1-1 = 3.

We need to learn that kind of unsophistication.

Black Swan Free World (10)

Black Swan Free World (9)

Black Swan Free World (8)

Black Swan Free World (7)

Black Swan Free World (6)

Black Swan Free World (5)

Black Swan Free World (4)

Black Swan Free World (3)

Black Swan Free World (2)

Black Swan Free World (1)

Advertisements
Explore posts in the same categories: Black Swan, Financial Crisis, Investment, People Risk, Risk, Risk Learning, Sub prime

Tags:

You can comment below, or link to this permanent URL from your own site.

One Comment on “Black Swan Free World (3)”

  1. riskviews Says:

    A peevish response to Taleb (their characterization – not mine)
    http://kotare.typepad.com/thestrategist/2009/04/taleb-10-principles-black-swans.html


Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s


%d bloggers like this: