Financial Crisis = Black Swan

I’m currently about 3/4 of the way through The Black Swan, a 2007 book by Nassim Nicholas Taleb which looks at the “impact of the highly improbable.”

The basic premise of the book is a theory of Taleb’s which asserts that our world is in effect dominated by Black Swan events - which according to the summary are “unpredictable, carry a massive impact, and, after the fact, we concoct an explanation that makes them appear less random, and more predictable, than they were”.  Common examples include the astonishing success of Google (remember that at one point search was dominated by AltaVista!) and the radical impact of 9/11.

The writing is fascinating, if a bit heady and hard to grasp at times.  There’s a ton of cited social psychology as well as applications to almost every area of life.

I read this particular section tonight before going to bed and just had to share it with everyone, as it’s so timely.  Talib makes a point of proving how incapable we are at accurately predicting events - yet we can shed some light on areas which are particularly suited for Black Swans.  He writes about the consolidation and globalization of financial institutions:

“[Globalization]…creates interlocking fragility, while reducing volatility an giving the appearance of stability.  In other words it creates devastating Black Swans.  We have never before lived under the threat of a global collapse.  Financial institutions have been merging into a smaller number of very large banks.  Almost all banks are now interrelated.  So the financial ecology is swelling into gigantic, incestuous, buruaucratic banks - when one fails, they all fail. The increased concentration among banks seems to have the effect of making financial crisis 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 homogenous framework of firms that all resemble one another.  True, we now have fewer failures, but when they occur…I shiver at the thought.  I rephrase here: we will have fewer but more severe crises.  The rarer the event, the less we know about the odds.  It means that we know less and less about the possibility of a crisis.”

Prescient stuff.