Of black swans, grasshoppers and dumb, dumb policies

Nassim Taleb's new book The Black Swan has been causing quite a stir. Taleb points out that there are very few things that we can truly know about the future as human life is continually besieged by events that were unexpected. Those who believe they control their own destiny may feel unsettled by these notions, those who like to cast fate to the wind, may take comfort.
For me the story of the ant and the grasshopper comes to mind. The ant knew the winters were inevitable and so he worked everyday preparing a cushion for challenges that lay ahead. This meant giving up some of his immediate pleasure and consumption for the discipline of having reserves stored away for future needs. The grasshopper continued to dance and play today without worry for the inevitability of winter.
Many investors in the “passive long” camp have been recently citing Taleb’s work as evidence to bolster their random walk notion that financial markets are wild, unpredictable things so one is best to just spread risk around, close one’s eyes and buckle in for the ride. Their great hope is that, over one's time horizon, profits will appear like barnacles on the bottom of a floating boat.
As examples of “black swan” events, Taleb cites things like 9/11, the Internet, and the fall of the Berlin Wall. I too have had some experience with best laid plans over the years, and I fully accept that the future is full of events, good and bad, many of which we may not now foresee. Galbraith said that there are two kinds of economists: those who do not know and those who know that they do not know. So yes, I accept that there will be some black swans ahead.
But I am also committed to living like the ant and not the grasshopper. And so, I am intent on managing exposure to the risks that we can foresee—from financial markets, to health, to our environment. In fact I insist that it is the duty of those of us in positions of trust to manage the exposure of our clients to foreseeable and unforeseeable risks in every prudent way.
Was 9/11 really unforeseeable by the US administration? I do not know. I was never privy to their intelligence. Only those who were insiders will ever know the extent of their own culpability in the carnage which befell.
This comes to my point: Is the current housing recession, and the resulting pain and loss playing out worldwide, a black swan?
“The former chairman of the US Federal Reserve warned today that the danger of a US recession had risen following the turmoil in the global credit market and he denied that regulators were caught unawares by the problems which caused the global credit crunch”. In an interview with BBC Radio 4's Today programme, Mr Greenspan said it was inevitable the house price bubble would burst.
On the current financial market turmoil sparked by a collapse in the risky US mortgage sector, Greenspan said he had little sympathy for the hedge fund community which was “presumably the largest culprit” behind it. He said: “We did know what was going on and the reason we didn't stop them was that to a large extent these types of questionably egregious actions are taken by people who have their own money invested.”
He wasn't concerned at seeing these wealthy investors' net worth dwindle. He also predicted that the era of low inflation was coming to an end:

I'm not really able to pinpoint the time but I'm reasonably confident that the inflation tranquility that we have experienced throughout the world actually for the last 20 years is not something we can hope to readily replicate as we move into the future.

Financial market participants today are super-levered—from consumers, to hedge funds, and many western world governments. It is not just the net worth of “wealthy hedge funds investors” at risk here. These issues are now broad and endemic, certain to effect the fate of future decades to come. All responsible insiders saw these issues coming. They ought to have seen them coming. And they ought to have structured risk management plans accordingly. Pleading ignorance can be no excuse. This is no black swan.

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2 Responses to Of black swans, grasshoppers and dumb, dumb policies

  1. Anonymous says:

    Tough words Danielle.
    I must admit I was surprised by Greenspan's statement re that it was only sophisticated investor capital that was at risk. These funds were leveraged and leverage in the credit derivatives market has helped support the real estate bubble. Leveraged hedge fund activity therefore has a direct impact on asset prices, asset price inflation and the integrity of the banking system via banks' hedge fund brokerage and lending businesses and off balance sheet conduits.
    In fact, all this third party financial leverage smacks of back door financial deregulation. Just investor capital? Think again Mr Greenspan.
    Andrew Teasdale
    The TAMRIS Consultancy

  2. Anonymous says:

    Thanks for the comment, it seems that you and I are one of a few people in the industry who are prepared to worry out loud about these issues. As you know, it is hard to have a person understand the risks, when thier pay cheque depends on thier not understanding it.

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