Review of The Black Swan, The Impact of the Highly Improbable Nassim Nicholas Taleb

This week the stock market did poorly. Many people pay no more attention to financial markets than they do to politics. The first inkling they get that something systemic has gone wrong comes only when they are directly impacted. Perhaps they lose their job; perhaps they find their credit has reached its limits. But most Americans have enough education and experience to know that a stock market crash can have a negative impact on their lives.

This would seem to be a vindication of Nassim Nicholas Taleb, who has a life-long relationship with what he calls Black Swans, which are unexpected events. He is also the author of Fooled By Randomness, the Hidden Role of Chance in Life and in the Markets (which I have not yet read).

The funny thing is, what is unexpected to one person can be expected by another. One person prepares for hurricanes, another can't be bothered until it is time to hang onto a tree for dear life. The current market turmoil has been expected by many for years; it was only a question of timing. I warned people not to take out adjustable rate mortgages on houses that were becoming increasingly unaffordable. Even when the Federal Reserve started raising interest rates in 2005 people kept on willfully ignoring the likely future. In 2007 the chickens, who know a hurricane when it starts to rain, have come home: defaults on home loans have led to institutional owners of the mortgages losing money; in turn those who borrowed money to make these investments have had to liquidate perfectly good investments, including blue chip stocks.

In fact true Black Swans, I gather, are not so easy to predict. The destruction of the World Trade Center was a Black Swan even though we knew there were organizations determined to fight what they saw as U.S. tyranny. Intelligence agencies, informed citizens, and maybe even President Bush knew about Al Qaida beforehand. The Trade Center had already been bombed by Islamic extremists. The only thing surprising was the method and timing.

Global warming, even though some scientists saw it coming decades ago, is a Black Swan. A global epidemic that kills more than 5% of the population would be a black swan to economists and financiers, but it probably would not be a big surprise to an epidemiologist. The only surprise would be the specific nature of the disease and the specific class of victims.
The Black Swan is an interesting and worthwhile read, but it is handicapped somewhat by occasionally confusing sentence structures. Taleb is best at narrating interesting stories from his own life, but there is seldom a truly dull moment in the book. It is as much about politics, the human mind, and philosophy as about economics and investing. His thoughts on history are quite engaging. I did not always agree with his analysis, but I found most of it thought provoking.

That said, we do have to plan for the future, and we should count our chickens before they hatch. Otherwise we will not be ready to care for them.

Amazon.com The Black Swan link