Nassim Taleb (Black Swan) open letter to David Cameron
guardian.co.ukTaleb needs to find something new to talk about. In his book Fooled By Randomness, he takes a paragraph and makes it a chapter. Takes a chapter and makes it a book, talking endlessly about black swans, how people who are successful are successful because they got lucky and repeating analogy after analogy to make the same basic point. In this post he makes sweeping statements about debt being bad, based on wisdom from Babylonian times and Roman proverbs:
"David, you must counter this complexity by lowering indebtedness. We have known since Babylonian times that debt is treacherous and allows no room for mistakes: felix qui nihil debet goes the Roman proverb ("happy is he who owes nothing")."
He sounds like Ahmedinejan in his letter to former president Bush advising him to embrace the ways of the prophets of old :)
There are many situations where debt is your friend but like all good things it can be abused. Common Taleb, find something new to talk about! Black Swan is so 2002!
Isn't it better to have one idea that is insightful and correct, than to have many ideas which are wrong, like most commentators?
Well perhaps. So let's think about it. Black swans are not rare, they were thought to be completely impossible, and then people found them not to be impossible. So far maybe not so correct.
Secondly, regarding insight. This idea which everyone credits to Taleb is of course described all over the place. For example, as "the impossibility of inductive reasoning in the natural sciences" in The Mathematical Experience. As far as fat tails are concerned, every textbook on financial maths I own talks about fat tails the corrections that must be made to account for them, and they were all published before either of Taleb's books.
Not when it keeps being rehashed ad nauseum.
Maybe he intends to keep rehashing it until people understand. Good ideas, it seems, need to be repeated.
Good ideas, it seems, need to be repeated.
Absolutely not. Ideas that are diffuse and unoriginal, on the other hand, are often repeated because they are uncompelling.
I've read The Black Swan, and although it was entertaining, I didn't feel like I learned anything of value.
Absolutely not.
Bastiat articulated the Broken Window Fallacy in 1850, and here we are 159 years later shredding perfectly good cars to 'create jobs.' It certainly seems like some good ideas can't be repeated often enough.
It wasn't that great of an idea: http://www.stat.berkeley.edu/~aldous/157/Books/taleb.html
The only good idea that he has is to repeat and rehash in order to sell more books.
Isn’t being better than most commentators an awfully unambitious goal?
It's a letter to the leader of the opposition and, potentially, the next primeminster. Taleb must be concise with his argument - it's not new to us because many of us have read The Black Swan or Fooled by Randomness.
I agree that commercial debt can be used for investment and is therefore useful. I think he is commenting on national debt. The problem is that the UK and US hold a magnitude of debt that will not be re-paid for several generations. Most of us would agree this is not healthy.
Further to this, his point about debt is that it is used to prevent the old institutions from failing and the resulting tax increases are hindering the next wave entrepreneurs. The financial crisis should have sped up the next wave of creative/destructive innovation in the financial sector but instead we are pretty much back to the status quo in The City and on Wall Street.
Have you read either of his books?
"Work on building a "robust" society, capable of withstanding errors, in which the role of finance (hence debt) would be minimal. We want a society in which people can make mistakes without risk of total collapse. Silicon Valley offers a good example, where people have the chance to fail fast (and repeatedly)."
Impressively scathing of both the Obama and former Bush administrations. I'm not sure how he would go about implementing some of his ideas since on one hand he argues against additional regulations and on the other he argues for a ban certain types of complex financial products (ie who would be the arbiter of what he calls a return to products that dependend on trial and error?). He is however a great writer and more importantly, he, even more than Peter Schiff was right (from an FT article that echoes some of his points in the letter and in some cases is a bit more specific - http://www.fooledbyrandomness.com/tenprinciples.pdf) :
"Then we will see an economic life closer to our biological environment: smaller companies, richer ecology, no leverage. A world in which entrepreneurs, not bankers, take the risks and companies are born and die every day without making the news."
Having been on both sides of the coin, I do wonder how much those who allocate the capital (bankers) should make relative to those who generate the ideas and innovation - but clearly in recent years, it was skewed towards the former. Lots more from Taleb at his site: http://www.fooledbyrandomness.com/
Taleb wants financial services to come in two flavors: boring, predictable, public banking utiliies; and no-safety-net no-bailout risk-taking investment.
He sees current regulation as helping to create the monsters we have now, where the risk-takers are allowed to play with the money that's supposed to be stable.
"Taleb wants financial services to come in two flavors: boring, predictable, public banking utiliies; and no-safety-net no-bailout risk-taking investment."
But how do you get there? How do you make sure they don't spin out of control or even how do you decide which firms to break up and how? (I don't disagree, I am genuinely interested in learning how he sees it can be implemented and without new significant regulations no less).
One way to make banks boring and predictable would be to define precisely what kind of products they are allowed to sell. This sounds like what Taleb would want, but it don't think it would be good to entirely eliminate innovation.
But if regulators would forbid any product valued by models they don't understand, it would probably be a good start.
Taleb has no problem with innovation - as long as the risk of the innovation is borne by the innovators, or investors putting their own money at risk. The problem occurs when people bet other people's money, reaping nost of the rewards when the bet pays off, and incurring little loss when the bet goes wrong.
"I'm not sure how he would go about implementing some of his ideas"
Mocking the young math-geek (I studied math) analysts, bankers, derivative creators or whatever their titles are, is a good start. I heard it somewhere that over the past decade or two, everyone's mom went from wanting their kid to be a doctor or lawyer to instead be a Wall Street I-banker. All we really need is for society to trust elaborate investment and debt schemes less.
I'm not sure if the moms had it right the first time though, because we have too many lawyers and doctors are taking a beating now from Obama,
Having not read his book, was I the only person annoyed that he used the phrase "black swan" a dozen times in the first paragraph without qualifying it?
He could have been saying "You and your party may be the only hope we have for a resilient society insulated from negative oranges and in which everyone has the opportunity to benefit from positive oranges." for all the difference it makes to me.
I cringed too - especially at the capitalization. I shall cringe again when Cameron starts using it. Forced memes like "black swan", "outlier" and "tipping point" are like little mini-advertisements for their books and their authors. Getting them into the vocabulary of politicians and business leaders is the ultimate marketing ploy.
I honestly don't know what memes you're referring too (nor the books) but outlier and tipping point have basic meanings without interpretation: tipping point is a cusp or specifically the point at which the force vector originating at the centre-of-gravity passes outside the foot of a body causing it to tip over. Outliers are statistical anomalies or unexpected results that are usually ignored as if they are insignificant.
Black swans on the other hand are birds with a particular pigment.
Now what are the additional layers of meaning, we see black swans referring to apparently unlikely events that nevertheless will occur (that's possibly not the definition given by this guy), but what about the super-definitions for the others?
That was my hang up too. Then when he did get round to the definition it's clear he needs a bit more than a sentence to qualify what he means: because call me a gambler but Black Swan's sound pretty much like something we should avoid planning for or risk getting paranoid.
(and even though I did start reading his book and do sort of know what he's on about I still cant get away from that feeling. Why cant he say "lets not be arrogant and high risk" without having to qualify it with IMO a poor reason (surely the sentence alone should be enough):(
Ditto. I read his book, and liked it. But this letter seems to try to force the point a little much.
Unless you're an entrenched partisan, I think it's still a tad too early to call Obama's economic policies "disastrous" or "calamitous."
I'm pretty sure that Taleb isn't a partisan - having also been pretty critical of Bush/Republicans (though he did point out the Obama administration's spending is magnitudes larger than his predecessor(s)). In the lead up to the crisis, Taleb was one of maybe only a couple people who not only forecasted the crisis but bet right on how it might occur. He used similarly dire language and was laughed at by many of his detractors. For this reason alone he shouldn't be so quickly dismissed.
"For this reason alone he shouldn't be so quickly dismissed."
I'm not sure he'd agree with you. Taleb's books repeatedly stress the importance of survivorship bias. In any population, they'll be someone forecasting just about any conceivable event. No matter how unlikely events turn out to be, somebody is eventually going to be right, and then that person is lauded as a genius for having forecasted correctly. When really they've done no such thing; rather, people have just retrospectively picked out the person who happened to guess right.
I think Taleb would say you shouldn't dismiss him because there's ample evidence throughout history that he's right, not because he happened to guess right this time. Whenever debt levels have risen to what they are now, it's resulted in economic instability and chaotic behavior. It's not just this century: you can find examples back to Roman times.
I think Taleb's main complaint is that Obama has not changed the incentives for Wall Streeters to put the economy at risk. Instead, we've had a big and apparently permanent transfer of risk from private to public, exacerbating the situation.
A Goldman Sachs executive just boasted that their business methods hadn't changed at all from before the crash. Think about that for a second.
I hear this from people all the time. From a financial viewpoint, the markets exist to transfer capital from those that have it to those that need it. In addition to that, the markets exist to transfer risk from one party to another. People outside of finance need to realize that companies like Goldman, when they are speculating, serve a legitimate purpose. They provide a mass of liquidity that otherwise wouldn't be there. So, before you start thinking about changing the way things work, imagine what things would be like if you attempt to remove speculators from the market. If you tie Wall Street's hands too much, last year's freezing of the credit market would look like a nice summer day.
Yet markets worked before mortgage-backed securities were invented. Have you read Talib's books? He's not arguing against taking risks, he's arguing that we shouldn't take risks that might bankrupt us, based on some high-falutin' economic model that says that the payoff is slightly larger than the risk, because the calculation is likely to be wrong. And he's arguing that because we can never understand these single events (the Black Swans) we must absolutely never put all our eggs in one basket. Resiliency is more important than efficiency, because in the long run the efficiency is an illusion brought on by imperfect understanding.
Yes, I have read Taleb's books and numerous academic articles by him. My comment was not about Taleb. It was a direct response to the parent of my comment.
Your slippery slope looks pretty flat to me. Some regulation does not mean locking down the entire market. And anyway, Taleb is proposing complete liberation for speculators; the only thing is they can't do it and expect bailouts, and they can't get some quasi-official stamp that says "AAA", please invest widows' and orphans' money here.
From a financial viewpoint, the markets exist to transfer capital from those that have it to those that need it.
No, that's what communism was supposed to do. Under capitalism, we use the market to allocate capital efficiently, to its most productive use. Perverse incentives, like excessive bonuses or government bailouts without penalties, interfere with the efficient allocation of capital.
Your twist on the poor being the group that "needs" the money is a clever little play on words, but you, and everyone else here, knows exactly what I meant. Companies need money. Investors have money.
As for some god-given right to bank accounts, I never said any such thing. It's not my fault, nor Wall Street's fault, that people aren't better prepared to understand finance. It's a dog eat dog world. If you want to keep hold of your money, learn how to invest for yourself, place it with a broker and accept that even they may lose money, or hide it in your bed. Those are your options.
Under capitalism, we use the market to allocate capital efficiently, to its most productive use.
You are not distilling finance enough. Your definition is a first-year economics definition. That's a definition from an idealized world. In the real world, companies exchange shares for cash. They invest that cash into the business to create value. Other instruments have their own purposes, but it's all about taking either money or risk and transferring it from one party to another based on needs.
You're right in some of your criticisms -- I had already edited it to remove some of that language.
But do we have no middle ground here?
We agree, for instance, that most people really AREN'T equipped to understand finance as it is practiced. The difference is that you believe there is a class of people whose advice can be relied upon. Taleb thinks not for epistemological reasons. The perverse incentives I mentioned are (for him) barely worth discussing, since they are just corruption rather than self-delusion.
(And when I say corruption, I don't mean they are necessarily evil people; I mean their agenda is now misaligned with the customers').
Anyway, I keep saying "Taleb says" because I am not well versed in these matters. I study it about as much as a layperson can, and all I know is that most of it still seems too complex to predict.
There is a class of people whose advice can be relied upon. It's up to you to find out who those people are. If your broker is not performing up to snuff, you have the right to fire him. It's just like I have the right to fire my auto mechanic, who knows more about cars than I do, if he's not doing a good job.
As for finance being complex, it's really not.
they pulled those tricks because widows and orphans money was regulated so it had to be in 'AAA' products, and the widows and orphans demanded higher returns because 'everybody' else was getting higher returns or they were going to invest they're money elsewhere.
look, by no means am i blaming 'widows and orphans' for this mess, it's just the reasons for it are very complex. even regulation that seems like a great idea, grading investment products, ended up playing some small part in the chaos.
This is ridiculous. The financial crisis was not a "black swan." Many people saw it coming and prepared accordingly. It was only groupthink and willful ignorance which kept most people from doing so.
It's not a black swan for everybody but it's a black swan for a lot of people.
I think Taleb makes an excellent point with his Black Swan theory. The point is, that we don't know what will happen. We don't know and governments don't know. Problem is, governments spend like they know :-)
Before one gets hysterical, consider debt as a function of GDP.
http://en.wikipedia.org/wiki/File:USDebt.png http://en.wikipedia.org/wiki/United_States_public_debt
Yeah, but the problem is that the rest of the world is not currently blown to smithereens and in need of American labor and capital to rebuild it the way it was in 1945 (not to mention deeply indebted to the United States as well). The trough of that graph is about the point where Western Europe and Japan managed to rebuild their economies to the point where they could actually compete effectively. The United States has no such competitive advantage at this point.
So where is all the US output going?
I wonder how Taleb reconciles his views on probability with respect to Cameron winning the next election in May?
Forget the Black Swan, please God just deliver us from Cameron.
Margaret Thatcher when asked what was her greatest political achivement - 'Tony Blair' she replied. Isn't Cameron just a more greasy version of the slimy Blair, Black Swan spotter or not?
Submarine.
> It is a low-probability, high-impact event that, because of its rarity and the instability of the environment, cannot be scientifically evaluated in terms of risk and return.
I stopped reading here. The only objective evaluation of economic matters is in scientific, risk-and-return terms. Anything else is quackery, fear-mongering, or worse.
A great deal of evil has been done in the last decade or so in the name of protecting us against horrible things. We are told that much good has come of it, because nothing horrible has happened. While I'm sure this is partly true, I wouldn't mind trading a few more horrible things for a little more autonomy.
"The only objective evaluation of economic matters is in scientific, risk-and-return terms."
That's not the problem; I suggest you read up on his theories. His point is, to put it more mathematically, that using inappropriate statistical models to try to model future events can lead to catastrophe. In particular, assuming something is a normal Gaussian process when in fact it's something that's almost a normal Gaussian but has a slight propensity towards total disasters that occur more often (and much stronger) than the Gaussian distribution would imply can result in you creating a system that is terribly brittle when those "black swans" occur.
"Scientifically" applying the Gaussian distribution or other advanced mathematical constructs when they manifestly do not apply is the real quackery, if Taleb is right. And it's hard to look at the evidence and conclude he's wrong here; it's simply objective fact that many of the interesting distributions are in fact prone to "black swans", there's a statistical test that shows it (kurtosis) quite clearly. It's really more a question of what we are going to do about his point than whether or not he's correct about the distribution. (There's no guarantee that his prescription is correct, but it's probably a better idea than listening to the "experts" who advise you to mortgage to the hilt because the worst case scenario can't possibly happen and you are 99.9% percently likely to be fine. You know, that worst case scenario that just happened and we're still living through. Yeah, that scenario that can't possibly happen.)
I agree about the statistical issues he highlights, but his anti expert stance is kind of odd. I mean we listen to this guy because he used to be a wall street trader. His books were published because he was accepted as some kind of an expert himself. So is he wrong because he's an expert?
He says: "We replaced the heuristics of the elders with arrogant (and incompetent) beliefs, breaking, in the name of science, the chain of knowledge."
In europe we had fascisim and stalinism within the past 100 years. That's three or four generations. Before the dawn of liberalism, capitalism, enlightenment and the industrial revolution we had 1000 years of depression caused by religious fanatics. We had to break that chain of "knowledge".
The heuristics of the elders are little more than mature, cultivated cliches of what past experts and ideologues told them. Taleb is correct, it's incredibly difficult to make predictions in a complex system. However, I don't see how a blanket condemnation of science and a blanket approval of crude traditions helps us to become better at that.
Black Swan theory isn't about denying science; it's about recognizing the limits of science.
Taleb's position (and argument in this paper) is that we need to recognize instances where we don't know the answer instead of making decisions based on assumptions that we do.
You can't discount the apocalypse. You just can't. And this pan-phobic concept "black swan" is just various degrees of unknowable apocalypses that we are supposed to account for based upon their very unaccountableness. I don't buy it. Read the tea leaves first, then tell me about swan feathers.
The housing bubble was BLATANT. No black swans involved. I remember talking about it with friends in 2005. No big deal, really.
"The housing bubble was BLATANT. No black swans involved."
Yes, but what was not blatant was that the housing bubble popping would kill Lehman Brothers, cause runs on banks and almost bring down the whole world economy.
Taleb's point is that you can't go around behaving like any system is, to borrow a phrase "too big to fail" - or rather too cleverly thought out/regulated to fail. To some extent this is simple engineering. I can test the resilience of my cluster to network failure by pulling out an ethernet cable and see what happens - maybe there's a small hiccup while systems fall back onto local resources, maybe nothing fails over properly and I am hosed for 12 hours. As I understand Taleb, his argument is that the economic powers (bankers, traders, politicans) spend too much time trying to figure out how to prevent network failure, rather than making sure that when the network does go out, it doesn't take your whole mission down with it. Because, no matter how well you think you have engineered the system, the chance of your network going out somehow, sometime is non-zero.
I do agree with the posters that Taleb overstates the cleverness of his own insight; but unfortunately, in his field, it seems that people really were too dumb/greedy to grasp this. Irrespective of what you think of his interpretation of events or the validity of his suggestions (and I too question them), I think as systems engineers we can appreciate the risk of designing political and economic systems under the assumption that they can't fail.
the problem isn't that people were too dumb/greedy to notice. it's that they weren't punished for not noticing it. you'd be amazed what a little incentive does to people's willingness to self educate.
If it really was that blatant, why did it happen? Doesn't the fact that it burst by definition mean that most people did not recognize it?
But Taleb makes a different point: Discounting the apocalypse is exactly what he's arguing against, because this is essentially what LTCM et al were doing with their models. They calculated probabilities to make sure that the estimated payoff was greater than the estimated loss, but they got the distributions wrong. What you should try to do is make sure that the apocalypse can't happen, that you aren't exposed so that one outlier will take you down. Because due to the nature of the system (there is only a sample of one of the world economy) you simply can't gather data that can pin down the wings of the distributions to the precision you need.
According to the models used at the time, the Black Monday 1987 was something like a 30-sigma event. If the distributions truly were gaussian, such an event should never happen in the history of the Universe. So you have a choice between thinking that we just had an incredibly bad luck, or the model is wrong. I'd go with the latter.
"If it really was that blatant, why did it happen? Doesn't the fact that it burst by definition mean that most people did not recognize it?"
Some data, some math, and an interpretation you won't hear every day:
http://quickfacts.census.gov/qfd/states/00000.html
http://photos1.blogger.com/photoInclude/x/blogger/2825/754/1...
There are 127 million housing units in the U.S. At the peak of the bubble, 7 million houses/year were sold. A total of roughly 30 million houses were sold in the boom years of 2002-2007, assuming there's no double-counting (people who sold a house multiple times), which is probably a pessimistic assumption. That means that over half of U.S. households took absolutely no part in the bubble - they just sat tight.
Now look at the inventory numbers from the last two years. They go up rather dramatically. This means there were more sellers than buyers, i.e. a large number of people realized that home prices were selling for more than they thought the house was worth, and quickly put their house on the market to take advantage of this. Sure looks like people recognized the bubble to me, it's just that by definition they can't all get out before it bursts.
My interpretation is that most people did recognize the bubble - it's just that they're not the ones that the New York Times writes stories about. They held onto their home and neither bought nor sold, instead just going about their business. Or they sold at the peak, rented for a bit, and are now buying back in at half price and pocketing a few hundred grand. Smart people tend not to brag about how they just made a killing off other people's stupidity. It prevents people from being stupid again, which limits the opportunities for future killings. Besides, it tends to kill the mood at parties.
Many people knew there was a housing bubble, but few predicted it would have such wide-reaching effects. Did you?
I had all my money in the foreign markets, and got out in late 2007 when it spiked down,
http://finance.yahoo.com/q/bc?s=VEIEX&t=5y
...I wouldn't have made any connection to US housing and foreign equities, but I was looking at both, and I knew both were bubbly. I've since lost money on a few stupid trades, so it's not like I'm an expert or anything. But the fundamentals are usually clear to all. Right now, the macros on S&P PEs, long-term treasuries, and high-yield,
http://finance.yahoo.com/q/bc?s=JNK&t=2y
...are clear, and they all scream "avoid". And that's the extent of my trading strategy right now.
"Taleb's position (and argument in this paper) is that we need to recognize instances where we don't know the answer instead of making decisions based on assumptions that we do."
Have you ever worked at an investment bank? I suspect you have not. Wall Street does not run on the scientific method. It runs on greed, fear and politics. The ones who check the assumptions and know the limits of their models don't have the power to make the decisions. This is the problem. And the Taleban apparently haven't yet figured it out. Quoting Janet Tavakoli: "malfeasance, not models, disrupted the global economy, and Taleb still gets that part wrong."
Last but not least: there's not such thing as a "blackswan theory". You can't steal ideas from probability theory and statistics that have been known for centuries, rename them, wrap them up nicely, and call them new or original.
Malfeasance enabled the models, the models enabled malfeasance. Declaring one thing "the culprit" and not the other is to fail to recognize the dynamic nature of the system. Even in a world of perfect angels, Taleb shows that broken models would still bring the system down. Even in a world of perfect models, unscrupulous jerks can bring the system down. It's all too related to pull apart.
So, what is the solution? Destroy the financial industry? Good luck.
Taleb is an anti-intellectual. He believes that all models are wrong and useless. To make it worse, he advocates that no further knowledge can be attained. The only knowledge and truth that is right is the "black swan theory". Come on, gimme a break!!! Aren't we HN'ers smarter than that? Why is Taleb's drivel being upvoted?!
The idea I've gotten from reading Taleb (articles, not books) is not that all models are useless, it's that assuming a normal distribution is often unjustified, and that once-in-a-century events come along quite a bit more often than that. Sure; he invented a catchphrase, not the exponential distribution--but "Black Swan" is more than just a cheap Australian Cabernet if it'll generate more positive awareness of systemic risks.
"You can't steal ideas from probability theory and statistics that have been known for centuries, rename it, wrap it nicely and call it a new, original idea."
Do you have any references to work centuries old that describes what Taleb calls 'Black Swans'?
No need for references. Probability was started by a bunch of bored french aristocrats who wanted to understand risk and uncertainty. Read what they wrote. They're the original thinkers.
Last but not least: in the late 1990s, Lehman Brothers had a trading desk dedicated solely to extremely unlikely events. That was before the so-called "black swan" theory came along. They made money only once. On 9/11.
Taleb's good ideas are not original, and his original ideas are no good.
To be fair, the work of Pascal and the Chevalier de Mere does not give much insight on how a water leak may turn into a mudslide. Whatever you may think of Taleb, his work is more of a popularization of catastrophe theory than it is basic probability. He even says as much in his writings.
I think if you put that statement in context, bin Taleb is saying that such "black swan" events can't be understood in the absence of a suitable behavioral model for the economy -- and furthermore, you don't want to rely on any global behavior models because they ultimately prove limiting. Communism anyone?
There is a lot going on in finance every day that simply cannot be objectively modeled or understood in scientific terms. That's a problem, but we also need to accept that there may not be a globally valid solution. Viewing complexity as the enemy sounds like as good an approach as any.
