At the London School of Economics in October, the Queen described the credit crunch as "awful" and asked a group of eminent economists the question that everyone wants the answer to: "Why did no one see it coming?"
One flustered economist apparently replied: "Someone was relying on somebody else, and everyone thought they were doing the right thing."
It was clearly an inadequate response, but one that would have come as no surprise to Nassim Nicholas Taleb. Indeed, Her Majesty might have been better off asking Taleb, because the trader-turned-author has emerged as the guru of the global financial meltdown.
Dubbed ‘the new sage of Wall Street’, Taleb’s recent book, The Black Swan: The impact of the highly improbable, is riding high in the bestseller lists and his theory of ‘black swan events’ has become one of the most appealing guides to the crisis in market capitalism.
A ‘black swan’ was the medieval metaphor for something that could not exist. But when black swans were discovered in the 17th century, the term became a metaphor for a perceived impossibility.
Fake reality
Most people, says Talib, live in ‘Mediocristan’, a fake model of reality where no rare events occur, and not in ‘Extremistan’, the complex real world where unpredictable and devastating events are par for the course
In Taleb’s view, unpredictable and seemingly unusual ‘black swan’ events such as 9/11, the dotcom bubble and the current financial implosion, are more predictable than we think. But most people, he says, live in ‘Mediocristan’, a fake model of reality where no rare events occur, and not in ‘Extremistan’, the complex real world where unpredictable and devastating events are par for the course.
“Black swans are unexpected events that end up controlling our lives, the world, the economy, history, everything,” he says. “They are rare, but their impact is monstrous.
“My main problem is that we don’t know that these events play such a large role. Why are we blind to them?”
He continues: “The world we live in is vastly different from the world we think we live in,” and accuses economists and financial analysts of being the most deluded of all.
He explains: “Black Swan comes from the overestimation of our skills in mapping the world. But I was only able to express my idea after I started working in the City and in Wall Street.
“It seemed so obvious that people in the City didn’t know what was going on, yet they thought they did. I kept a tally of predictions and realised they can’t predict – but they somehow manage to convince themselves they can.”
The apparent unpredictability of recent events would have been less unpredictable if we had the right tools to understand them, continues Taleb. Just as a turkey has a false sense of security by being regularly fed and watered in the run-up to Christmas or Thanksgiving, only to suffer ‘a revision of belief’ on the day it is slaughtered, so Mediocristan economists and financial analysts are reassured by computer models that don’t account for rare devastating events.
“We need new tools,” he says. “We will have to finance the losses [which he estimates to be over $1tn – more than was ever made in the history of banking] because of a huge misunderstanding.”
