January 5, 2009

The Brown Swan

My critique in VDARE.com of Nassim Nicholas Taleb's bestseller "The Black Swan: The Impact of the Highly Improbable" tries to walk the delicate line of giving the book credit while explaining some of the ways it will be misinterpreted -- especially its title phrase.

In From Dawn to Decadence, 94-year-old historian Jacques Barzun offered a dozen dictums on pp. 655-656 summarizing what he's learned from three quarters of a century of scholarship. One was:

"The potent writings that helped to reshape minds and institutions in the West have done so through a formula or two, not always consistent with the text. Partisans and scholars start to read the book with care after it has done its work."

(By the way, this is certainly true of Barack Obama's autobiography, which has "done its work" without being carefully read!)

A reader explains how Taleb's new catchphrase "Black Swan" is being rapturously greeted on Wall Street by the very people who poured billions into subprime mortgages in Compton. Hey, it's not their fault they didn't see all those defaults coming: it was a Black Swan!
I would emphasize, that in my opinion the Black Swan is a timely rationalization for the gross incompetence seen across finance (both the more private part and their governmental overseers) regarding very predictable events. That is, it is wrong in principal, because, and as you state, the disaster(s) should have been expected (or rather, the ‘black swan’ event would have been loaning to bad credit risks and having them actually paying the loans back, not the other way around).

Furthermore, you focus on residential mortgages and minority ownership (i.e., given VDare’s emphasis), but, of course it also applies to commercial mortgages, credit card debt, etc. In short, Taleb has given incompetent and/or corrupt finance types (especially “quants”) an easy out. For example, let’s say you are a risk manager at [gigantic but inept financial institution] (which I was), and you missed seeing, as you point out, that based on a normal distribution the default rate for Mexicans is on average X% (which is significantly more than for your typical founding stock American). Basic probabilities based on normal distributions would suggest you were a fool for not seeing a wave of defaults coming, but then you now have Taleb’s ‘black swan’ event to explain yourself.

I will now give you personal insight into this. I worked at [humongous Wall Street money pit] (until February of 2008) on what was called a “credit specific risk” add-on to their Value-at-Risk model. My focus was covering Credit Default Swaps (“CDSs”) and related credit derivates (CDOs, CDO-squareds, etc.) and non-derivatives. After the financial markets began their meltdown (which continues predictably to this day, and beyond) in late July/early August of 2007, the head of the Market Risk asked me if I had read The Black Swan. I told him that I had not, and asked if he had read [Taleb's earlier book] Fooled by Randomness. ... By Thanksgiving almost every high level risk manager on Wall Street had read (or said they had read) The Black Swan. In hindsight, it is all so clear, here is a book that essentially goes on and on about what is normally a true but normally trivial point, by definition.

In effect Taleb gave the elites that screwed up on a monumental scale an easy out For example, “yes, I’m head of risk for Merrill and some say I should have seen it coming, but surely you have read ‘The Black Swan’ and now understand how that would have been impossible.” In short, Taleb has given all of finance the copout they need when they most needed it (i.e., everyone - practitioners, academics, regulators, etc.).

Attributing the worthlessness of your mortgage-backed security full of 2006-vintage Sand State subprime loans to a "Black Swan" is, in effect, a lot like blaming it on "Sh*t Happens," but it makes you sound erudite rather than stoned.

As today's WSJ article "Housing Push for Hispanics Spawns Wave of Foreclosures" suggests, the mortgage meltdown wasn't an unpredictable Black Swan at all. That rapidly Hispanicizing regions (the great majority of defaulted mortgage dollars came from just four states -- California, Arizona, Nevada, and Florida) turned out to be full of people who couldn't pay back their giant mortgages wasn't impossible to forecast: instead, it was, to coin a term, a Brown Swan -- a predictable disaster that goes unforeseen due to pervasive political correctness.

My published articles are archived at iSteve.com -- Steve Sailer

15 comments:

Anonymous said...

Taleb says in an online inteview that this crisis was a white swan, that it was obvious it's gonna happen. The 1987 crash was a black one.

Wikipedia:
On a Charlie Rose show Taleb said that he was pleased that none of criticism he received for "The Black Swan" had any substance as it was either unintelligent or ad hominem/style over substance, which convinced him to "go for the jugular" with a huge financial bet on the breakdown of statistical methods in finance.

David Davenport said...

Steve,

Sorry, but your opinion about Nassim Taleb, which you have gotten at second hand, is incorrect.

Mathematician Benoit Mandelbrot, the source of Taleb’s mathematical ideas, has been saying for many years that both the so-called Black-Scholes model and the Capital Asset Pricing Model are wrong. Mandelbrot’s claim is that many natural events, including stock market events, follow a power law probability distribution instead of a Gaussian distribution. A two-sided power law distribution looks similar to the Gaussian bell curve, except that the power law distribution is somewhat narrower at the shoulders and wider at the tails or right and left skirt edges. Fatter, wider tails imply more extreme, outlying events are likely to happen than one would predict from the Gaussian distribution.

These outlier events may be big tornados or Nile River floods or financial crises. All are more common than one would infer from Gaussian statistics.

Mandelbrot and Taleb give Wall Street villains an excuse only in the sense of Keyne’s aphorism that mad dictators who seem to be distilling their frenzy from the air are actually parroting the bad ideas of defunct economists.

dearieme said...

People who wear sunglasses find it hard to see black swans. It's their fault for wearing sunglasses.

David Davenport said...

Check out "Taleb gets upset at the economists":

http://www.stephenkinsella.net/2008/10/13/taleb-gets-upset-at-the-economists/

Embedded Video

This being iSteve.com, I'll point out that Nassim T.'s ethnicity is Lebanese Christian.

Anonymous said...

I hope you get the credit for the definition of a "Brown Swan". That has to be the best new expression in years!

tommy said...

Or consider history. Taleb, who is from the affluent Christian upper class of Lebanon (his grandfather was deputy prime minister), saw his homeland devastated when a 15-year-long civil war broke out while he was a teenager. For anyone who remembers the post World War II era, when Lebanon was universally viewed as the Switzerland of the Middle East, that was a black swan indeed.

Taleb goes too far. It was precisely this sort of example that turned me off to the book. If he were making the weaker case, he would have been right. It certainly would have been hard to predict exactly when or even if Lebanon might descend into civil war. However, Taleb seems to argue that since conventional wisdom saw Beirut as the Paris of the Middle East, no one could have predicted Lebanon might have been more of a powder keg than a country like Finland. As your own piece on Lebanon illustrates, it may just be that the dispensers of conventional wisdom are deluded.

To argue that "black swans" prove that bell curves don't work is a little like arguing that since you might find an autumn day that is cooler than a given winter day, this disproves the notion that we say that the winter is cooler than the fall. It's confusing the particular with the general.

I think Taleb's greatest mistake is conflating the notion that people often forget about the tail ends of bell curves with the idea that the curves themselves don't exist.

Anonymous said...

Agreed with the above poster, I also hope you get wide recognition for this. If the Black Swan explanation obscures the depression's human capital aspect it will be a national tragedy. The "Brown Swan" is a wonderful phrase--it is accurate and renders silly those who are obfuscating the truth.

TGGP said...

I haven't read Taleb's books but I made the same point about the crash not really being that improbable a coincidence of events (or singular event like 9/11) in the comments to this GNXP post.

Anonymous said...

When a big flock of brown swans converge, it can look just like a shit storm.

- Fred

Anonymous said...

THE BROWN SWAN would be a brilliant choice of title and topic for a book-length treatment. The, um, brownwashing process described by the term is ubiquitous and goes well beyond the current financial meltdowns.

Bill said...

In effect Taleb gave the elites that screwed up on a monumental scale an easy out For example, “yes, I’m head of risk for Merrill and some say I should have seen it coming, but surely you have read ‘The Black Swan’ and now understand how that would have been impossible.” In short, Taleb has given all of finance the copout they need when they most needed it (i.e., everyone - practitioners, academics, regulators, etc.).

I would interpret this differently. Rather I would compare them to Otto from a A Fish Called Wanda

Otto: Don't call me stupid.
...
Otto : Apes don't read philosophy.

Wanda: Yes they do, Otto. They just don't understand it!

Anonymous said...

"Brown Swan" - I love it!

Freddie said...

Sigh.

Most subprime mortgages went to white people, Steve, and most went to middle class people, Steve. Why can't you ever tell the truth when it doesn't conform to your limited hobby-horse?

Anonymous said...

Ahem.

Let me also restate my submission: the Truffle Hunt.

As in, when Malcolm Gladwell and Nasim Taleb go on a truffle hunt to unearth that politically correct gourmand's delight (the Aztec physicist, the Muslim social democrat, the monogamous and conservative gay couple, etc.) so we'll construct government policy around the rare and delectable truffle instead of all those mushrooms everywhere.

--Senor Doug

Anonymous said...

Freddie:

You have no data, yet you call someone else a liar? You have brass balls. Guess what, the truth's out there. See sample link below, or simply have the common decency to google "site:isteve.blogspot.com minority subprime" before talking nonsense.

Cuz this isn't the Atlantic no more, Freddie. It's the *real* reality-based community, and we are not bound by tired lies. You want to go to the statistical mattresses? Bring it pardner!


http://isteve.blogspot.com/2008/10/my-new-vdare-column-big-enchilada.html

Federal Home Mortgage Disclosure Act data dug up by reader Tino suggests that the recent American Housing Bubble was, more than anything else, a Hispanic Housing bubble, as total mortgage dollars handed out to to Hispanics more than septupled from 1999 to 2006! (Is "septupled" even a word?)

Moreover, in 2006, according to Tino, 51% of subprime and other "higher priced" mortgages (for purchasing homes and for refinancing older mortgages) went to minorities. The higher priced mortgages are, of course, where most of the unexpected defaults have shown up.