Tuesday, May 11, 2010

Taleb’s Self-fulfilling Prophecy…

Nassim Taleb, the Arab author/scientist/businessman who wrote The Black Swan warned of a global banking crisis based on his models showing the consequences of excessive interconnectivity of civilized systems.  (I guess he prefers uncivilized randomness.)

A Wall Street Journal article described Taleb’s role in triggering the 1000 point drop on Wall Street last week:

Shortly after 2:15 p.m. Eastern time last Thursday, hedge fund Universa Investments LP placed a big bet in the Chicago options trading pits that stocks would continue their sharp declines.

…coming on a day when all varieties of financial markets were deeply unsettled, the trade may have played a key role in the stock-market collapse just 20 minutes later.

The trade by Universa, a hedge fund advised by Nassim Taleb, author of "Black Swan: The Impact of the Highly Improbable," led traders on the other side of the transaction—including Barclays Capital, the brokerage arm of British bank Barclays PLC—to do their own selling to offset some of the risk, according to traders in Chicago.

Then, as the market fell, those declines are likely to have forced even more "hedging" sales, creating a tsunami of pressure that spread to nearly all parts of the market.

Taleb predicted such a “global banking crisis” in his book “The Black Swan”.  Apparently the crisis didn’t occur quickly enough.  He felt he had to help it along.

In 2007, in The Black Swan[37]

Globalization creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial Institutions have been merging into a smaller number of very large banks. Almost all banks are interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crisis less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur ....I shiver at the thought.

The government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deem these events "unlikely".

While I understand that Taleb is Greek Orthodox and not Muslim, his ideas in some respects mirror the mission of Islam: To evoke distrust toward essential elements of civilization (e.g. technological systems) and help assure that such distrust is justified by having a hand in achieving their dysfunction.

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