Black Swan Lessons on the Japanese Disaster

When the Japanese earthquake, tsunami and nukes crisis hit, Nassim Taleb, author, former options trader, and Distinguished Professor of Risk Engineering at New York University, was besieged with 600 interview requests. It's not surprising: Taleb popularized the phrase "black swan" in his 2007 best-selling book of the same name.

Taleb isn't giving interviews ( "I think for a living & write books not interviews," Taleb writes on his website) so I took another look at his writings and tried to glean where he might stand. First, some background: A "black swan" is a metaphor used by philosophers over the centuries to capture the surprise effects of scientifically improbable and therefore unexpected events on history, inspired by the 17th century discovery of black swans in Australia when biologists had previously declared all swans were white swans.

In Taleb's definition, a black swan event has three conditions:

1. It is an "outlier," a highly unexpected event with little historic evidence warning us of its prospective occurrence.
2. The event has extreme impact.
3. Although the event is a black swan, we concoct explanations for the event after the fact, making it palatable and predictable.

"We don't understand the world as well as we think we do and tend to be fooled by false patterns. We mistake luck for skills (the fooled by randomness effect), overestimate knowledge about rare events (Black Swans), as well as human understanding, something that has been getting worse with the increase in complexity."

In The Black Swan, Taleb seeks to help "robustify" us against the risk of future Black Swan events. What happens to a turkey at Thanksgiving is a black swan event for the turkey, but not the butcher, Taleb explains.

In Note 142 of his blog, Taleb offers additional insights.

• The improbable happens. He cites Japan's Nuclear Commission policy that a fatality risk from a nuclear accident is about one incident per million years--a policy written just eight years ago. Therefore, an event the authorities projected as minutely improbable--a once in a million year event--occurred less than a decade later.
• Small probabilities tend to be hard to compute; the smaller the probability, the harder;
• Survivorship bias: if you compute the likelihood of an event that threatens your survival, you will inevitably underestimate its probability;
• Having faith in predictions about young industries is dangerous. It is one thing to make models based on the natural world for which we have 3 billion years of experience--it is another, more dangerous thing to trust models about the nuclear power industry which has been in existence for 60 years;
• Because of globalization, the costs of natural catastrophes are increasing in a nonlinear way. We're so interconnected by information and large institutions that events build momentum quickly: a real tsunami generates a tsunami of reactions and decisions.

• "What is fragile should break early while it's still small: Nothing should ever become too big to fail." A lesson to heed now about nuclear power?
• "People who drove a school bus blindfolded (and crashed it) should never be given a new bus: The economics establishment lost its legitimacy with the failure of the system in 2008. Find the smart people whose hands are clean to get us out of this mess."
• "Don't let someone making an "incentive" bonus manage a nuclear plant - or your financial risks: Odds are he would cut every corner on safety to show "profits" from these savings while claiming to be 'conservative'."
• "Compensate complexity with simplicity: Complexity from globalisation and highly networked economic life needs to be countered by simplicity in financial products."--An excellent insight for managers.
• "Do not give children sticks of dynamite, even if they come with a warning label." In other words, know what is too complicated to manage effectively in a Black Swan world, and outlaw it.
• "Make an omelette with the broken eggs: The crisis of 2008 was not a problem to fix with makeshift repairs."--In the aftermath of a major Black Swan event, don't fix things piecemeal or with the same assumptions. Don't be afraid to start over.