Indeed, for their lending business, banks hire dull people and train them to be even more dull. But this is for show. If they look conservative, it is because their loans only go bust on rare, very rare, occasions. There is no way to gauge the effectiveness of their lending activity by observing it over a day, a week, a month, or … even a century! In the summer of 1982, large American banks lost close to all their past earnings (cumulatively), about everything they ever made in the history of American banking – everything. They had been lending to South and Central American countries that all defaulted at the same time – “an event of an exceptional nature”. So it took just one summer to figure out that this was a sucker’s business and that all their earnings came from a very risky game. All that while the bankers led everyone, especially themselves, into believing that they were “conservative”. They are not conservative; just phenomenally skilled at self-deception by burying the possibility of a large, devastating loss under the rug. In fact, the travesty repeated itself a decade later, with the “risk-conscious” large banks once again under financial strain, many of them near-bankrupt, after the real-estate collapse of the early 1990s in which the now defunct savings and loan industry required a taxpayer-funded bailout of more than half a trillion dollars. The Federal Reserve bank protected them at our expense: when “conservative” bankers make profits, they get the benefits; when they are hurt, we pay the costs.
After graduating from Wharton, I initially went to work for Bankers Trust (now defunct). There, the chairman’s office, rapidly forgetting about the story of 1982, broadcast the results of every quarter with an announcement explaining how smart, profitable, conservative (and good looking) they were. It was obvious that their profits were simply cash borrowed from destiny with some random payback time. I have no problem with risk taking, just please, please, do not call yourself conservative and act superior to other businesses who are not as vulnerable to Black Swans.
Another recent event is the almost-instant bankruptcy, in 1998, of a financial investment company (hedge fund) called Long-Term Capital Management (LTCM), which used the methods and risk expertise of two “Nobel economists”, who were called “geniuses” but were in fact using phony, bell curve-style mathematics while managing to convince themselves that it was great science and thus turning the entire financial establishment into suckers. One of the largest trading losses ever in history took place in almost the blink of an eye, with no warning signal (more, much more on that in Chapter 17).[18]
From the standpoint of the turkey, the nonfeeding of the one thousand and first day is a Black Swan. For the butcher, it is not, since its occurrence is not unexpected. So you can see here that the Black Swan is a sucker’s problem. In other words, it occurs relative to your expectation. You realize that you can eliminate a Black Swan by science (if you’re able), or by keeping an open mind. Of course, like the LTCM people, you can create Black Swans with science, by giving people confidence that the Black Swan cannot happen – this is when science turns normal citizens into suckers.
Note that these events do not have to be
A BRIEF HISTORY OF THE BLACK SWAN PROBLEM
This turkey problem (a.k.a. the problem of induction) is a very old one, but for some reason it is likely to be called “Hume’s problem” by your local philosophy professor.
People imagine us skeptics and empiricists to be morose, paranoid, and tortured in our private lives, which may be the exact opposite of what history (and my private experience) reports. Like many of the skeptics I hang around with, Hume was jovial and a bon vivant, eager for literary fame, salon company, and pleasant conversation. His life was not devoid of anecdotes. He once fell into a swamp near the house he was building in Edinburgh. Owing to his reputation among the locals as an atheist, a woman refused to pull him out of it until he recited the Lord’s Prayer and the Belief, which, being practical-minded, he did. But not before he argued with her about whether Christians were obligated to help their enemies. Hume looked unprepossessing. “He exhibited that preoccupied stare of the thoughtful scholar that so commonly impresses the undiscerning as imbecile”, writes a biographer.
Strangely, Hume during his day was not mainly known for the works that generated his current reputation – he became rich and famous through writing a bestselling history of England. Ironically, when Hume was alive, his philosophical works, to which we now attach his fame, “fell deadborn off the presses”, while the works for which he was famous at the time are now harder to find. Hume wrote with such clarity that he puts to shame almost all current thinkers, and certainly the entire German graduate curriculum. Unlike Kant, Fichte, Schopenhauer, and Hegel, Hume is the kind of thinker who is
I often hear “Hume’s problem” mentioned in connection with the problem of induction, but the problem is old, older than the interesting Scotsman, perhaps as old as philosophy itself, maybe as old as olive-grove conversations. Let us go back into the past, as it was formulated with no less precision by the ancients.
The violently antiacademic writer, and antidogma activist, Sextus Empiricus operated close to a millennium and a half before Hume, and formulated the turkey problem with great precision. We know very little about him; we do not know whether he was a philosopher or more of a copyist of philosophical texts by authors obscure to us today. We surmise that he lived in Alexandria in the second century of our era. He belonged to a school of medicine called “empirical”, since its practitioners doubted theories and causality and relied on past experience as guidance in their treatment, though not putting much trust in it. Furthermore, they did not trust that anatomy revealed function too obviously. The most famous proponent of the empirical school, Menodotus of Nicomedia, who merged empiricism and philosophical skepticism, was said to keep medicine an art, not a “science”, and insulate its practice from the problems of dogmatic science. The practice of medicine explains the addition of
Sextus represented and jotted down the ideas of the school of the Pyrrhonian skeptics who were after some form of intellectual therapy resulting from the suspension of belief. Do you face the possibility of an adverse event? Don’t worry. Who knows, it may turn out to be good for you. Doubting the consequences of an outcome will allow you to remain imperturbable. The Pyrrhonian skeptics were docile citizens who followed customs and traditions whenever possible, but taught themselves to systematically doubt everything, and thus attain a level of serenity. But while conservative in their habits, they were rabid in their fight against dogma.
Among the surviving works of Sextus’s is a diatribe with the beautiful title
Where Sextus is mostly interesting for my ideas is in his rare mixing of philosophy and decision making in his practice. He was a doer, hence classical scholars don’t say nice things about him. The methods of empirical medicine, relying on seemingly purposeless trial and error, will be central to my ideas on planning and prediction, on how to benefit from the Black Swan.
In 1998, when I went out on my own, I called my research laboratory and trading firm Empirica, not for the same antidogmatist reasons, but on account of the far more depressing reminder that it took at least another fourteen centuries after the works of the school of empirical medicine before medicine changed and finally became adogmatic, suspicious of theorizing, profoundly skeptical, and evidence-based! Lesson? That awareness of a
