The 2007-08 crisis resulted not because of a natural Black Swan, but because of one bred by the Basel Committee.

“Martial arts legend Bruce Lee, whom many people regarded as immortal, died at the age of only 32 of a cerebral edema, or brain swelling, after taking some sort of aspirin. I have not the faintest idea whether that pill actually had anything to do with his death but I have frequently used (or misused) this sad death as an example of how an organism could be in such a highly tuned and perfect condition that it could not resist a small external shock.

And as a consultant I often used this metaphor to explain why companies nowadays, pressured by the stock market’s expectations for the next quarterly results; the latest theories in corporate finance as to how squeeze out the last drop in results; and, perhaps, even some bit of creative accounting, might be so well-tuned (no little reserve fat left) that they would not be able to withstand any minor recession. (Whenever I expose this theory, I can see in my wife’s eyes that she believes this is just my preparing an excuse for my growing—ok, grown—midline.)”

That and which I wrote in my book Voice and Noise (2006) should be more than enough evidence on how much I share and enjoy Nassim Nicolas Taleb’s discussions on fragility and the need for redundancy.

But where I have serious disagreements with NNT is when he relates his “black swan” to the financial crisis that occurred in 2007-08. And not because it was not a black swan event to most, it sure was, but because it provides bank regulators with the perfect excuse to avoid accountability. That Black Swan was not a natural black swan, it was a man made black swan… it was a Black Swan bred by the loony portfolio-invariant-credit-risk-equity-requirements for banks. 

For instance when NNT writes in “Thinking” 2013 “use of probabilistic methods for the estimation of risks did just blow up the banking system” I have to jump out of my chair to shout No! It was the use of the wrong risk factors that blew up the banking system. The Basel Committee used the risks of the banks assets when setting the equity requirements for banks, and not the risks banks would not be able to manage the risks of those assets.

Empirically, in terms of causing major bank crises, it is clear that banks are much worse managing “safe” assets than “risky” ones.

And when NNT, in the same chapter of “Thinking” writes about his four quadrants: Simple binary decisions in Mediocristan; Simple decisions in Extremistan; Complex decision in Mediocristan and; Complex decisions in Extremistan…no matter how much I agree and find that interesting, it has nothing to do with the bank 2007-08 bank crisis.

My more directly applicable to banks quadrangle, which explains the consequences for bank based on the ex ante perceptions of asset risks and ex post realities, IS THIS

At what moment does intuition turn into an overpowering prejudice that blocks all deliberate decision making?

Intuitively bank regulators think “risky is risky and safe is safe” and impose on banks credit-risk-weighted capital (meaning equity) requirements… more risk more capital – less risk less capital.

But then, in the hope of provoking a better and more deliberate decision, I sit down with them and explain:

First, that what has always turned out really risky for the bank system, has never ever been something perceived as risky, but always something that ex ante was perceived as absolutely safe but that, ex post, turned out to be very risky.

And second, that discriminating this way for risk already perceived by bankers, and already cleared for through interest rates, size of exposures and other terms, dramatically distorts the allocation of bank credit to the real economy.

And they say: “Yes, you are entirely correct Per”… but still insist on doing the same… How come?

At what moment does intuition turn into an overpowering prejudice that blocks all deliberate decision making?

Have anyone of you who participated writing in “Think-ing” edited by John Brockman any idea of how to break through intuitions when these are too powerful?

I appreciate all the help I can get… as these regulations have introduced a very faulty and extremely dangerous risk aversion that is really messing up all the economies of the Western World. These regulations are stopping our banks from financing the risky future by keeping them busy profitably re-financing the safer past

I also read the following on the site of Edge.org founded by John Brockman:

“To arrive at the edge of the world's knowledge, seek out the most complex and sophisticated minds, put them in a room together, and have them ask each other the questions they are asking themselves.”

And that makes me want to ask anyone of you about when complex and sophisticates minds, put together in a room, could turn into a dangerous mutual admiration club?

I say this because there are such monstrous errors in these bank regulations that could perhaps only be explained by the possibility that no one dared to ask the questions… as these had to reflect too badly on a member of the club 

Thanks… and best regards

Per Kurowski

PS. I have discussed part of this regulatory mistake while reading Professor Daniel Kahneman’s “Thinking Fast and Slow”

Failed bank regulators must adore Nassim Nicholas Taleb’s black-swan.

In “Learning to love volatility”, Wall Street Journal, November 17, Nassim Nicholas Taleb writes:

“Several years before the financial crisis descended on us, I put forward the concept of "black swans": large events that are both unexpected and highly consequential. We never see black swans coming, but when they do arrive, they profoundly shape our world…. Still, through some mental bias, people think in hindsight that they "sort of" considered the possibility of such events; this gives them confidence in continuing to formulate predictions” 

And so Nassim Taleb still provides the failed bank regulators with the comfort of this being an unforeseeable crisis. Boy how much they must adore him and his black swan. 

Well several years before this crisis, me and others, put forward that this was a crisis doomed to happen… no black-swan… a totally man-made crisis.

When regulators allowed the banks to hold immensely less capital for exposures considered as not risky, “The Infallible”, than for exposures considered “The Risky”, they virtually doomed the banks to originate dangerously excessive exposures to “The Infallible”, precisely the kind of exposures that have always detonated major crisis when, ex-post, most often because they are too much financed, turn out, ex-post, as very risky…. like the triple-A rated securities backed with lousily awarded mortgages to the subprime sector, like Greece, like Spanish real estate… 

And by the way there is nothing much new in the concepts in “Learning to love volatility” or “Anti-fragility”, they represent precisely what we mean when praying in our churches “God make us daring!”

The fatidic black-swan explanation still keeps us in the crisis

When you restructure a company that has gotten itself into financial problems, you do not inject new funds before you have made the structural changes that allow you to reasonably expect that the company will recover, and so that you are not just throwing good money after bad. 

Unfortunately there has been no fundamental or significant restructuring carried out at all during the current crisis. And that is because so many bought into the fallacy of this crisis being caused by a “black swan” event, one which no one could foresee, and which therefore needed not to happen again. Bank regulators have of course been especially fond of this concept, as it reinforces their innocence.

But no! This was no black swan event. When regulators allowed the banks to hold immensely less capital for exposures considered as not risky, “The Infallible”, than for exposure considered “The Risky”, they virtually doomed the banks to originate dangerously excessive exposures to “The Infallible”, precisely the kind of exposures that have always detonated major crisis when, ex-post, these appear as very risky…. like triple-A rated securities backed with lousily awarded mortgages to the subprime sector, like Greece, like Spanish real estate… 

And so all bail outs, fiscal stimulus and quantitative easing done, without any fundamental structural change, like eliminating the capital requirements for banks which discriminate based on perceived risks, have just wasted preciously scarce fiscal and monetary policy space. 

When are our governments to wake up to the fact that those who messed it up were the not so white white-regulator-swans? And to the fact that the Basel regulatory paradigm is silly and sissy and must be thrown out the window... urgently?

Risk taking provides the financial system with the Lebensraum it needs to grow sturdy

The better the credit ratings are, and the better our risk models are, the better will we stack our financial system, for a while, but then also the higher¸ in Nassim Taleb´s terms, its fragility, or its brittleness will be. 

If we want a flexible, a sturdy, or in Nassim Taleb´s terms an anti-fragile system, then our financial system need risk-taking, a lot of it, of many varied kinds. Risk-taking is not only the oxygen of economic growth it is also what allows our financial system the Lebensraum it needs.. 

Risk-taking is “anti-fragility”, which is why in our churches we can hear the prayer of “God make us daring!” Our current problem is that our nanny bank regulators in the Basel Committee completely forgot all about it… or perhaps they never knew.

PS. I spoke and wrote much about fragility before Nassim Taleb