Tuesday, 6 December 2011

Blacks Swans are Everywhere

In June 2008, at the height of the financial panic, I wrote a blog article about the concept of the black swan effect as asserted by Nassim Nicholas Taleb, the renowned author of 'The Black Swan: The impact of the highly improbable'.

Taleb argued that as a black swan is so rare that its existence could be said to highly improbable, then to see one is almost impossible. He asserted that a single 'Black Swan' event triggered the downfall of the world's banking system and caused the crisis of 2008.

I wrote then that it wasn't a 'Black Swan' event. I argued strongly that the supposed cause of the meltdown, sub-prime mortgages in the US, was merely a manifestation of a deeply unstable and flawed financial system. I likened the whole system to a house of cards built on pillars of sand. Every contact point was not just frail but it had the potential of bringing down far more of the structure, if not all of it.

Last night's program on RBS and Robert Peston's series on 'The Party's Over' should remind us all that rather than Black Swans being a rarity in the system, it seem that most swans are black if we analyse our system. Debt and its trading is the basic issue mapped against a single assumption that all assets will rise in value. From that basic principle, the financial world invented a whole series of deeply complex and convoluted products that created money out of thin air from which only a very few benefited. There was simply no substance to it. 

This whole assumption was less apparent yet underpinned the massive boom in less secured credit to consumers in Britain and with goods getting cheaper from the Far East, we forgot our the basic principle of spending within our means as our true earnings decreased and we ditched saving for the future. 

As the banks went pop as inevitably they had to, the massive debts they ran up were merely transferred to the Public Sector and so Sovereign debt is now the main issue while banks, having been reloaded and forgiven, have carried on trading in exactly the same way. 

At that time, I predicted that credit crunches would become cyclic unless we solved the base issues and changed the entire banking system - something that people like Tony Blair argue against and God knows what Gordon Brown now thinks. Do we even care? Sure enough, we have another credit crunch and this time it has only been staved off by Central banks easing their lending. Meanwhile, the Eurozone slips into deeper crisis as even mighty Germany is in danger of over reaching itself.

Taleb was right in asserting that banks only ever make money from lending to consumers - investment banking is all about huge booms and cataclysmic busts with no net movement. We learned very little from Fred Goodwin's lunacy and because we are all stupid enough to believe there are such things as free lunches and that our houses are cash machines when all we are doing is loading ourselves with more debt, then the world will not change.

Black swans are now cluttering the system. They are everywhere. 

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