Heed the warning: a “Black Swan” is soon approaching

Nassim Nicholas Taleb's best-selling book "The Black Swan." (Courtesy of ermbooks.files.wordpress.com)
Nassim Nicholas Taleb’s best-selling book “The Black Swan.” (Courtesy of ermbooks.files.wordpress.com)

“We have never lived before under the threat of a global collapse. The financial ecology is swelling into gigantic, incestuous, bureaucratic banks — when one fails, they all fall. 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.”
~Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable (2010)

The financial markets are reeling in Europe. The European Central Bank can no longer be sure if the member banks will support its existence. Greece is set to default. There are no more economic bullets left in the European Union’s policy- making gun that can make up the math for the massive debt issue.

Will the EU be able to extricate itself or will it splinter, fragment or morph into something we have not dared to envision? How will it affect us here across the Atlantic?

As you read this, we may have a potential “Black Swan” in the making.

The term “Black Swan,” popularized by Mr. Taleb in his first book, “Fooled by Randomness,” and later seen in the film “The Black Swan” refers to a statement of impossibility, or to an event so unlikely that it defies comprehension.

Take the events of 9/11, for example. The notion that modern jetliners could be used as missiles was outside the purview of comprehension by U.S. intelligence. Since they couldn’t fathom this as a possibility, there was no way of preparing for this threat. It, therefore, constituted a “Black Swan” event.

The term “Black Swan,” is derived from Latin phrase “rara avis in terris nigroque simillima cygno,” which translates to, “a rare bird in the lands, and very like a black swan.” This English expression was derived from the presumption that all swans are invariably white, as there were no historical records of swans being any other color. The first report of a black swan was in the 17th century in Western Australia.

A catastrophic event must have the following three attributes to qualify as a “Black Swan”:

1. It is an outlier beyond the scope of regular expectations with no historical precedence,
2. The event has a major impact, and
3. After the event has occurred, it is rationalized in hindsight as human nature takes over and concocts a justification, making it a predictable event.

In the past decade, there are quite a few examples of financial “Black Swan” events. Among them are the credit default swaps and financial derivatives that derailed the banking system, the demise of Lehman Brothers and the liquidation of Bear Stearns that sent shivers through Wall Street and its untouchable investment houses, the BP oil spill and the Dow Jones flash crash, which had the Dow reeling with a 1000 point move on May 6, 2010.

Since events of these magnitudes are all previously unheard of in history, their repercussions ripple for years to come.

The ability to define and quantify the unthinkable is in the purview of risk management.

Ponder the improbable.

Expect the unexpected. Profit from the unexpected.

A Black Swan is unfolding…

Aliya is a sophomore. You can reach her at apadams1@swarthmore.edu.

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