The Black Swan – Another Meltdown
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Though more common now, especially in Australia, Europe, and Asia, black swans (Cygnus atratus) were once thought to be almost extinct … so rare that a sighting of one was considered to be an unexpected, improbable event.
Today, The Black Swan is a metaphor for an unpredictable, unforeseen, random event, typically one with extreme consequences. Today’s best technology cannot predict their cause or emergence. The only thing we know for certain is that someday, somewhere, another Black Swan will appear.
Black Swan events were discussed by Nassim Nicholas Taleb in his 2001 book Fooled By Randomness. Taleb is a Lebanese American author, professor, statistician, and risk analyst. Taleb discusses the fallibility of human knowledge and the existence of randomness … as in the random appearance of a Black Swan. The 2007 Financial meltdown was a Black Swan event. His 2007 book The Black Swan extended the metaphor to events outside of financial markets.
Taleb regards almost all major scientific discoveries, historical events, and artistic accomplishments as “Black Swans”— undirected and unpredicted. He gives the rise of the Internet, the personal computer, World War I, the dissolution of the Soviet Union, and the September 11, 2001 attacks as examples of Black Swan events.
Taleb asserts that Black Swan events have the following three attributes:
- First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility.
- Second, it carries an extreme ‘impact’.
- Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.
The Great Real Estate Depression
The Great Recession started in 2007 with the collapse of the real estate market in the United States. Some estimate the US suffered a $14 trillion loss in wealth. Others estimated the loss as high as $21 trillion. This event is more commonly referred to as The Great Real Estate Depression by those of us who are or were in the real estate industry back then. About 8.7 million jobs were lost, GDP contracted 4.2% and nine million families lost their homes due to foreclosure. The financial crisis of 2007–2008 is considered by many economists to have been the most serious financial crisis since the Great Depression of the 1930s. It was and is considered to be the best analogy of a Black Swan.
Are There White Swan Events?
If The Black Swan is an unexpected, improbable event, conversely, is there a predictable and expected White Swan event? Do White Swans follow Black Swans?
I have hypothesized and I say yes … absolutely, and with history about to repeat itself, we need only look at today’s irresponsible lending practices to accurately predict what will soon happen. With the benefit of hindsight, we now know what caused the 2007 financial meltdown and it is easy to see similar irresponsible lending practices in use today.
White Swans occur when conditions accumulate to a “combustible” point much like a vast forest of trees and tinder starved of moisture by a severe drought. We can’t predict the inevitable cause of the coming conflagration or the exact moment it will occur but we know, without doubt, that something will spark the event. It is all predictable.
We are in the midst of a White Swan event!
So, let us look at what Nassim Taleb might assert the attributes of a White Swan to be:
- First, a White Swan event in not an outlier, outside the realm of the regular expectation. Rather, a White Swan event would be a predictable, probable event, based upon known cause and effect, and well within the realm of possibilities.
- Second, a White Swan event may cause less impact because of remedial actions implemented after the Black Swan event.
- Thirdly, because a White Swan event follows a Black Swan event our hindsight allows us to understand, explain and predict the event.
Examples of Events Predicted by a White Swan:
- Appraisal waivers
- Hybrid appraisals
- Bi-furcated appraisals
- The raising of the de minimus for commercial and residential loans
- Greater use of AVM’s
- The use of Evaluations, Drive By’s and BPO’s
- Promotion of “The Digital Mortgage”
- Disruptive technologies in the brokerage, valuation and lending industries
- The use of Big Data and Artificial Intelligence
- Low doc, no doc underwriting guidelines
- Low down, no down mortgages
Another Meltdown – The Inevitable Outcome of a White Swan:
Why would we allow another Financial Meltdown to occur? White Swans make it all predictable and probable.
When revenues and profits decline, lenders and financial institutions throw caution to the wind and relax their once prudent lending policies in favor of more aggressive, inclusive policies. When prolonged low interest rates no longer serve as an effective stimulus to borrowing and lenders can’t squeeze any more revenue or profits from a declining market, the expected and probable result is to implement imprudent lending policies … least the stockholders suffer a loss in value. The perfect analogy to the White Swan are the post recession imprudent and scandalous actions of Wells Fargo.
Hindsight has taught us that there is no serious consequence to imprudent lending policies. Perhaps a multi million dollar fine is assessed but that is just the small cost of doing business for some violators. Only one person went to jail from The Great Recession. Lenders are not stupid and are more than willing to repeat the mistakes of the past because they know that the US Taxpayer will, of necessity, bail them out again in the next financial meltdown. Losses from bad loans are largely mitigated with mortgage insurance and the FDIC or offset by enormous profits. Higher reserve requirements may soften the fall. Corporations and people may go bankrupt but nobody goes to jail. Nobody jumps off the ledge anymore. Capitalism will always have winners and losers … in fact must have losers for there to be winners.
We know there will be another downturn. It is inevitable. Many predict it will start next year. Recessions are simply the end of the business cycle. We know that today’s imprudent lending policies will cause it.
Today’s White Swan predicts that the next recession is inevitable. It’s being cooked into the books right now. Are you ready for it? Will you be one of the winners or one of the losers?
I know this sounds crazy but, knowing what we already know, is there any chance we could prevent it?