Anyone interested in Black Swans, systemic risks and looming catastrophes should take a close look at the work of Yale University sociologist Charles Perrow. The central thesis of his recent work is that complex, change-resistant institutional bureaucracies operating in densely networked complex systems will inevitably produce crises that strain our collective coping mechanisms. Perrow calls these crises “Normal Accidents”.
In 2012, my co-author James A. Kaplan and I coined the term “Routine Anomalies” to describe the rising frequency of events that defy traditional theories and risk models. However we characterize these events, we should remember the following points (detailed here and here).
First, “Black Swan” is an outdated metaphor. The original meaning of Nassim Taleb’s catchy coinage doesn’t fully capture the salient changes in the character of capital markets since 9/11 or since the collapse of trust in 2008. Anomalous events that defy traditional economic theories have become a routine occurrence. Not all of them are cataclysmic. Importantly, most of them are man-made.
Second, the routinization of anomalies primarily reflects flaws embedded in the system of perverse incentives for corporate leaders. Many public companies still employ governance practices that reward poor performance and excessive risk-taking. They also exploit accounting conventions to mask resulting vulnerabilities.
Third, we should not fixate on improbable risks. True, chaos theory is fascinating, and it can improve our study of risk by asking us to imagine how a butterfly flapping its wings can contribute to hurricane formation. But our risk models would improve far more substantially if we pay closer attention to systemic flaws that elevate risk as surely as sedentary lifestyles elevate the risk of heart disease.
Corporate character affects corporate valuations during every single trading session. What makes it difficult to predict and avoid the next Enron or Lehman is not the complexity of the underlying causes, but rather our culturally conditioned resistance to acknowledging facts that don’t fit our theories.
I’ll conclude with a quote from the 2012 essay I co-authored with Jim Kaplan:
Taleb published his Black Swan bestseller in 2007. But the study of risk did not begin and end in 2007. It started at the dawn of human civilization, and it will continue as long as human beings remain aware of their environment. As a battle-hardened student of capital markets, I genuinely respect and enjoy Taleb’s work. He is a serious scholar, a poet of risk, an iconoclast. It is unfortunate that thoughtless overuse has moved some of his ideas from the realm of serious scholarship into the realm of slogans and catchy coinages often uttered reflexively and dogmatically.
This tendency to regurgitate the novel ideas of 2007 blinds us to the continuing mutation of risk; it obscures the need for further innovation. As we address this need, we should continue to study the hyper-complex causes of highly improbable events, but we should not neglect the obvious red flags of bad governance and bogus accounting.