He was dubbed the Prophet of Doom and Gloom by his many critics when he warned of a global financial crisis more than 12 months before the collapse of Lehman Brothers. But now, Nassim Nicholas Taleb must be revelling in the infamy his prediction has brought – and he is certainly reaping its financial rewards.
The 48-year-old scholar and author is today among the most in-demand thinkers and can reportedly command up to $60,000 (Dh220,00) an hour on the speaking circuit.
His first book, Fooled By Randomness (2001), brought him acclaim, but it was with the publication of The Black Swan (2006) that he rose to become a household name in banking and finance circles.
More than one million people pored over its pages, which espoused his Black Swan theory – the failure to protect against the impact of hard-to-predict events – but no-one heeded its warnings.
Today, Taleb is not shy in pointing the finger of blame for the global financial crisis – it is the fault of governments who allowed banks to grow unchecked by regulators, he said. "Governments let these banks get big but didn't allow natural selection to act on them – thus they are fragile to changes," said Taleb. "According to me, let everything that's fragile break, it makes the rest robust.
"Banks took risk beyond their capacity because they couldn't say 'I don't know'. Failure was not an option for them. Today, the concentration of banks has made the entire world centrally fragile. The banking system uses capitalism for the profits and socialism for the losses.
"Citibank hid risk and profited from huge bonuses. Then it was bailed out by society. This is opposite of ideal capitalism and socialism," said Taleb, who was in the UAE last week.
In The Black Swan, the Lebanon-born US resident wrote: "The [US] government-sponsored institution Fannie Mae, when I look at its risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry – their large staff of scientists deem these events 'unlikely'."
Dismissed and scorned at the time, Fannie Mae and Freddie Mac were bailed out by the US Government in September 2008 to avoid their collapse – events that vindicated Taleb's notion.
Since the publication of The Black Swan, every significant event draws mention of positive or negative black swans, grey swans and white swans – none contributing to ornithology.
Taleb said banks and trading firms were vulnerable to Black Swans and were exposed to huge losses beyond what their models projected.
"Some environments are subject to the Black Swan. Banks were fragile and vulnerable to a single mistake," he said. Criticising the West's inability to acknowledge the lack of a solution or awareness, Taleb added: "In the West, it's essential to have a scientific explanation for everything. I predicted the West would collapse because its society is based on scientific principles, which are vulnerable to Black Swans. Science is the illusion of control.
"Governments need to protect their citizens from Black Swans. For example, we don't know what the effect of a large internet company failing will be until it happens. But governments could prepare for such an event."
The first to admit his book simply describes the current predicament but doesn't offer solutions, Taleb is convinced the current situation will self-correct.
"I don't have a better method [to deal with this situation]. But unlike the West, I have the ability to say, 'I don't know'. I'm just using my reputation to convince people to change society and make it more robust," he said.
Asked if he ever thought he could be wrong, he said: "No, because all I ever advised was caution. Is my theory mathematically sound? You lose something mathematising things. It is the ludic fallacy.
"The role of mathematics in society has been largely disruptive. You can't mathematisise ideas. Mathematicians are frauds."
The ludic fallacy is another term Taleb coined in The Black Swan and is a central argument in the book. It is a rebuttal of the predictive mathematical models used to predict the future – as well as an attack on the idea of applying naive and simplified statistical models in complex domains. "None of them can predict rare events. How can these models take into account events that haven't occurred yet?" he said.
Taleb said 'non-scaleable' professions like dentistry offered more security than those whose reach was undefined. "A dentist can only treat so many people in a day. He is fully aware he can't treat a million a day, so he acts accordingly," said Taleb.
"Professions that feel they can reach millions bring all the risk. Systems complicated by mass communication are more vulnerable."
But, as straight-talking as he is, Taleb said: "I wouldn't take my own advice. I didn't expect The Black Swan to be a big success."
He now intends to return to the Middle East to write his next book, called Tinkering. "My next book will be about how to live in a world we don't understand."
Taleb's Black Swan theory refers to large-impact, hard-to-predict, rare events beyond the realm of normal expectations. It refers only to events of large consequence and their dominant role in history. Taleb mentions the rise of the internet, the personal computer, the First World War, and the September 11 attacks as examples of Black Swan events. The term black swan comes from the long-held assumption that 'all swans are white'.
In this context, a black swan is a metaphor for something that could not exist. The discovery in the 17th century of black swans in Australia changed the term to suggest that the perceived impossibility actually came to pass. The main idea in Taleb's book is not to try to predict a Black Swan, but build robustness. The problem Taleb identified with banks and trading firms was that they were very vulnerable to Black Swans and were exposed to huge losses beyond what their defective models projected.
Hedge fund in the black
As Taleb published The Black Swan, he also helped start a hedge fund, Universa Investments, which based many of its strategies on his book.
Universa's strategy, which keeps more than 90 per cent of assets in cash or cash equivalents such as treasury bonds, either breaks even or loses small amounts in most months while waiting for periodic, infrequent spikes in volatility. Taleb, who acts as principal/senior scientific advisor at the Santa Monica-based fund, said: "Doing nothing is still a decision – and when you keep your money in cash it's still an investment if everyone is in debt."
Separate funds in Universa's 'Black Swan Protection Protocol' were reportedly up by a range of 65 to 115 per cent in October 2008, according to a person close to the fund.
Assets under management at Universa have neared $2 billion (Dh7.34bn) since the fund launched, with $300 million now under management. An example of the fund's success came late last year. In September, when Standard & Poor's 500-stock index traded around 1,200, Universa purchased options that would pay off if the index fell to 850 by the end of the October. Since such a plunge was considered unlikely, such options cost only 90 cents.
On October 10, those options cost $60 as the S&P 500 tumbled.
Universa sold most of its position in the high-$50 range.
Nassim Nicholas Taleb was born in Amioun, Lebanon. He holds a MSC from the University of Paris, an MBA from the Wharton School at the University of Pennsylvania and a PhD in management science also from Paris.
He is currently Distinguished Professor of Risk Engineering at Polytechnic Institute of New York University and Visiting Professor of Marketing (Cognitive Science) at London Business School. He has served as managing director and proprietary trader at UBS, chief currency derivatives trader for Banque Indosuez and MD at CIBC-Wood Gundy.