Nassim Taleb Kills $20 Billion Mythical Black Swan, WSJ Credibility Crash

By: Janet_Tavakoli

A May 2009 European GQ article featured an extraordinary "quote" from Nassim Nicholas Taleb about gains made for clients he advises and "screwing" banks during the financial crisis:

"I went for the jugular--we went for the max. I was interested in screwing these people--I'm not interested in money, but I wanted to teach them a lesson, and the only way you can do it is by trying to take it away from them. We didn't short the banks--there's not much to be gained there, these were all these complex instruments, options and so forth. We'd been building our positions for a while...when they went to the wall we made $20 bln for our clients, half a billion for the Black Swan fund."

(First page, second column, 7th full paragraph of "The Thinker," GQ UK edition, May 2009) Emphasis added.

Great "quote," except the part about making $20 billion for clients wasn't true.

I checked with Nassim Taleb regarding the $20 billion in gains and asked if he were misquoted. Taleb responded that the quote was inaccurate, and the $20 billion "might correspond to the face value of positions." This response was both vague and different in character from the mythical $20 billion in gains inaccurately quoted in GQ's article.

In fact, the total gains were a tiny fraction of what Taleb loosely described as "face value." At the time, Taleb's web site home page had shown this article as one of two "most representative overall profiles." After my May 19, 2009 query, Taleb added a qualifier next to the link to the article: "(with typo on the 'billions')." In my opinion, it is important to be specific about corrections, especially when the error is enormous. Silence could be interpreted as endorsement. The error could have the side effect of attracting investors to the black swan fund, similar to advertising or salesmanship.

Will Self, the author of the GQ article, did not respond to an email sent to his agency in June 2009. I also contacted GQ several times. They said they were checking into the matter. To the best of my knowledge, GQ never issued a correction or retraction.

After other media picked up on the error, Taleb posted a correction on his web site in late June 2009 saying the $20 billion was notional exposure in future value of options, and the funds only made between "a quarter and a half a billion."

Taleb asserted the article was about philosophy, and one should ignore the numbers. The Times (among others) didn't seem to see it that way. The Times's original reference to GQ's article focused on the erroneous $20 billion in trading gains months before Taleb made his correction in the face of media pressure.

The black swan fund's strategy is purportedly to buy out-of-the-money put options on stocks and broad market indices and hedge tail risk for clients. The strategy may produce long periods of mediocre--or even negative--returns followed by a large gain and vice versa. No one can tell you for certain exactly when (or for how long) large gains are possible. Initial success in a newly created fund may not be replicated in the future, and there is always the problem of scaling. Scaling refers to the fact that an individual fund may make a high return on an initial investment, say 100% on $100 million, but lose 10% on $1 billion.

The Market Can Stay Irrational Longer Than You Can Stay Solvent (or Patient)

We know that big unanticipated market moves always result in big winners and big losers. After the fact, many winners claim they were smart--not just lucky.

In my opinion, any claim of enormous gains for any strategy--including a black swan fund--should be explained and balanced with caveats. The siren song of enormous gains is always enticing, but the actual swan song may be off key.

A black swan fund strategy may produce future huge gains, but it may also produce mediocre returns (or even slowly burn cash for long periods) before producing another huge gain. The waiting period for the next big payday could be brief, or it could be longer than your investment horizon.

The Wall Street Journal's "Crash" Story

Today's Wall Street Journal asks if a trade done by Universa, the hedge fund Taleb advises, sparked last Thursday's stock market upset. It didn't. But unrelated to Universa, there are indications of problems with models and of possible market manipulation.

This might make for good book sales for today's release of the second edition of The Black Swan, but the Wall Street Journal article misleads the public about an important event. See more details at "'Banging' the U.S. Stock Market," Huffington Post, May 10, 2010.

The Global Financial Crisis

According to The Guardian: "to establish his credentials as the sage of our current predicament, Taleb frequently refers to an August 2003 article in The New York Times in which he correctly predicted [Fannie Mae] had underestimated the risk of [a big move] in interest rates that would destroy the value of their portfolio." By the time Taleb spoke up in August of 2003, I and many others had already raised issues not only about the models, but also about the GSEs' massive exposure to a handful of counterparties (Wall Street Journal June 2003 and The Street.com July 2003), a risk Taleb missed. The New York Times article also asserted that Fannie Mae's business plan seemed safe, "since people typically do not default on their mortgages," so it would not establish anyone's credential's as the sage of our current predicament.

Malfeasance, not models, disrupted the global economy, and Taleb still gets that part wrong. Black Barts imitating the gentleman highway robber--not black swans--caused most of the damage. See Also: "Wall Street's Fraud and Solutions for Systemic Peril," TSF, May 12, 2010.

By Janet Tavakoli

web site: www.tavakolistructuredfinance.com

Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct associate professor of derivatives at the University of Chicago's Graduate School of Business. Author of: Credit Derivatives & Synthetic Structures (1998, 2001), Collateralized Debt Obligations & Structured Finance (2003), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, September 2008). Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street (Wiley, 2009).

© 2010 Copyright Janet Tavakoli- All Rights Reserved
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