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Black Swans Or Black Albinos? Why Bell Curves Still Rule

By Steve Sailer

"With financial markets suddenly crashing, the timeliest book of 2008 has turned out to be published in 2007: The Black Swan: The Impact of the Highly Improbable, an exuberant attack on the very concept of forecasting the future by a Wall Street trader-turned-philosopher named Nassim Nicholas Taleb.

Taleb’s book is proving highly influential. His popular but confusing
buzz phrase, “black swan", is seemingly already ensconced permanently
in our jargon.

For example, Joe Nocera’s article in Saturday’s New York Times
Magazine, "Risk Mismanagement," [January 2, 2009] does a fine job of
applying Taleb’s insights to how Wall Street catastrophically
underestimated the riskiness of securitized junk mortgages during the
Housing Bubble. The financial industry assumed that the performance of
financial instruments is distributed according to a bell curve, with
few outliers. They assumed that mortgage defaults happen randomly due
to miscellaneous human tragedies (illness, death, divorce, and job
loss), so bundling a lot of mortgages together would virtually
eliminate the risk of the entire package.

But instead, of course, the new populations of California, Nevada,
Arizona, and Florida proved unable to earn enough money to afford
their mortgages.

Taleb argues that bell curve-based forecasts fail frequently because
outliers—"black swans"—have dramatic impact. If the bell curve
actually applied to wealth, for instance, Bill Gates couldn’t exist.

Or consider history. Taleb, who is from the affluent Christian upper
class of Lebanon (his grandfather was deputy prime minister), saw his
homeland devastated when a 15-year-long civil war broke out while he
was a teenager. For anyone who remembers the post World War II era,
when Lebanon was universally viewed as the Switzerland of the Middle
East, that was a black swan indeed.

Similarly, who, say, could have predicted in 1924 that a failed artist
then moldering in jail would go on to such a cataclysmic career that
even 85 years later in 2009 the world remained structured around the
geopolitical and intellectual arrangements forged in his defeat? A
Hitler couldn’t exist in a world wholly framed by the bell curve.

Taleb’s conclusion: human beings think too much in terms of normal
probability distributions—of means and standard deviations—and not
enough about the Hitlers and Bill Gates of the world.

Oh yeah? Obviously, Taleb has spent much of his life hanging around
with a rather unrepresentative slice of humanity—Wall Street quant
jocks.

Do we really not think about Hitler enough? For instance, there were
at least five (5) Hollywood movies released in the last couple of
months to qualify for the Academy Awards that were set in Nazi-
controlled Europe (Valkyrie, The Reader, Defiance, Good, and The Boy
in the Striped Pajamas.)

Moreover, in recent years we’ve heard various Middle Eastern
politicians compared to Hitler, such as Hassan Nasrallah of Hezbollah
in Taleb’s Lebanon, Mahmoud Ahmadinejad of Iran, and, most
disastrously, Saddam Hussein.

Of course, as it turned out, Saddam didn’t particularly want to
conquer the world. And even if he did, he didn’t have the human
capital do it: he was ruling Iraqis (average IQ of 87), not Germans.

Unfortunately, as its correct but limited lessons get overgeneralized
in the elite mind, The Black Swan is likely to wind up doing similar
damage to intellectual life over the next few years. After all,
there’s always a big market for attacks on bell curves. And Taleb’s
ideas will inevitably get misapplied outside of Wall Street to public
policy, where they will be used to buttress the conventional wisdom.

For example, in the new bestseller Outliers: The Story of Success,
which I reviewed in VDARE.com last month, the always-trendy Malcolm
Gladwell attempts to apply Talebian-style anti-bell curve thinking to
the perennial question of why ethnic groups perform so differently on
average. (Here’s Gladwell’s 2002 article on Taleb’s money management
business, "Blowing Up.")

Taleb isn’t to blame for Gladwell getting befuddled. But his inability
to fully understand why he’s right about the things he’s right about
doesn’t help matters.

Still, if you can put up with Taleb’s egomania and free-floating
hostility, which I find amusing but you might not, The Black Swan is
almost as easy to read as Gladwell’s book, and far more valuable.

Taleb’s term for rare but important events, "black swans," (which, in
a display of his sometimes-excessive erudition, he borrowed from John
Stuart Mill paraphrasing David Hume) is disastrously mischosen. Black
swans aren’t rare at all, much less particularly important. In
Australia, all wild swans are black, and there are as many as a half
million of them. Even in the rest of the world, they have become a bit
of a cliché of ornamental water gardens—there are a pair of black
swans paddling about in a fake stream outside a dowdy restaurant a
mile from my house.

Instead of calling his book "The Black Swan," Taleb, had he wanted to
stay with his the white-black theme, could have used as a title a more
self-explanatory term such as "The Black Albino". White-skinned blacks
are indeed rare, yet rather more common than you might assume.

Of course, nobody (except maybe the VDARE Foundation) would have
published it with that title. Still, an all-around better title for
his book would have been Outliers—which would have had the auxiliary
benefit of preventing Gladwell from misusing it.

Needless to say, Taleb is right than making an accurate forecast is
difficult, especially about the future.

But here are many phenomena in life where the glass is both half-full
and half-empty. The secret is knowing when it’s one or the other.

Taleb is smart enough to admit on about 5 percent of his pages that
making predictions using bell curves is a half-full glass. But he’s
cocksure enough in the other 95 percent in denouncing its half-
emptiness that careless readers likely will take away the lesson that
it’s completely empty.

In fact, there’s a general pattern here that Taleb misses. The things
we are most likely to argue the longest over, such as whether bell
curves are useful or not or over nature vs. nurture, are those where
the evidence is most abundant for both sides.

For example, Taleb draws a helpful distinction between probability
distributions in "Mediocristan", where datapoints tend to be
distributed roughly according to bell curves (he lists 11 examples
including height, weight, car accidents, and IQ) and in "Extremistan"
where a small number of rare items greatly influence the average (he
lists 21 examples, such as wealth, income, and book sales per author).

Taleb then asserts: "The Extremistan list is much longer than the
[Mediocristan list].” Of course, he made up the lists …

Is he right about which list is actually longer? Personally, I have no
idea i.e. I have no more idea than Taleb does.

All I know for sure is that I have less self-confidence than Taleb.
His experience as a Wall Streeter skews his view toward Extremistan.
My experience as a marketing researcher showed me the pervasiveness of
Mediocristan.

Consider the recent election. You will all recall how the countless
election polls, with their bell curve-based "margins of error", were
humiliated on Election Day when the ultimate Black Swan was elected
President—John McCain!

Oh, wait! That only happened in Talebstan. In the world in which you
and I live, the pre-election polls proved to be extremely accurate.

Another only thing I know for su events in Extremistan are much
more interesting than events in Mediocristan. Enron is much more
interesting than Procter & Gamble. WWI and WWII are far more exciting
than America and Canada not having a war.

We’ve all seen the "Dewey Defeats Truman" picture a million times. But
the reason we’ve seen it is because it’s unusual. Contra Taleb, human
beings love rarities.

But that doesn’t mean rarities are, as Taleb claims, more important.

We are most interested in things that are hard to predict, not
necessarily those things that are most important. Science is in the
business of making predictions, but the better it gets at predicting
anything, the more boring those predictions become for us.

Indeed, much of what interests us has been carefully contrived by
experts to seize our attention. It’s very hard to predict the winner
of the Super Bowl because the NFL carefully rigs the system to make
each team’s chances as equal as possible.

In contrast, if something becomes a sure thing, we get bored.

Thus, from 1934-1976, there was a prestigious summer exhibition
football game at Soldier Field in Chicago pitting the previous year’s
College All-Stars versus the reigning NFL champion team. Initially, as
the famous rookies held their own against the champs, winning nine of
the first 30 games, it was wildly popular. It drew over 100,000 people
three times in the 1940s. After 1963, however, as professional teams
got more professional, the college boys never won again. Attendance
drooped as the outcome became more predictable. In 1976, a
thunderstorm stopped the game in the third quarter with the Pittsburgh
Steelers up 24-0. Nobody saw any point in resuming the series.

By the same token, rare events and people are interesting because they
are rare.

For example, every few years Hollywood makes a movie Based on a True
Story about some Black Swan teacher who goes into a gritty slum school
and unleashes the brilliant scholars within the minority students. But
they don’t make movies about the countless White Swan teachers who try
equally hard and don’t succeed. Guess why not.

In fact, it’s actually easy to make accurate predictions about
important phenomena. For example, I predict that public schools in
gritty Compton CA will have lower average test scores than public
schools in lovely San Marino, CA in 2009. And in 2010, and in 2011
and…

Well? Anybody care to bet against me?

I can make a 100 such predictions about significant topics with a 99
percent accuracy rate. But nobody would even bother reading all the
way through the list. It would just get so boring and depressing, as I
kept reiterating things that we all know but don’t want to talk about.

Let me, therefore, make some fun predictions.

*

I foresee that Oklahoma will win the college football national
title game 35-31 when Florida quarterback Tim Tebow, having heroically
driven his team 91 yards, throws a heartbreaking interception in the
end zone on the last play.
*

In the week before the inauguration, the Obamas will begin
secretly consulting about resolving problems in their marriage with
Oprah Winfrey.

How do I know these things?

Well, obviously, I don’t. I just made them up. Indeed, to be frank, I
chose Florida to lose because I couldn’t remember the name of the
Oklahoma quarterback.

But aren’t these predictions more interesting than me yammering on
about how school test scores won’t change?

How can we tell whether we are in Mediocristan or Extremistan?

Bell curves work best when individuals are of fairly equal importance.
That’s definitely not true on Wall Street. But it is somewhat true in
voting, public life, and, for many items, shopping.

A quarter of a century ago, I was running a test market in Eau Claire,
Wisconsin for a Procter & Gamble deodorant brand. I was comparing two
samples of 1250 households who were being shown different TV
commercials over their cable television systems. I noticed a screwy
pattern in our results. I eventually figured out that one household
was buying 30 to 40 sticks of deodorant per month, affecting the
market share for its entire sample. That’s Taleb’s definition of a
Black Swan.

But did P&G pay us a bonus for discovering the Black Swan of the
Deodorant Market—the Bill Gates of Perspiration Prevention?

Did P&G suddenly wake up to the fallacy of the bell curve and stop
doing marketing research?

Nah. We all just agreed to drop that &%#$* outlier from the sample.

Surely, though, the world is dominated by outliers as Taleb says—not
by boring stuff like deodorant?

Well, what about cars, which are in the news a lot these days, what
with GM and Chrysler demanding a bailout? Is the world market for cars
driven by a small number of Jay Lenos who buy hundreds of cars?

No.

How about mortgages? Now we’re playing on Taleb’s own financial turf.
Do houses tend more toward Bill Gates’s Extremistan or Joe Average’s
Mediocristan?

Well, let’s look at Bill Gates’s house. He famously built one of the
largest houses in America, 66,000 square feet. It’s almost 40 times
larger than my house. And yet his net worth is, I would imagine,
considerably more than 40 times my own.

(I can’t make a precise calculation because I haven’t been masochistic
enough to open any letters from my 401k funds since last summer.)

And that turns out to be hugely important in understanding the
mortgage meltdown, which has come straight out of Mediocristan. It
wasn’t caused by a few giant defaults by Bill Gates, or even by Ed
McMahon. It was caused by a huge number of defaults among people of
average or below average wealth, typically working class folks in the
second quartile up from the bottom.

And that followed, unsurprisingly, a decade and a half of government
policy pushing easier credit for home buyers, especially for
minorities. Both the Clinton and Bush Administrations wanted to boost
the home ownership rate, which had been stuck at about 64 percent
since the 1970s. Bush explicitly demanded the raising of black and
Hispanic homeownership rates from about 50 percent to the white rate
of 75 percent by such obviously risky ploys as zero down payments.

In other words, the marginal homeowners would primarily come from the
financially marginal portions of the population.

The subprime fiasco wasn’t an impossible-to-predict Black Swan. It was
the result of average humans following straightforward incentives to
the best of their capabilities.

And they turned out to be distributed on bell curves.

Despite the Black Swan flap, bell curves still rule. We ignore them at
our peril.

In fact, we just did."

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