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Black Swan Lake


Most often one of the factors that make an event high-impact is that it seems improbable and imponderable in the same way as all swans were once assumed to be white until the appearance of the rare black swan.

I told you not to wander 'round in the dark.
I told you 'bout the swans, that they live in the park.
Then I told you 'bout our kid, now he's married to Mabel.
Yes, I told you that the light goes up and down.
Don't you notice how the wheel goes 'round?

--Badge by Eric Clapton and George Harrison

For all the water in the ocean
Can never turn the swan's black legs to white,
Although she lave them hourly in the flood.

-- Shakespeare

Après le deluge, after the crash of 1987 as more than lore would have it, President Reagan called the Fed and the Treasury Department and said words to the effect, "whatever that was, don't let it happen again."

In fact, the corn seed for the creation of the Federal Reserve was the Rich Man's Panic of 1907 when the Government had to go to one man, J. P. Morgan, to bail out the system. No government likes to depend on any one man.

The Fed began its handwork a few years later in 1913 although it did not prevent the panic in 1929 anymore than it prevented the panic in 1987.

If you were to overlay the charts of the two years prior to and after the peaks of 1929 and 1987 you find a remarkable parallel – to a point. The parallel is notable for the diversion of the pattern a few months post crash – in other words the divergence in 1987 occurred a few months after the October waterfall of that year.

The Fed got it right in 1987, flashing its six guns, mounting its mandate, the Fed rode in with its white hat like the Lone Ranger and used its Silver Bullets.

To wit, on the occasion of Milton Friedman's 90th birthday on November 8 2002, the future Fed Chief Ben Bernanke stated "Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression, you are right, we did it. We're very sorry. But thanks to you, we won't do it again."

Ever since then the Fed has been shooting at every critter that crops up with the potential to cleanse any financial excesses.

They say absolute power corrupts absolutely. In trying to avoid the mistakes of the last century has the Fed (inadvertently or intentionally) been trying to expunge the cycles of confidence, trying to repeal the business cycle?

As business guru Peter Drucker states "success always makes obsolete the very behavior that achieved it." To everything there is a season: however, are the "successes" after 1987 and the subsequent upheavals such as the Asian currency crisis in 1997, the Long Term Capital Management fiasco in 1998, the technology/dotcom bust in 2000, corporate scandals, 9/11, the bust of the housing bubble examples of the staving off of the cleansing of the wounds – of putting a band-aid on a malignancy – of shooting a heart attack victim with steroids?

In a word is the Doctor giving the economic patient an all clear and letting him run down the hallway jacked up on howitzers of dollar hormones, and crack pipes of credit and dilaudids of debt? Is the Lone Ranger Fed running out of Silver Bullets? And we all remember the old joke about the Lone Ranger who, bitten by a snake in the most excruciating of places sends Tonto to ask a doctor for advice.

Did a new Treasury Secretary stave off the laws of action and reaction once again last fall on the heels of the Amaranth Advisors hedge fund blowup? Was that a factor in the failure of the four-year cycle due to play out in October?

Are the machinations at the edges of the money supply and the tinkering at the core of natural economic forces of supply and demand turning Newtonian physics on its head and sending apples into orbit? The light still goes up and down, the wheel still goes 'round.

As Nicholas Taleb claims in his Black Swan theory, all consequential events in history come from high-impact events while humans convince themselves that these events are explainable in hindsight. Black swans are rare events beyond the realm of normal explanation.

Most often one of the factors that make an event high-impact is that it seems improbable and imponderable in the same way as all swans were once assumed to be white until the appearance of the rare black swan. Likewise, does the rareness of the black swan temper the expectations of such an appearance? (The longer the black swan stays in the dark, so the risk of its appearance pales.)

Such seems to be the case with CDO's and the recent blowup of two hedge funds at Bear Stearns (BSC): until these derivatives were scrutinized under the light of day and had to be priced accordingly to the reality of the markets rather than the fantasy of a romp in the quant... er... park.

Said another way, if a black swan swims in the lake and no once sees it does it swim at all? If a derivative is priced in a forest and no one sees it axed, does it still fall?

Although seemingly more imponderable in the last 20 years given its acquiescence and its tendency to be tamed quickly, the Black Swan event is nonetheless viable.

So I'm wondering, if a crowd of white swans gets mesmerized by a black swan, is the result a domino of derivative swans?
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