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    What are Black Swan Events? What are Some Examples of Black Swan Events?

    Editor, TRANSFIN.
    Invalid date 6 min read

    The term “black swan” was devised and popularised by Nassim Nicholas Taleb, a New York University professor and author of The Black Swan: The Impact of the Highly Improbable.

    What is a Black Swan Event?

    A black swan is an event with three characteristic features:

    • First, it is unpredictable.
    • Second, it has a monumental impact. Be it the Chernobyl nuclear blast or the Great Depression, all black swan events have had a profound impact on human society.
    • Third, after the event, people have the tendency to rationalise them giving the illusion that they were expected. Various conspiracy theories come into existence trying to prove how we could have predicted and prevented the black swan event.

    Here are some examples of some high-profile black swan events of recent years.

     

    9/11 Attack

    The 9/11 attack was arguably the most devastating terrorist attack in history. The attack might not have been predicted but in hindsight there are a few theories to prove how the attack could have been prevented.

    Mainstream media found evidence that the organisations were aware of airborne attacks and had even conducted exercises for the same before. The US administration, FBI and CIA received multiple prior warnings from foreign intelligence services. The warnings were varying in their level of detail, but all asserted that they believed an Al-Qaeda attack on the United States was anticipated.

    The impact caused by the 9/11 attacks was devastating. The price of gold spiked upwards, which was a symptom of the economic uncertainties ahead. Prices of basic commodities like gas also shot up briefly. Currency trading continued with the US Dollar falling shortly against the Euro, British Pound and Japanese Yen. Stock markets around the world suffered losses before trading was halted. The attacks themselves resulted in roughly $40bn in insurance losses, making it one of the largest insured events ever.

    Insurance losses due to 9/11 were more than 1.5x greater than what was previously the largest catastrophe (Hurricane Andrew) in terms of  financial losses. The losses included business disturbance ($11bn), possessions ($9.6bn), liability ($7.5bn), workers compensation ($1.8bn), and others ($2.5bn). Insurance companies became reluctant to provide coverage for future terrorist attacks.

    Share prices of numerous airlines and airplane manufacturers plunged after the attacks. Other airlines were threatened with bankruptcy, and tens of thousands of dismissals were announced in the week following the attacks. To help the industry, the US federal government provided an aid package to the industry. The September 11th attacks also led to the War in Afghanistan, as well as supplemental homeland security spending. The attacks were also cited as a justification for the Iraq War. The cost of the post-9/11 wars, as of 2019, had exceeded $6trn.

     

    2008 Housing Bubble

    The 2008 housing bubble is often termed as preventable. The argument that the United States government had received plenty of warnings but chose not to act has been the major theme for many articles and reports.

    In November 2006, the first leading indicator revealing trouble surfaced. The Commerce Department announced that new home permits dropped 28% in a year. That meant new home sales would subside for the next nine months. But no one could believe that housing prices would fall. It hadn't happened since the Great Depression.

    The Federal Reserve Board remained optimistic. In the November Beige Book report, the Fed said the American economy was strong enough to pull housing out of its slump. It pointed to gainful employment, low inflation and growing consumer spending.

    In 2006, the Fed ignored the second clear sign of economic distress, the inverted Treasury yield curve. An inverted yield curve means that the interest rates have flipped with short-term bonds paying more than long-term bonds. The inversion of the yield curve was often followed by recession as seen in 1981, 1991 and 2001. Economists ignored this sign because interest rates were lower than in earlier recessions. They believed that they would still observe an economic growth of 2-3%; they had plenty of liquidity to fuel growth after all.

    In fact, 2007 GDP growth came in at 1.9%. But economy-watchers didn't realise the sheer size of the subprime mortgage market. It created a "perfect storm" of bad events.

    Banks were not worried about the credit-worthiness of borrowers: they resold the mortgage in the secondary market. Unregulated mortgage brokers made loans to people who weren't qualified. Homeowners took out interest-only loans to get lower monthly payments. As mortgage rates reset at a higher level, these homeowners could not pay the mortgage. Then, housing prices plummeted and they couldn't sell their homes for a profit. As a result, they defaulted. Banks repackaged mortgages into mortgage-backed securities and further repackaged these into high-risk and low-risk bundles. The programmes were so complex that no one understood what was in each package. The resale value of these derivatives was unclear. Many of the buyers were not just other banks. They were individual investors, pension funds and hedge funds. That spread the risk throughout the economy. Hedge funds used these derivatives as collateral to borrow money. That created higher returns in a bull market but heightened the impact of any downturn.

    The 2008 housing crisis obviously had devastating consequences. The financial crisis cost the US approximately $648bn due to slow-moving economic growth. The United States lost $3.4trn in real estate wealth from July 2008 to March 2009 according to the Federal Reserve. 500,000 additional foreclosures began during the severe phase of the financial crisis than were expected. $7.4trn in stock wealth was lost from July 2008 to March 2009. 5.5 million American jobs were lost due to sedated economic growth. The Troubled Asset Relief Program (TARP) was launched to buy toxic stocks and equity from financial institutions to strengthen its financial sector.

     

    Fukushima Tsunami

    Fukushima Daiichi was a nuclear disaster at the Fukushima Daiichi Nuclear Power Plant in Ōkuma, Fukushima Prefecture, Japan. The nuclear disaster was on par with the 1986 Chernobyl disaster as the only other disaster to receive the Level 7 event classification of the International Nuclear Event Scale.

    On March 11th 2001, a disastrous earthquake of magnitude 9.0 shook Japan for approximately three minutes. The movement was so extreme that the country's largest island moved a few metres east, the coastline dropped, and it set off a tsunami which killed thousands of people.

    Japan is located in one of the most seismic areas in the world. It has a long history of dealing with earthquakes. The Fukushima Daiichi nuclear plant, located on the coastline, was designed to withstand a 5.7m-high tsunami. The one that struck the plant was around 15m-high. The resultant loss-of-coolant accident caused three nuclear meltdowns, three hydrogen blasts and the emission of radioactive contaminants. Radiation was later emitted into the environment over the coming days, both on purpose and by accident, as radioactive steam was released into the air, either through leaks or in an attempt to reduce the increasing pressure. Further radiation was released by explosions caused by the liberation of hydrogen in the four days following the tsunami. Radioactive water also leaked into the Pacific ocean.

    However, the nuclear disaster did not directly kill people. The 2,000+ reported deaths at the facility were attributed to the chaotic evacuation.

    However, Fukushima was a live television event, and the world watched aghast. Immediately, Germany said it would hasten the closure of its reactors. Italy held a referendum where 94% voted against a proposal to build new plants. China (briefly) suspended its nuclear programme. Elsewhere, anti-nuclear sentiments surged - to such levels that public support for nuclear power is now lower than that for even coal!

    The earthquake and the tsunami, meanwhile, inflicted staggering damages damage. The Bank of Japan provided market liquidity to ensure the stability of financial markets, but the long-term impact was harmful to the country's struggling economy. Rebuilding lifted the economy a bit, but the increase in the national debt outweighed it. Setbacks to Japanese taxpayers exceeded 12 trillion yen ($100bn). Japan's economy had just started to recover from 20 years of deflation and recession. The earthquake only added to the country's economic challenges. In December 2016, the government estimated decontamination, compensation, decommissioning, and radioactive waste storage costs at 21.5 trillion yen ($187bn), nearly double the 2013 estimate.

     

    Schroders article on the global financial crisis by David Brett

    US Energy Information Administration

    Centre Piece Volume 11 Issue 2 Autumn 2006