Nassim Taleb on BP oil spill

July 7, 2010

Nassim N Taleb has been twittering about the BP oil spill. Here is one of his tweets from today:

My expl of BP spill in The Black Swan II : “don’t give the manager of a nuclear plant an incentive bonus based on cost savings”.

I spoke with Nassim and asked him to expound upon his tweet. Here is what Nassim wrote me:

Because security analysts and investment “experts” don’t understand robustness and redundancy, managers have an incentive to hide risks of blowups, Black Swan exposures, by cutting corners they get better numbers and appear cosmetically to be profitable while sitting on dynamite. This is not too different from banks stashing their portfolios with more and more hidden risks. So this condition of increased fragility over time comes from the incentive system and the bogus risk measures and empirically invalid business school techniques used by analysts. A manager collects annual bonuses, and does not pay back his past compensation in the event of a blowup. There is a mismatch between the bonus frequency and the time to eventual blowup.

The tragedy is that, in this case, as with banks, there are externalities and shareholders are not the ones footing the bill, but society at large.

More can be found about the 10 rules for a black swan robust society in Nassim’s second edition of The Black Swan.

Comments

And by an extended logic: “rats work harder when the rewards are unpredictable (B.F.Skinner, Psychologist)”. No wonder the risk-hiding tendency is matched by legendary hours spent at work that some industries have become famous for! So, a limitless incentive linked to irrelevant metric -> more risk cover ups -> longer hours worked. Everybody is happy until the unthinkable happens!

 

It’s too bad for America that administrations have “special interests” advisors (Paulson, Geithner).

Wall Street pays out billions in bonuses and over paid execs… Oil companies post record profits while receiving tax breaks and subsidies… Each year, an estimated 443,000 people die prematurely from smoking or exposure to secondhand smoke, and another 8.6 million have a serious illness caused by smoking while the US govt subsidizes tobacco!

Insanity!!

Posted by JackC NYC | Report as abusive
 

Terrific. Nassim is correct. This things also happen due to the wrong understanding of what is “optimization”. Sometimes, to cut costs means to increase them at some areas in the company and reduce in others. The whole optimization does not means to optimize all parts of the system.

Regards
Adriano R. de Lima
http://www.arlima.com.br

 

Nic is right on again, the alignment of incentives and outcomes is skewed towards risk for others and rewards for uninvolved.

Derivatives on food is a perfect example, over 80 percent of the people that buy wheat on the market never intend to take delivery, so farmers and bakers are being squeezed by greedy jerks in suits.

We should dump them into a harvester or pass laws so that they can’t ove food prices with speculation. Either one works for me.

Posted by Joe Stafura | Report as abusive
 

Good job, Katharine. I agree with Jack C. Insanity! But I can rest easier knowing LeBron James will rake in close to $17 million during his first season with the Heat. There’s good news. We sure have our priorities in order.

 

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It’s too bad for America that administrations have “special interests” advisors (Paulson, Geithner).

Wall Street pays out billions in bonuses and over paid execs… Oil companies post record profits while receiving tax breaks and subsidies… Each year, an estimated 443,000 people die prematurely from smoking or exposure to secondhand smoke, and another 8.6 million have a serious illness caused by smoking while the US govt subsidizes tobacco!

Posted by al3aredh | Report as abusive
 

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future posts. how do i configure the rss again? thanks! hguhf|htbl

Posted by andalusy | Report as abusive
 

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