You & Your Money, June 2010
Posted by Jill Kerby on June 01 2010 @ 22:31
You and Your Money – June 2010
By Jill Kerby
WHEN BLACK SWANS ONLY OCCURRED IN NATURE...
When my son was little, because we lived just across from the River Liffey and the Phoenix Park, we visited Dublin Zoo a lot. It was our own exotic playground and we each had our favourite animals that we had to see.
Mine were the black swans. They reminded me of the first time I went to Swan Lake with my mother and sister and I saw Odile, the black swan and sorcerer’s daughter who is mistaken by Prince Siegfried to be Odette, the white swan that he falls in love after she is transformed by the moonlight into a woman.
In the days when the child and I played in the zoo, scouting out our favourite animals, black swans were just …rare swans. No one had ever heard of ‘black swan events’ back then - those rare, improbable but calamitous events that the economist Nassim Nicholas Taleb first articulated in his 2007 book The Black Swan.
The collapse of the global financial system back in 2008 is now considered to be ‘a black swan’ by the ‘light touch’ politicians and bankers who actually caused it, though of course many people like Taleb genuinely saw it coming. No doubt the same naysayers will consider the collapse of Greece a black swan – something that was also utterly improbable.
The collapse of the Greece was no such thing. It was just what happens to insolvent little countries – or companies, or individuals and families when they have no savings, wildly overspend, run out of income and cook their books. Lenders, naturally enough in such circumstances, refuse to extend them any more credit.
The end of the euro may also be considered an improbable black swan, but who’s kidding whom? The euro is just another trumped up, fiat currency, backed up by now by nothing more than the faith and promises of a collection of European countries, many of them as badly mismanaged and indebted as Greece. The collapse of the euro was going to happen eventually, just as every paper currency, devalued by politicians, has eventually disappeared. Genuine money is not just paper and promises…it is backed by an asset of value that is real, immutable, precious and rare…like gold.
But this isn’t a column about gold. It is about black swans.
The Icelandic volcano, Eyjafjallajokull, is a black swan geological event. Most volcanoes in Iceland tend to produce a lot of lava and steam, not lava and 30 mile high columns of explosive rock and fine ash that can close European air space.
This angry black swan, which couldn’t be predicted and can’t be stopped, was certainly improbable given how seldom it goes off (in our time, not geological time). If it continues indefinitely it certainly will have a significant financial impact – just ask someone in the hotel or tourism industry here.
But do ‘black swans’ of the Nassim Taleb kind, appear closer to home? Do they happen to individuals too?
Of course they do, and with just the same dramatic, sometimes catastrophic effect for the person concerned and their loved ones.
This Great Recession is just part of the same Greece/euro event that many saw coming, but it has impacted on both the prudent, and the financially reckless. Some people have quite rightly lost their businesses and livelihoods: they made idiotic, unethical and sometimes downright criminal decisions that have now caught up with them.
But what about their innocent suppliers, employees or dependents, who had no hand, act or part of their recklessness?
Every financial advisor and insurance broker has a raft of black swan stories to tell. Last week, one described a young couple he assisted to secure a large mortgage five years ago. They had to buy mortgage protection as a condition of the loan but since they had no other kind of protection insurance, or even health cover, he recommended they buy some…just in case.
“Their attitude was pretty typical. They said they were young…they were perfectly healthy…their jobs were secure. She was French and said if anything ever happened she’d go home to France and its wonderful health and social welfare system.
“Well, it was as if she was tempting fate. Last autumn I got a call from the husband. His wife had had a baby a few months earlier but developed an allergic reaction to something and went into anaphylactic shock. By the time she got to hospital for treatment, the oxygen deprivation she suffered caused brain damage. He was hoping – in desperation – that the mortgage protection policy they bought five years earlier included a financial benefit other than the life insurance.”
It didn’t, of course, and this man is now left to take care of his wife and child full-time. He had to quit his job but cannot keep up the repayments on their house, which he knew they were going to lose.
There’s very little that ordinary people can do to prepare for the appearance of a geological or climate related black swan, except perhaps to accept that we are mere specks on mother earth’s landscape. That said, we can take some steps to protect ourselves against financial black swans – whether they perfectly match Mr Taleb’s definition or not.
Future asset bubbles, for example, can be identified and avoided if you just use some common sense: the next time a share rises spectacularly on media or political hype (a la Eircom and most of the other dot.coms from back in the last 1990s) but has no profit stream or even customers, keep your money in your pocket. Ditto if the rise in house prices exceed your annual income.
And if someone comes along with a ‘sure thing’ investment or a horse in the 3.40 from Fairyhouse, get him to buy it or back it for you with no strings attached and an unwritten promise to pay him back after it “absolutely doubles in price” or comes in at 10 to one.
Keep in mind too that the only way to avoid losing a mortgaged home to a black swan – say, a catastrophic illness or death - is to pay it off early or know someone who can on your behalf. It’s called insurance.
No one with dependents (and an earned income) should be without top up life insurance, serious illness or income protection insurance in addition to the mandatory mortgage protection insurance that will at least clear the outstanding debt on their home. We should all aim to have three to six months worth of income in a ring-fenced contingency account.
Those personal black swans – in all their terrible beauty - will glide away and do little to no harm if you accept that, however improbable and unwelcome they are, they do exist.