Future Blindness Redux
Future blindness is the cognitive bias of assuming that the absence of past extreme events means they cannot occur in the future, and using past deviations as anchors for worst-case scenarios, leading to underestimation of tail risks.
THE IDEA
A forecasting error discussed in Chapter 12 is failing to apply a lesson about the past to the future: earlier generations also faced events outside their experience. Yet a gentleman called Alan Greenspan, the former chairman of the U.S. Federal Reserve Bank, went to Congress to explain that the banking crisis, which he and his successor Bernanke helped cause, could not have been foreseen because it "had never happened before." Not a single member of congress was intelligent enough to shout, "Alan Greenspan, you have never died before, not in eighty years, not even once; does that make you immortal?" The abject Robert Rubin, the bankster, a former secretary of the Treasury, used the same argument—but the fellow had written a long book on uncertainty (with, ironically, my publisher and the same staff used for The Black Swan).*
At the time, I found no research testing whether large deviations in economics can be predicted from past large deviations—whether large deviations have predecessors, that is. This is one of the elementary tests missing in the field, as elementary as checking whether a patient is breathing or whether a lightbulb is screwed in, but characteristically nobody seems to have tried to do it. It does not take a lot of introspection to figure out that big events don’t have big parents: the Great War did not have a predecessor; the crash of 1987, in which the market went down close to 23 percent in a single day, could not have been guessed from its worst predecessor, a one-day loss of around 10 percent—and this applies to almost all such events, of course. My results were that regular events can predict regular events, but that extreme events, perhaps because they are more acute when people are unprepared, are almost never predicted from narrow reliance on the past.
The fact that this notion is not obvious to people is shocking to me. It is particularly shocking that people do what are called “stress tests” by taking the worst possible past deviation as an anchor event to project the worst possible future deviation, not thinking that they would have failed to account for that past deviation had they used the same method on the day before the occurrence of that past anchor event.*
These people have PhDs in economics; some are professors—one of them is the chairman of the Federal Reserve (at the time of writing). Do advanced degrees make people blind to these elementary notions? Indeed, the Latin poet Lucretius, who did not attend business school, wrote that we consider the biggest object of any kind that we have seen in our lives as the largest possible item: et omnia de genere omni / Maxima quae vivit quisque, haec ingentia fingit.
When to use it
When assessing financial risks, avoid using the worst historical loss as the worst-case scenario; instead, consider a wider range of possibilities.
In project management, do not assume that the biggest delay in the past bounds future delays; one-off events can be much larger.
In personal safety, recognize that uncommon accidents can happen even if you have never experienced them, so take precautions.
In scientific modeling, remember that the absence of a large deviation in the past does not predict its future absence.
FROM THEORY TO EVERYDAY LIFE
In practice
Alan Greenspan's 'Never Happened Before' Argument
Alan Greenspan claimed the banking crisis could not have been foreseen because it 'had never happened before.' The author points out the fallacy by comparing it to assuming immortality because one has never died.
The 1987 Stock Market Crash
The 1987 crash, with a 23% single-day loss, could not have been predicted from its worst predecessor of a 10% loss, illustrating that extreme events often have no extreme predecessors.
A MOMENT TO REFLECT
Put it to work.
Consider a time when you or your organization dismissed a possibility because it 'had never happened before.' How might that assumption have been flawed?
In what domains do you rely on historical extremes to set boundaries? What is the risk of that approach?
Why might extreme events not have predecessors? How does this challenge common forecasting methods?
Often confused with
CONTINUE THE CONVERSATION
Source texts
- The Black Swan The Impact of the Highly Improbable With a new section On Robustness and Fragility (Nassim Nicholas Taleb)