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Black Swans and Turkeys

The industry isn’t as robust as we might think.

Fortnightly Magazine - November 2010

side, what if researchers achieved a bona-fide revolutionary breakthrough in cold fusion, or dirt-cheap photovoltaics and battery storage?

Unlikely? Yes, but not impossible. That’s the nature of black swans. They don’t come along frequently. But when they do, they change everything.

Setting aside for a moment the dilemma of planning for the unprecedented, the second point in the parable is this: the turkey is clueless about Thanksgiving, but the farmer knows all about it. In other words, the truth is out there somewhere—but like the turkey, we can’t access the information.

Taleb’s argument focuses on the first point of the parable; the second point, the farmer’s role, Taleb defines as basically metaphysical. The farmer is the equivalent of an omniscient angel: Just as the farmer could explain everything to the turkey, with no effect whatsoever, so too could an angel reveal the future to us humans, and we’d either fail to understand it, fail to believe it, or fail to do anything about it.

Nevertheless, it’s tempting to think the turkey’s first mistake lies in failing to ask questions, or in failing to pay attention to what the farmer is saying. The equivalent for us humans would be failing to perform enough research, or failing to heed the counsel of those who actually do foretell black-swan events.

For example, during the past decade, while mortgage bankers and federal lawmakers were busy blowing up the real-estate bubble, some people were correctly predicting a catastrophe. As long ago as 2004 Rep. Ron Paul (R-Texas) warned, “[T]he mortgage market is hopelessly distorted. Millions of mortgages in this country are federally insured, and the tax bill for defaults could be astronomical if the housing bubble bursts.”

Yet Paul’s predictions didn’t stop lawmakers from voting to loosen credit requirements for federal mortgage insurance, just as his warnings today about monetary policy haven’t convinced Wall Street to stop trading U.S. Treasury notes. That’s because we human turkeys feel most secure relying on assumptions we’ve developed over a lifetime of experience, and we naturally distrust anybody who says our beliefs are based on erroneous or incomplete information.

So are we doomed? Or can the utility industry become truly black-swan proof?

Getting Robust

Utilities are known to be cautious—sometimes maddeningly so—about jumping on any particular bandwagon. No technology or process gets adopted until we’ve put it through almost endless scrutiny and pilot testing. This protects us from much of the fragility that Taleb warns against.

And the regulatory compact offers another layer of protection—barring franchised companies from extracting monopoly rents beyond what’s justifiable to maintain reliable service. In principle at least, this structure should prevent the perverse incentives that Taleb says create institutional vulnerabilities. And our 50-state patchwork of regulation virtually eliminates the too-big-to-fail problem that Taleb excoriates in his analysis of the financial industry.

So investor-owned utilities might seem fairly robust. Nevertheless, we’re not impervious to black swans, and Taleb counsels that the quantitative approach to risk management can’t help us. As hard as we try, we can’t hedge against risks we can’t measure.

This might seem like an