6 Ways to Avoid Black Swans

by: Wall St. Cheat Sheet

Can we avoid black swans? Ken Posner - veteran Morgan Stanley securities analyst and author of the book Stalking the Black Swan: Research and Decision-Making in a World of Extreme Volatility - says “Yes.”

Posner states, “Volatility results from market economies, global capital flows, and information technologies and is necessary for innovation and progress. Rather than wishing volatility away, we need to design a financial system that is more robust in the face of extreme volatility, and refine decision-making techniques to account for the risk of Black Swan events.”

Here are 6 ways Posner asserts we can avoid black swans:

1. Cut government debt, a potential cause of extreme outcomes. Politicians should focus on this rather than blaming markets, which reflect volatility but do not cause it.

2. Place Fannie Mae (FNM), Freddie Mac (FRE), and the Federal Home Loan Banks into run-off and reduce US government liabilities by some $7 trillion.

3. Build “shock absorbers” into the system like mandatory “contingent capital” for systemically important financial firms, rather than proscribing activities for banks and hedge funds.

4. Impose shorter term limits on the Federal Reserve Chairman’s service because too much trust in the persona can contribute to excessive volatility (the “Greenspan put”).

5. Improve corporate governance to mitigate the problem of ”cognitive dissonance,” when successful executives dismiss new data that contradicts deeply held-beliefs, evidenced by Goldman Sachs’ (NYSE: GS) missteps in reacting to the SEC lawsuit and managing the firm’s political vulnerability.

6. Return to fundamental research, a practice that executives, risk managers, and individual investors should follow to better understand the macro and micro causative factors likely to affect a company’s performance.