John Kay on Taleb distributions

In 2003 A strategy for hedge funds and dangerous drivers :
"The practice of bad driving has what I call a Taleb distribution, after one of the themes in Nassim Nicholas Taleb's brilliant Fooled by Randomness. A Taleb distribution has the property that many small profits are mixed with occasional large losses. Overtaking on the inside is an activity with a Taleb distribution....
Many apparently successful traders and business people are still on the upside of their Taleb distribution. They are accidents waiting to happen. It puzzled me for years that so many organisations believed they were making money out of proprietary trading in securities markets. These businesses were trading mostly with each other: since there is no perpetual motion, where did the money to fuel the system come from? From Taleb distributions.

Arbitrage in financial markets generates a continuing stream of small profits. Large losses are exceptional items. They are the product of misjudgments, rogue traders, unpredictable events and the failures of risk control. The same misjudgments, rogue drivers, unpredictable events and system failures that lead to crashes on the French motorways.

We find Taleb distributions not only on the road and in financial institutions. Hedge funds make them accessible to a general public. Business people learnt centuries ago that you can water the milk again and again and again. Until Taleb strikes back: people notice and take their custom elsewhere. Marks and Spencer, the UK retailer, pushed to the limit of what its customers could stand until it discovered that it had crossed that limit. Banks have treated their account holders the same way. Eventually, you pass on the inside once too often.

Evolution favours Taleb distributions. The gene pool of dreadful French drivers is depleted by road accidents - but only at the rate of 8,000 a year. Most young Frenchmen make it to their dates. Evolution within organisations has a similar bias. Someone who makes steady, small gains ranks as a safe pair of hands and is promoted until he meets his apotheosis."

and yesterday Banks got burned by their own ‘innocent fraud’:
"I have several times in this column described the Taleb distribution of regular small profits interspersed by large losses. Taleb distributions are the basis of the carry trade – which exploits interest rate differentials – and many types of statistical arbitrage. Taleb distributions are exploited by traders in hedge funds and at proprietary trading desks.......
Ponzi schemes, Taleb distributions and martingales, revenue recognition and mark-to-market accounting: these are the means by which successive generations of financial hotshots perpetrate what John Kenneth Galbraith described as innocent fraud. This is the process that systematically benefits one group at the expense of another but generally falls short of outright criminality.

But to benefit from the innocent fraud, you must be organiser rather than participant. In the New Economy, banks collected commissions on transactions but limited their own direct involvement. The participation of banks in the recent round of follies brought humiliation. Is the deception of others more or less venal when one has also deceived oneself? That question must be left for moral philosophers – and historians of our era – to answer."
P.S. From today's Bloomberg Taleb's `Black Swan' Investors Post Gains as Markets Take Dive ( via a comment in "Taleb vs Economists")
P.P.S. Yves Smith's reaction to "Innocent Fraud":
"I much prefer the terminology and analysis of George Akelof and Paul Romer. From the abstract of their paper, "Looting: The Economic Underworld of Bankruptcy for Profit""