Betting on failures

Order is hard to maintain. Ordered systems have lower entropy which means that there are few stable states that the system may reorder itself to. As a consequence, the more structured or ordered a system, the greater the odds of things going wrong. This is especially true in hyper-efficient systems which do not have redundancies built-in. The human psyche is generally oblivious to negative consequences. As James Shipley says in The Big Short, “People hate to think about bad things happening so they always underestimate their likelihood”. The inherent instability of ordered systems and the naive optimism of humans at times can be used as a compass to identify opportunities.

Michael Burry, the center-piece of The Big Short has created a name for himself by identifying opportunities prior to the bursting of the Internet Bubble and the real-estate crisis of 2007–08. Nicholas Nassim Taleb constantly refers to the idea of betting on failures instead of betting on successes because there simply are more failures than successes. One obvious way to use this methodology is to identify things that might fail and opt for insurance against these. During the subprime crisis, Michael Burry and others who identified the fragility of the system purchased insurance products (Credit Default Swaps) aware that the system was inherently unstable. One other way to use this methodology would be to invest in alternatives to a sure-thing failure. The future could play out in any number of ways and one could imagine most versions of the future looking to move away from fossil fuels as the threat of global warming looms. Investing in alternatives to fossil fuels would be a direct application of this model.

It’s usually easier to identify what is going to fail than to determine what will succeed. Using this wisdom, one must make decisions that looks to eliminate the losers rather than pick winners.


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