Designing better futures

Social Strata in Dubai

Over  a bit of post thanksgiving turkey and serious mixed drinks, the topic of Dubai came up. 

I spent a year shuttling back and forth between Dubai and London, playing strategy consultant in Dubai and learning to para-glide on the Isle of Wight while courting my wife in London.  

Dubai is a lot like the bar in the first star wars film crossed with an American Shopping mall:

Everyone there is a little special and everyone there is looking to trade, barter or hussle something.  The location makes it a natural stop over and cross roads for Asia, India, Pakistan, China, Europe and the Gulf. 

Dubai started out as a simple trading port, then was a hardship post administered by the British, the discovery of oil in the region changed everything as it always does.

Dubai as an Emirate is dwarfed by its larger neighbors and outclassed in the geological oil lottery by Qatar and Abu Dhabi, it boldly brought in some outside consultants and made itself into a logistics hub with the Jebel Ali Duty Free Port and a massive world class airport. 

The location, top notch administration and history as a trading port combined with a tradition of English Common Law co-incided to get things humming.  The first gulf war saw Dubai really function as a logistics port and set it alight.  From then on the investment projects became ever more outlandish and strikingly ever more successful.  

Dubai seemed to offer the only desert in the world where the rule of thumb was the more exotic the idea seed planted, the more likely it would take off.  The cast of characters in Dubai includes deposed prime-ministers, exiled govts, creative marketers, questionable "traders", thuggish indian gangsters, uzbeki gangsters, Eastern European engineers wiring the place up and the world's best architects pursuing ever greater follies for the financiers.  Of course all the consulates are loaded with spies, technicians and assorted types.  Dubai is filled with some wonderfully interesting people, probably like New York at the turn of the century.

From its early days trading pearls to trading gold and goods Dubai has been a bit of a husslers paradise.  The officials are efficient enough and corruption was mostly in check.  Booze flows freely and prostitutes discretely ply their trade flying in from all over the world.

Dubai is a four layer socio-economic cake:

On the top of the Cake is the respected ruler, his family and hangers on.  In true fashion staying close to the king is vital for power.  Camel Racing with child Jockeyes is a big past time.

The next layer on the cake is being a "national" or native.  Dubai has about three hundred thousand nationals. out of a population of 2.3 million.  Nationals stick to themselves mostly.  Female nationals are off limits.  Male nationals like to bet at the camel races, drive souped up cars, smoke sheesha and peddle influence.  Any firm wishing to do business in Dubai has to have a local partner who own a majority of the Dubai operation.  The best partners are those with connections or at least those who provide the least hindrance in the operation of things.

For example the local Starbucks, Friday's, Pizza hut etc. are all on offer and present the same comodified stale experience available to the bored mall goer in the US.  Indeed one of The nationals biggest issues is health.  In 2003 the average citizen walked something like 2,000 paces a day.  Heart disease and diabetes are serious issues.  The walk from the house, to the car to the mall and back is not a uniquely Western ritualized Experience.

Dissent is of course squelched, in Dubai, the internet is on offer but behind a giant firewall.  It blocks mostly pornography and political websites.  The local media and newspapers have managed to take the puff piece advertorial to new levels of pap.  The international political news on offer is biased or bland. 

Local political coverage involves the reporting of various emirate officials sending each other telegrams for their birthdays and being cloyingly lovey dovey.  Dubai, like many closed societies doesn't do honesty as it interferes with politeness and unchallenged political power.

Politeness is held up as a virtue and thus the mention of anything corrupt or truly interesting is considered impolite and rude.  The local television on offer has little sex, but more than makes up for in pointless violence.  Syrian television seems to set the benchmark for pointless violence and anger all wrapped up in trite nationalism.

The next layer in the socio-economic cake is the western expat, typically from western Europe or the US with a balding head and bad sunburn during the first 6 months.   These figures are mostly older white men living with their expat wives holding down sr. management and consulting roles in various local firms.  All the major consulting, advertising, accounting etc. firms send their slowest or most exotic for a turn in the sun.

The men make money and the desperately bored housewives make mischief.  With a maid or nanny available for a few hundred dollars a month and zero taxation, domestic bliss quickly leads to boredom and the typical expat games of slap and tickle with the local tennis club pro and a stiff gin and tonic. 

Expat Children have the opportunity for good schooling and are typically well taken care of until puberty at which point it is best to place them in an academic setting outside of the country where questioning authority is a rite of passage and not a potential pre-cursor to expulsion or prison.

The next layer of the socio-economic cake is slightly slavic or cold war flavoured.  Typical Eastern European or former Soviet satellite states provide their citizens who have top notch engineering and technical backgrounds all provided efficiently and with endearingly accented English.

The final layer of citizenry are the tireless worker bees, typically from Kerala in India or parts of Pakistan.  These are men who live in camps and help manifest the architects dreams and engineers plans.  Dubai has one of the most skewed sex ratios on the planet due to its expat workforce.  The worker bees are typically sending home a few hundred dollars to their thankful families on the sub-continent.  They live in dormitory settings, sometimes paid months late and do not have access to their passports.  Imagine something from a Victorian sweatshop served with curry on the side and an extra helping of 140 degree heat. 

These are of course crude generalizations. There are enough fabulously wealthy Indian traders, Uzbeki and Iranian merchants, American hustlers, Polish traders and Irish expats slinging Guinness to break any hard rule on occupation, nationality or sentiment.  It is the star-wars bar  serving venti mocachiatos to arms dealers and real estate moguls, where can you be or buy anything in an American mall air-conditioned setting.

The rules are enforced relative to your standing on the socio-economic cake and most things tend to work well, but some icky things get swept under the carpet.  All the components of the well oiled police state are in place, ministry of information, no dissent etc.

Dubai as a country/company is a bit like Madonna going in for a new vogue every few years and amazingly pulling ever larger rabbits out of its performing hats.  From logistics to tourism, to real estate to ironically a financial center.  Dubai was positioning itself as a financial center, the Switzerland of the region, but unfortunately lost a few good outsiders brought in. 

The recent problems with Dubai will probably highlight many economic and political issues that were overlooked while the malls were full and the cranes were busy.  Dubai does have a debtors prison.  Pity they can't take the Kuwait option and just pay off everyone's debt.

Bad bonds auctions & SIC code identity politics?

The 30 Year bond auction was a bit disappointing. According to Bloomberg:

Treasury 30-year bonds declined after a record $16 billion sale of the debt, the last of this week’s three offerings totaling $81 billion, drew the weakest demand since May.

The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was 2.26, the least since May and below an average of 2.39 at the last 10 auctions. The bonds drew a yield of 4.469 percent, higher than the forecast of 4.424 percent in a Bloomberg News survey of five of the Federal Reserve’s 18 primary dealers.

The fact remains that the US has roughly a 4 year debt duration with north of 40% due to mature within a year is a serious issue.  The worlds bond markets aren't quite used to the $100b in auctions week in and week out.  This figure is equivelent to $5.1 trillion for nexts years issuance.  This supply could seriously challenge the demand for more US debt.

Current US cultural behaviours and beliefs strongly indicate that more economic trouble will beget more stimulus etc.  The flawed stimulus doom loop will keep going until the world decides to stop funding the party. 

Shock and awe no longer accompany domestic bailouts, stimulouts etc.  Every new announcement of federal activity seems to create the belief in the public that we all need a bailout so get in line.  The rhetoric is capitalism is for the other guy.  I am a victim. 

The new Identity politics is defined by SIC code .

Trained as anthropologist, I treat economics as a bounded belief system.

The US is now challenged as many actors in the culture are rapidly adopting defeatist and self defeating beliefs.  Accountability and a sense of responsibility go out the window. The dangerous doom loop thinking goes like this:

I am a member of industry/group X. I am important or at least my local representative tells me this when I fund his/her campaign.

Everyone else got bailed out, why not me.  Soon the positive feedback loop will accelerate as people feel "cheated" for not being stimulated.  I am a victim.

The heart of the Keynesian argument for counter cyclical injections of liquidity and stimulus is based on loose assumptions of the multiplier effects.

In my opinion The Keynesian stimulus thesis rests on one of two flawed assumptions.

1. Officials are expert at stimulating or allocating efficiently.

2. It doesn't matter where liquidity goes as it will multiply and create demand.

The only paper I trust these days is either labeled Charmin or produced by the Norwegian central bank, good luck with those insured muni's the fun isn't going to stop at the federal level, it could bubble up as well.  MBIA, AMBAC etc. bond insurance may not be a backstop, of course the state of New York can help out.

Black Swan group on Linkedin & the lo-fi finance model

For those interested, I manage the Black Swan group on Linkedin.  You can join here. 

The general discussion is in regards to systemic risk and how to think about extreme events.  My own biases are for the implementation of  Lo-Fi finance (low fidelity), the idea being a loosely coupled financial system is safer by design than any focus on strengthening individual components via micro-management.  

Lo-fi works on 2 levels, one is that it is the opposite of high fidelity a highly engineered system and it is based on individual units not trusting each other too much so they are more cautions.  Counter intuitively ratings agencies made things riskier.  After all nobody got fired early on for buying a AAA rated CDO tranche. 

Lower trust would have meant more independent thought.  Lo-Fi is safety at the expense of efficiency and innovation. The slow movement in finance if you will.

Instead of focusing on weak links in the chain such as specific instruments, participants or markets, I argue we should focus putting more space between the links via regulation.

If you want safer roads, don't put ever more airbags in the cars, make sure there is enough space between the cars, (more roads, fewer cars, slower speeds that sort of thing).  Yes this goes against most cultural values that push for ever greater speed and the role of the individual as independent unbounded actor. 

Glass-Steagall was an example of lo-fi finance, sub-optimal in terms of efficiency of scale but safer and thus more stable in the long run.  Lo fi would lead to more work on the analysis side of the business in smaller institutions and regulated boundaries to growth defined by either product or market niche.

Inside the US debt bubble

Any business or organization that depends on the charity of others is vulnerable to that charity being withdrawn.

The US debt outstanding is just under $12 Trillion dollars.

Roughly 43% of that debt has a maturity of less than one year according to The Economist. 

This equates to $5.16 trillion that needs to be rolled over or approximately $100 billion every week. 

If one assumes that the maturity of foreign holders is equivalent to the average maturity outstanding then the US and the world are playing a large game of chicken. 

The Treasury currently has the luxury of cheap money 3.5% on the 10 year and 4.40% on the 30 year, but can't be seen to go to far out on the curve in future issuance as it might kill the golden goose, but the rate of roll overs and amount of debt issuance is most likely to be stimulating in the next few quarters, pun intended. 

In case you are wondering about who plays the world largest game of chicken with us, here is the data from the Treasury of Foreign US Debt Holders.

 

I would recommend reading Nial Fergusson's The Cash Nexus to see how this game of Chicken has usually played out in the previous 300 years of debt and empire, then reach your own conclusions.

China or Japan doesn't have to sell debt to crash the price, the merely stop showing up at the auctions for a year and roughly half of the debt expires, with payments due.   As Japanese or Chinese populist it is a tough message to swallow, that you can't stimulate your own economy, because, there is some requirement to purchase more debt.

And yes Japan is in the same boat, just 20 years ahead of us.  It looks to be race to see whose bubble pops or melts first, the Japanese with a DEBT to GDP ratio of 190% or the US with a current debt to GDP ratio of roughly 80% but a legislated ratio almost 4 times that.  

He who pays the piper calls the tune and the music is starting to change.

Black Swan author is an awkward bird

Nassim Taleb is a mixed blessing, part cheerleader for ignoring the false rationalism of statistics in the realm of human folly we call economics and part self indulging jester for being "mis-understood" and protesting too much.  I think he suffers a case Roubini syndrome.

Roubini syndrome involves being right once about a big thing and therefore attributing every utterance and opinion subject to that opinion and framework.  Having only a single mental hammer seems to have forced both men to see all problems before them as nails.   

The risk in Roubini syndrome is that of the one hit wonder pop star who slowly fades away.  Both men have more to contribute but seem bent on correcting the media with ever more shrill voices.  They have an analog version of SIWOTI syndrome which currently keeps them from more interesting and lasting contributions to thought on economics.

Take a look at Taleb's latest paper Oct 18,2009 entitled Common Errors in Interpreting the Ideas of The Black Swan and Associated Papers.

The paper's first pages are a tiresome tirade, but he has some solid points in the back end of the paper.  My own opinion is that his overly emotional rebuttals to prior rebuttals to his work cheapen his voice and muddle the waters. Don't feed the trolls.  A good idea stands the test of time and the best of ideas attract the strongest of criticisms early on before being accepted.

New paradigms are rarely acknowledged as such immediately, that is the role of fads masquarading as innovations.  History and ideas of historical note are only acknowledged correctly in the breech.

My recommendation is that the Black Swan should sink or swim in the sea of ideas.  The author needs to let it leave the nest to defend itself and fly on its own.  Ideas once submitted for consideration are no longer their author's property, but rather become a part of a useful collective consciousness or fade away.   Paradigms are a group phenomenon whether true or not.

The gifted Anish Kapoor creator of the Cloud Gate sculpture in Chicago long ago accepted that it would forever forward be known as "the bean", such it is with all creators and their creations in the public domain.

So you want to run a hedge fund...

Hedgies have a certain stereotypical image as portrayed by the press.  That image is typically a male about 40-70 years old making hundreds of millions or billions of dollars a year.  This sells newspapers and lexus'. 

The truth while nice is not as grandiose.  Depending on whose database you follow, there are 8-12,000 hedge funds globally.  The term hedge fund itself is elastic enough to basically include anyone, who will place a bet on anything on someone else' behalf and charge 2 & 20 for the privilege.

Here is a little data.  Hedge funds success is like movie, sports etc. success in that a few do extremely well and most do fairly well.  The average (median hedgie) doesn't own or probably even lease a plane.   Note the data below most likely overstates incomes and returns due to survivorship and reporting bias which is significant in most hedge fund databases.  They are marketing tools after all.

Here is a break down using the Tass database over time.   One can see the evolution of a cottage industry paying white collar professional level salaries and then exploding.  More recent data would be interesting to see.  I have included the spreadsheet Download HedgeFund Data gogerty dot com I built for those interested in playing with assumptions behind the data.  Also note that some funds have a hurdle rate which may downplay the income more.

 

 

If anyone is interested in chatting about what makes a fund a more "successful business" drop me a line.  Getting more AUM (assets under management) is the goal of most funds. 

The magic threshold in this business is $100m AUM with +36 months of operations because these are the  levels where most institutions start looking at making allocations.   Instituional sales cycles for allocations are estimated at 9-12 months, while family offices are estimated at 12-18 months. Establishing trust takes time.

From an institutional perspective funds under the $100m AUM level are mostly noise.  As a hedge fund operator this means you chase high nets, feeders and those specialized in emerging managers etc.  which means lots of due diligence for smaller allocations. 

The business of a hedge fund is managing the investing process, managing the back office processes and sales in that order.  Growing and maintaining AUM is about establishing trust and faith in all the funds ongoing processes.  Hanging the shingle out with a sharpe ratio alone draws attention, but doesn't close the sale.

The back-office operations need to be stable and in place for real money to show up.

Return and Risk at the business level of hedge funds are as important as return and risk at the trading/allocation level of running the business.

Having top quartile risk adjusted returns is a good start.  Pros want to know about risk, ie. after verifying the apparent stability of the returns on the money, the need to verify the return of the money.  Fashions  come and go in various hedge fund sectors, but as a manager it is best to stick to your knitting.  Offering a 100/130 product for a long short value fund may work, but moving from value to convert arb is a stretch.

Mature back offices, SMA (separately managed accounts), operational stability and experience as well as lots of checks and balances are vital to the allocators due diligence process.

The more transparent all processes in a fund, the more successful it should be.  There are a few black box exceptions to this rule, but trust in process and people is vital to a funds survival.  Trust is built with more than logos with Greek columns and names that end in Capital.  Some of my favorite funds are the value based ones that put out newsletters or presentations extolling the thinking behind their positions.  Greenlight and Pershing Square are good examples of this.

Madoff was avoided by many banks who didn't understand the process he claimed to use. Acknowledging and then acting on ones ignorance is a powerful thing.  If you don't understand it move on.  "not getting it" may not be cool, but it is wise. Know thyself.

Another potential benefit of having investors understand about your funds operational and investment process is that they are more likely to stick around during tough times.  Many fund's revenue declined this year relative to previous years even though performance may have been extraordinary even adjusting for high water marks.  Redemptions reflect a lack of faith.  This lack of faith can be related to many of your funds aspects, don't make them your people or your processes.

Revenue adjusted for performance probably declined for hedges funds in 08-09 due to skittish investors who sold the "lows" of the fund.  Research into hedge funds and mutual funds shows the median investor under-performs the funds they invest in, due to buying high and selling low.

If someone doesn't have faith in your funds processes, then they are betting on your last month or quarter etc.  This isn't any way to build a stable business. 

I advocate transparency and openness wherever possible for a fund or fund of funds as it helps to retain clients.  The risk in transparency is that it shows a lot of these funds or FoF's for the smoke and mirrors marketing machines that many are.  Some black boxes in this business are black because they are full of junk, see Galleon, Madoff etc.

One could argue Buffet runs a hedge fund with an open structure that makes him immune to capital calls, this allows him to retain cash at the most interesting times and to compound returns, without having to change the rules of the game midstream such as putting up gates etc.

Running a small business, be it a hedge fund or dry cleaner is about trust and process building with employees, customers and anyone else who comes into contact with your firm.  Low trust or strong alpha male power based cultures should be avoided at all times.  Bullshit and bravado are often bedfellows that rarely build stable lasting enterprises.  As an investor I would seek funds with questioning & listening cultures rather than posing and posturing cultures.

About the charts above: my cost assumptions are for a small fund with 3 full-time employees, a basic  master feeder structure, no marketing payouts and outsourced legal, accounting and reporting functions in small office.  The incomes may be over stated by 20-40% due to high water marks, redemption flows, survivorship & reporting biases and start up costs.

18 rules of complex system failure

 This list below was on ZDnet and is a cut and paste job from this Brief Paper "How Complex Systems Fail"  by Richard I.  Cook.   I suggest reading Normal Accidents if this field of extreme risk interests you.

In finance complex failure at the largest level is called systemic risk and it is what we are currently facing. 

How many items below relate to a recent  failure or proposed solution?  (real estate, CDS and AIG, US DEBT bubble, stimulus...) the comments in parenthesis are my opinions.  My own solution is a lo-fi finance approach.

1. Complex systems are intrinsically hazardous systems. The frequency of hazard exposure can sometimes be changed but the processes involved in the system are themselves intrinsically and irreducibly hazardous. It is the presence of these hazards that drives the creation of defenses against hazard that characterize these systems.

(Finance is nothing more than risk allocation)

2. Complex systems are heavily and successfully defended against failure. The high consequences of failure lead over time to the construction of multiple layers of defense against failure. The effect of these measures is to provide a series of shields that normally divert operations away from accidents.

(robust checks and balances need to be in place at all levels.  Innovation is frequently a form of subverting these for the sake of efficiencies (capital, tax or otherwise).   Risk eventually shows up.

3. Catastrophe requires multiple failures - single point failures are not enough. Overt catastrophic failure occurs when small, apparently innocuous failures join to create opportunity for a systemic accident. Each of these small failures is necessary to cause catastrophe but only the combination is sufficient to permit failure.

(The media reflecting audience desire seeks to identify point failures. There is rarely just a bad guy or broken part. )

4. Complex systems contain changing mixtures of failures latent within them. The complexity of these systems makes it impossible for them to run without multiple flaws being present. Because these are individually insufficient to cause failure they are regarded as minor factors during operations.

(people and organizations fail all the time.  All things fail eventually.  Systems need to allow for system failure.  To paraphrase someone else: Capitalism without failure is like religion without hell.  It doesn't really function as social tool.)

5. Complex systems run in degraded mode. A corollary to the preceding point is that complex systems run as broken systems. The system continues to function because it contains so many redundancies and because people can make it function, despite the presence

(Optimization comes at the expense of safety: 100:1 leverage or some other "innovation" may seem optimal, but may be unstable.)

6. Catastrophe is always just around the corner. The potential for catastrophic outcome is a hallmark of complex systems. It is impossible to eliminate the potential for such catastrophic failure; the potential for such failure is always present by the system’s own nature. of many flaws.

(Only the paranoid survive, find a culture or organization that is fat and happy and you will find un-acknowledged risks.)

7. Post-accident attribution accident to a ‘root cause’ is fundamentally wrong. Because overt failure requires multiple faults, there is no isolated ‘cause’ of an accident. There are multiple contributors to accidents. Each of these is necessary insufficient in itself to create an accident. Only jointly are these causes sufficient to create an accident.

(See earlier comment in regards to the media, this also applies to congressional committees, which are typically witch hunts.)

8. Hindsight biases post-accident assessments of human performance. Knowledge of the outcome makes it seem that events leading to the outcome should have appeared more salient to practitioners at the time than was actually the case. Hindsight bias remains the primary obstacle to accident investigation, especially when expert human performance is involved.

(This is the forehead slap effect, that accompanies after a bubble event.)

9. Human operators have dual roles: as producers & as defenders against failure. The system practitioners operate the system in order to produce its desired product and also work to forestall accidents. This dynamic quality of system operation, the balancing of demands for production against the possibility of incipient failure is unavoidable.

(Unfortunately positive feedback in the form of earnings, bonuses and industry recognition, amplifies this bias.  A fair assessment of skill rarely gets in the way of ego amplified by culture.  Cultures be they national, organizational or group that assume instant monetary reward directly equates to insight or skill almost always fail due to this bias.)

10. All practitioner actions are gambles. After accidents, the overt failure often appears to have been inevitable and the practitioner’s actions as blunders or deliberate willful disregard of certain impending failure. But all practitioner actions are actually gambles, that is, acts that take place in the face of uncertain outcomes. That practitioner actions are gambles appears clear after accidents; in general, post hoc analysis regards these gambles as poor ones. But the converse: that successful outcomes are also the result of gambles; is not widely appreciated.

( Few do post-mortems on successful outcomes that deviate from the norm.  These are better than post mortems on failures as  they paid for themselves.)

11. Actions at the sharp end resolve all ambiguity. Organizations are ambiguous, often intentionally, about the relationship between production targets, efficient use of resources, economy and costs of operations, and acceptable risks of low and high consequence accidents. All ambiguity is resolved by actions of practitioners at the sharp end of the system. After an accident, practitioner actions may be regarded as ‘errors’ or ‘violations’ but these evaluations are heavily biased by hindsight and ignore the other driving forces, especially production pressure.

(See CDO's, black boxes and any obfuscation.  Wall street is excellent at packaging and selling things, fairly mediocre at purchasing them.  See the mutual fund industry performance among others in these regards.)

12. Human practitioners are the adaptable element of complex systems. Practitioners and first line management actively adapt the system to maximize production and minimize accidents. These adaptations often occur on a moment by moment basis.

(wrong incentives, confusing short term motivations versus long term risks are part of the system. We need to design, organizations and regulations with this in mind.)

13. Human expertise in complex systems is constantly changing. Complex systems require substantial human expertise in their operation and management. Critical issues related to expertise arise from (1) the need to use scarce expertise as a resource for the most difficult or demanding production needs and (2) the need to develop expertise for future use.

(Expertise is a false notion in complex systems due to their changing nature.  For this reason anything seeking to "optimize a system can make it unstable.)

14. Change introduces new forms of failure. The low rate of overt accidents in reliable systems may encourage changes, especially the use of new technology, to decrease the number of low consequence but high frequency failures. These changes maybe actually create opportunities for new, low frequency but high consequence failures. Because these new, high consequence accidents occur at a low rate, multiple system changes may occur before an accident, making it hard to see the contribution of technology to the failure.

(see above and regulatory reform etc.  The law of unintended consequences runs deep in complex systems.  The ratings agencies offering stamps of approval to structured products is a classic case of this.)

15. Views of ‘cause’ limit the effectiveness of defenses against future events. Post-accident remedies for “human error” are usually predicated on obstructing activities that can “cause” accidents. These end-of-the-chain measures do little to reduce the likelihood of further accidents.

(Establishing boundary conditions etc. that assume point failure, human error (greed,stupidity and crowd blindness) need to be built in.)

16. Safety is a characteristic of systems and not of their components. Safety is an emergent property of systems; it does not reside in a person, device or department of an organization or system. Safety cannot be purchased or manufactured; it is not a feature that is separate from the other components of the system. The state of safety in any system is always dynamic; continuous systemic change insures that hazard and its management are constantly changing.

(see above large stable systems are the results of small stable systems. Consider the role of audit integrity and other sub functions of the financial system.)

17. People continuously create safety. Failure free operations are the result of activities of people who work to keep the system within the boundaries of tolerable performance. These activities are, for the most part, part of normal operations and superficially straightforward. But because system operations are never trouble free, human practitioner adaptations to changing conditions actually create safety from moment to moment.

(System participants need to look out for changes, be they over or under performance of a system normal behaviour.  Keeping an eye out for "innovation" in finance is highly recommended.)

18. Failure free operations require experience with failure. Recognizing hazard and successfully manipulating system operations to remain inside the tolerable performance boundaries requires intimate contact with failure. More robust system performance is likely to arise in systems where operators can discern the “edge of the envelope”. It also depends on providing calibration about how their actions move system performance towards or away from the edge of the envelope.

(More work needs to be done discussing multiple points of failure in a system, including the hubris or collective myopia that lead to the failure.  My own belief is that a culture or group which reflects hubris, is obsessed with over optimizing or believes that today's profit means they are "right", are the things to watch for. For quants out there: beware of geeks baring gifts.)