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MEET THE GRAY RHINO
In the autumn of 2001, Glenn Labhart was chief risk officer at Dynegy. The energy company was considering buying an energy trading company whose stock had fallen by 80 percent in recent weeks, sending shock waves through the energy markets. Dynegy’s chairman and CEO, Charles Watson, knew the company well—or thought he did—and had a plan to buy its energy marketing capabilities for a song, stabilize the energy markets, combine the two companies’ trading capabilities, and protect itself from the exposure it already had in case the company failed. It was a chance to be a white knight, and to make some money in the process.
Labhart, a plainspoken, no-nonsense Texan, was a seventeen-year veteran oil-and-gas trader and a former risk consultant who now had a $42 billion portfolio of trading, power generation, and energy assets, along with the associated insurance and credit risk, under his oversight. He already had helped steer Dynegy through the recent California energy crisis and the aftermath of the 9/11 terrorist attacks. He had developed a dynamic tool to provide real-time risk-management information. Now he was tasked with assessing the risks associated with the $25 billion deal and advising the board.
He did a value-at-risk analysis of the company to generate a set of metrics not unlike the dashboard of a car, with its speedometer and gas gauge. It had already become obvious that Dynegy would have to put more capital into the company it was considering buying and assume a significant amount of its debt. The more Labhart looked at the company’s financials, though, the more concerned he became. “I extrapolated out to one year for risk-adjusted return on capital, and the results were sobering,” he told me in a conversation over coffee. He just couldn’t figure out how the company had calculated the profitability and cash flow of its trading operations. When he tried to envision standing in front of a ratings agency and justifying the deal, he simply couldn’t picture it.
Nearly fifteen years later, Labhart vividly recalled a 7:30 AM due diligence meeting, at the venerable Houston law firm Baker Botts, with Dynegy executives and their lawyers about their risk assessment. He told them bluntly, “If we’re going to do this kind of deal, we need to ask them how they value risk on non-liquid assets.” He presented his report to the board, warning members that the numbers didn’t seem to add up and that they needed to do more due diligence or hold off on the deal. “The report said we didn’t need to do this,” Labhart recalled. “I said we needed to ask more questions, but the train had left the station. I wish I’d had more lead time.”
The company to be acquired was, of course, Enron, the corporation that went down in the annals of business history as an example of the colossal failure of auditors, analysts, and investors to recognize that a firm valued at $90 billion was merely a house of cards. It has become a classic example of greed and willful ignorance of warning signals.
Recounting the story, Labhart quickly sketched a daunting organizational chart, outlining the short-term and long-term assets and liabilities and flows within the company. He drew an arrow and a circle around the thing that had set off alarm bells for him: the way the company marked its assets to market—an accounting practice commonly used for securities trading but which this company used to value its turbines. “How do you mark-to-market a turbine?” he asked. Unlike frequently traded stocks and bonds, turbines are large, unwieldy machines that simply don’t lend themselves to easy exchange—and for which, therefore, prices are hard to determine.
While Labhart wished his report had gotten the board’s attention soon enough to prevent the deal earlier, his warning wasn’t completely in vain. The report did convince board members to be sure to include protections in the deal, just in case he turned out to be right. “When you’re chief risk officer, you’re being second-guessed a lot because you’re taking a negative look,” Labhart said in hindsight. But even when you’re second-guessed there may still be room to make a difference.
As the date of the proposed merger neared, Labhart worked with management on a contingency clause that would reduce Dynegy’s credit risk by giving it ownership of the Northern Natural Gas Company, the only pipeline Enron owned and its most profitable physical asset. Enron put the 16,500-mile pipeline up as collateral.
On November 19, 2001, Enron filed with the SEC notifying it of $690 million in new debts, leaving Dynegy in a very difficult position. It had already channeled $1.5 billion in financing to Enron and assumed responsibility for nearly another billion dollars of debt. Rating agencies downgraded Enron’s debt to junk status. On November 28, as Enron’s stock price approached zero, Dynegy withdrew its offer. Early the next year, as its own stock price wobbled because of the debacle, it took possession of the pipeline, which, at least temporarily, stabilized Dynegy. The following year, the Global Association of Risk Professionals named Labhart Financial Risk Manager of the Year.
Dynegy’s experience and Enron’s collapse may be a particularly dramatic case, but the episode has much in common with events that unfold every single day for people faced with evidence of danger: we simply don’t want to see it. We avoid asking the questions for which we don’t want to know the answers, because we don’t want to deal with the consequences of knowing, especially when inconvenient truths get in the way of the stories we tell ourselves about how wonderful things will be if they go the way we’ve told ourselves they would. We view risks through rose-colored glasses, downplaying the possibility that our bets may go wrong—even as we overreact to less likely yet more emotionally resonant threats.
Even when we do recognize the existence of a clear and present danger, perverse incentives embedded in our political and financial systems—a heavy emphasis on short-term thinking, poorly allocated resources, and mispriced risks—are often arrayed against doing the right thing to get out of the way. As a result, we can’t count on the best designed warning systems in the world to sound the alarm loud enough to persuade our leaders to do what they need to do. Even when we acknowledge evidence of danger, all too often we don’t act until the threat is fully upon us—and, sometimes, when it’s too late.
But the consequences of the grim unfolding of human nature and perverse incentives—the Enrons, WorldComs, Long-Term Capitals, collapsed buildings and bridges, and disasters of all kind that litter our history, from the geopolitical to the humanitarian and the personal—are not inevitable.
In recent years, behavioral economists have identified many of the cognitive biases that keep us from acting in our best interests, and helped draw much needed attention to the ways in which warped perceptions and emotional and irrational motivations shape the decisions we make. In Chapters 2 and 3, we’ll explore some of these biases, along with strategies for countering them. An equally difficult challenge, to be addressed in Chapter 4, is the set of perverse incentives, structural obstacles, and crass calculations of self-interest—the tragedy of the commons—that prevent individuals, businesses, and governments from acting in time even when we recognize the many problems in front of us.
There are examples among the wreckage of people who see the danger, are willing to say something, and sometimes can prevent at least part of the worst-case scenario from unfolding. Their success is a combination of leadership and character, awareness of the ways in which we humans trip ourselves up and how we can avoid those mistakes, and sometimes sheer luck in having the right set of circumstances—for example, sufficient resources and a critical mass of others who recognize a challenge and are motivated to respond.
Breaking the Rules
Imagine that you’re on safari in Africa, where you’ve traveled far for a chance to see a rhinoceros alive before it’s too late. The Western black rhino was declared extinct in 2011, after five years without a sighting, and the number of all remaining black rhinos is in the low thousands. You know time is running out. You’ve seen the grisly photos of dead rhinos, with their horns brutally hacked off of their faces by poachers to be traded in Asia at a dearer price than that for cocaine or heroin.
It’s been three days, and you and your two best friends are anxious to see what you came for, to shoot a prize trophy not with a gun but with your top-of-the-line camera. The sun is so fierce that you can see the heat shimmering in the air. But you and your friends are determined, so focused on your mission that you ignore your guide’s instructions and drift away while he’s not looking.
You’re nearly ready to give up and return to the group. But, suddenly, there they are: a rhino cow and her calf. The massive mother flicks away flies with her tail and her long ears. You realize that you’ve forgotten to breathe: the very definition of a breathtaking sight.
The calf is several yards away from the mother, who is looking in the other direction. You creep closer, trying to get just the right angle. Getting a picture with your telephoto lens is one thing, but a close-up would be worth the risk. You forget everything the guide has told you about avoiding startling the rhinos by keeping out of their immediate territory, staying downwind, and being quiet. They’re more afraid of you than you are of them, he’d said.
Your friends are also too excited to remember the admonition to be quiet. “Try to get him to look at you so we can get a picture of his face,” one whispers. Without thinking about the consequences, the other friend whistles. The calf looks your way, but, unfortunately, so does the mother. That’s when you realize your mistake. You’ve disturbed a rhino cow. Worse yet, you’ve managed to get closer to her calf than she is. The baby rhino quickly scampers back to her side, but she’s still angry. She shifts her weight from one side to the other as she decides what to do.
That’s the least of your problems, though, because a bull rhino has appeared nearby, and he has noticed you, too. He’s easily half again as big as the cow. He lowers his head and paws the ground with his left hoof, preparing to charge. The tip of his horn is pointed right at you as he gathers all two tons of his weight and prepares to launch himself in your direction.
You’ve already ignored the advice the guide gave you—that the best way to avoid being charged by a rhino is not to provoke the animal in the first place. Once the rhino charges, it’s nearly impossible to stop him. But it’s too late now. The rhino has taken his first steps, and starts accelerating to his top speed of close to forty miles an hour.
As he bears down on you, you freeze. What to do? You could climb a tree, but there is none high or strong enough. Throw something in his path? Can you make enough noise to scare him? You could run in a zigzag pattern or in the opposite direction, but the heat has sapped your energy. If you were close enough to the safari vehicle, you could get the driver to put the pedal to the metal, but you’ve wandered too far from the group for that. You look at your friends for ideas, but they’re paralyzed, too. Your final option is to wait for the rhino to get close and then jump out of the way, counting on his inability to turn quickly to save you from being trampled. If there is one thing you must remember about what to do when a rhino charges, your guide has told you, it is this: Do not stand still. Freezing is not an option. But, so far, by (seemingly) making no choice that’s what you’ve chosen to do.
Thinking about what to do when facing a rhino’s charge is very much the way many leaders approach an impending threat, whether it’s a tectonic geopolitical shift with implications for the future of the world as we know it; a market disruption or a management challenge that affects the future of a company, organization, country, or region; or a personal decision with consequences for us or our families. When crisis looms, leaders need to make decisions quickly. Each choice depends on what happened beforehand; every error compounds the stakes. Good decisions ahead of time—like staying away from potentially angry rhinos—make all the difference. Once mistakes have been made, the stakes rise and the options narrow to the point where the choices are not between good and bad but among bad, worse, and almost unthinkable.
A Gray Rhino is a highly probable, high-impact threat: something we ought to see coming, like a two-ton rhinoceros aiming its horn in our direction and preparing to charge. Like its cousin, the Elephant in the Room, a Gray Rhino is something we ought to be able to see clearly by virtue of its size. You would think that something so enormous would get the attention it deserves. To the contrary, the very obviousness of these problematic pachyderms is part of what makes us so bad at responding to them. We consistently fail to recognize the obvious, and so prevent highly probable, high-impact crises: the ones that we have the power to do something about. Heads of state, CEOs of businesses and organizations, like all of us, are often worse at handling Gray Rhinos than they are at acting swiftly when an unexpected crisis arises seemingly out of the blue. This has huge and dangerous implications for leaders, who are particularly vulnerable to threats they ought to see coming but nevertheless fail to recognize and react to in time.
When facing a rhinoceros that’s about to charge, doing nothing is seldom the best option. Yet all too often that’s exactly what happens. Danger rarely comes as a complete surprise; instead, it follows many missed opportunities for taking precautions, reading and responding to warning signals. The impulse to freeze is hard to overcome. Sometimes the grip of denial is so strong that we do nothing at all; or, even worse, as in many market booms leading to bust, we do more of what was dangerous in the first place. Think of the family who wouldn’t evacuate ahead of a hurricane. The smoker who just wouldn’t quit. The president who wouldn’t give up his cheeseburgers until he had a heart attack. The gambler who kept digging himself deeper into a hole in the false hope of climbing out.
Perverse incentives and calculated self-interest can turbocharge our natural impulse for denial. Think of the bankers who were warned of the dangers of subprime loans but wouldn’t get out of these risky investments, and the policy-makers who wouldn’t step in. (“This time” is rarely, if ever, different.) The officials who knew how badly bridges had deteriorated but kept putting off needed repairs. The foremen of a factory building with cracks in the walls who insisted on business as usual until the whole thing collapsed. The supervisors and executives, warned of suspicious accounting, who refused to listen to the whistle-blowers. The engineers who knew how dangerous a flawed fifty-seven-cent ignition switch could be but did nothing to change it. The CEO of a market-leading company that failed to respond to the disruptive new technologies that took away its head start seemingly overnight and left it struggling to stay alive. The aging patriarch who knows the clock is ticking and it’s time to let the new generation take over but prefers to drive his company or country into the ground rather than relinquish control.
Many of the biggest problems the world faces are Gray Rhinos. Look at climate change, for which scientists have presented a clear case that more than 350 parts per million (ppm) of carbon dioxide is dangerous for the planet. Yet we are at 400 ppm and rising, as efforts taken so far seem to make only a dent. Rising sea levels are causing one catastrophic weather event after another: in New York City, hundred-year storms Irene and Sandy two years in a row; in the Philippines, Typhoon Haiyan, the most powerful storm ever measured. In 2013, forty-one weather-related disasters each left more than $1 billion in damages, a record.
Unsustainable national debt levels, anemic economic growth, and profound changes in labor-market dynamics have left many countries vulnerable to a new round of financial crises. Widening income disparities will intensify social unrest and political turmoil, sparking riots, toppling governments, and destroying economies. Water shortages around the world are already threatening populations, stability, and supply chains, and will only get worse: by 2030, the United Nations predicts, half of the world will face water shortages as demand outpaces supply by 40 percent. This will dry up crops and cause people to go hungry, force tens of millions of people to move from their homes, and could even spark wars over water sources that cross national boundaries.
Across the globe, in both developing and developed nations, youth unemployment is a huge problem contributing to desperation, unrest, and outright violence, along with a huge loss of human potential. By 2045, Africa will be home to 400 million people between the ages of fifteen and twenty-four who will need livelihoods, without which they will direct their considerable energies to protesting and worse. Africa’s youth already make up 60 percent of its jobless, and the problem will only intensify. How will Africa provide enough jobs for the rising number of youths and prepare the new generation for whatever the jobs of the future end up being—or risk the kind of unrest that makes the aftermath of the Arab Spring look like a child’s playground?
Disruptive technologies like 3-D printing will decimate some industries and launch new ones, just as the Internet has done over the past two decades to media companies that did not respond to change. Crumbling infrastructure will cost lives and bring cities and economies to their knees. More than a million people are moving to cities each week, feeding projections that by 2050 two-thirds of the world’s population will live in cities. Yet overburdened transportation systems, creaky power grids and sewage systems, outdated economic-growth models, and disengaged citizens mean that these rapidly growing metropolises cannot respond quickly enough to provide needed services, create jobs, and weave a new social fabric. Adding to the urban threat is the fact that most major cities lie along coastlines, where rising sea levels and increasingly violent weather—the result of the climate-change Gray Rhino—threaten the people who live in them. The frequency of pandemics warns of a much bigger global-health threat to come: it’s not a matter of if but when.
Ask any cyber security expert how likely it is that any given company or organization will suffer a major attack and he won’t hesitate to tell you that the odds are more than 100 percent; these incursions go on constantly. “There are two types of companies: those who have been hacked, and those who don’t yet know they have been hacked,” Cisco’s CEO, John Chambers, told the leaders assembled in Davos, Switzerland, for the 2015 annual meeting of the World Economic Forum. Cases like Target and Neiman Marcus are small potatoes compared with what is coming. The hackers who attacked Sony did serious damage to the company’s reputation and ignited a geopolitical confrontation. These are just the beginning.
All of these challenges, like rhinos grazing on the distant horizon, began as distant threats. The closer they get, the higher the cost of heading them off; yet the further off they are (or we convince ourselves they are) the less likely we are to do anything about them. Persistent threats can exhaust us, making it seem that we’ll never win, or making us complacent as the threatened disaster inches toward us too slowly to make us jump out of the way.
In some cases, these Gray Rhinos have the potential to become herds: rising sea levels, coinciding with the move to coastal cities, increasing the number of people at the risk of typhoons and hurricanes. Water and food shortages go hand in hand. So do water and energy, since it takes water to produce energy, and energy to produce water. Interconnections among global markets mean that a bank failure in one country has the potential to send financial systems around the world reeling and, in turn, throw people out of work and spark riots in the street.
In the zoological world, a rhinoceros herd is called a “crash”; I cannot think of a better choice of words. Any one of the threats described here can be overwhelming in and of itself. Combined, they are daunting. Prioritizing them is anything but easy. The pressures of daily life make it hard enough to cope with simple challenges, much less things that are so complex and overwhelming that they seem hard to grasp.
An Ounce of Prevention
But, you may say, these are all highly obvious crises. Global leaders recognize that they exist and are doing something about them, aren’t they? Unfortunately, it’s just not so. Our track record on many of the most obvious crises is dismal. One high-profile summit after another, from the G20 on the economy to the United Nations on climate to you name it, ends with little to show for all the hype and money spent on fancy hotels, catering, travel, and security details for global leaders who, despite the best of intentions, end up doing little more than hand-wringing.
Each year, the World Economic Forum surveys a thousand CEOs, government, media, and NGO leaders, asking them to rank which threats they believe are most likely to affect them in the coming year and how big an impact those threats will have. In 2007, the second edition of the Global Risks report identified a global asset-price collapse as the top risk in terms of potential severity and the sixth most likely to happen. By 2008, the report cited “mispricing of financial risk” as a central theme. Just months before Lehman Brothers collapsed, it noted that the predicted housing recession, liquidity crunch, and high oil prices were all happening, heightening the risk of a major collapse. Though the report based its assessment on the opinions of business leaders themselves, when it was released in time for the Forum’s annual meeting in January 2008, the business leaders gathered in Davos, Switzerland, pushed back, not wanting to recognize what they themselves had predicted.
In 2013, major systemic failure of the financial system was at the top of the list, followed by rising greenhouse-gas emissions and failure to adapt to climate change. Those surveyed also saw as both highly probable and high-impact a set of challenges: wealth gaps, unsustainable government debt, pandemics, and cyber threats, mismanaged urbanization, water-supply crises, food shortages, risks associated with an aging population, rising religious fanaticism. The 2013 survey asked leaders to assign their own countries a score on a scale of 1 to 5, from least to most able to deal with economic and environmental risks. The ten countries with a critical mass of respondents scored under 3.5, and four of them were under 3. In other words, all of them were mediocre at best in how much they had done to prepare for highly likely threats. Switzerland, Germany, and the United Kingdom scored highest on preparedness, with the United States and China close behind; Russia and Japan had the lowest scores; and India, Brazil, and Italy were in the middle.
Other surveys report similar results. When the United Nations Global Compact and Accenture surveyed a thousand CEOs in 2013, only 32 percent of those CEOs believed the economy was on track to meet the demands of a growing population within environmental and resource constraints, and just 33 percent believed that business was doing enough to meet those challenges.
Child death rates are dropping dramatically, yet every day 18,000 children die of preventable diseases, according to UNICEF. Pneumonia (17 percent of deaths), diarrhea (9 percent), and malaria (7 percent) are the biggest killers. They don’t have to be: we know the causes of these diseases; the amounts of money required to prevent them are well within reach; and there’s no disagreement that these are terrible ailments that need to be addressed.
Even at times when we think we’re dealing with a problem, we can be sorely wrong. Initial headlines about Typhoon Haiyan suggested that preparations for the storm had headed off a major disaster. As the typhoon approached in November 2013, an Associated Press article cited efforts by the Philippines to become more serious about preparations to reduce deaths from violent storms. “Public service announcements are frequent, as are warnings by the president and high-ranking officials that are regularly carried on radio and TV and social networking sites,” the article said. “President Benigno Aquino III assured the public of war-like preparations, with three C-130 air force cargo planes and 32 military helicopters and planes on standby, along with 20 navy ships.” Yet twenty-four hours later the headlines were very different: as many as 10,000 dead and more than 600,000 displaced. Sometimes no amount of preparation is enough.
Haiyan was not the only storm in which people died because of the overconfidence or complacency of leaders. In New Orleans, the Federal Emergency Management Agency shared a detailed, 113-page disaster plan with Louisiana state officials in January 2005, presenting an analysis of what would happen in a Category 3 hurricane, based on a simulation dubbed Hurricane Pam: “thousands of fatalities,” “floating coffins,” and “large quantities of hazardous waste … [that] would result in airborne and waterborne contamination.” Yet as Hurricane Katrina, a near-exact replica of the fictional Pam storm, approached that August—just months after officials had reviewed a clear plan for what to do, and right after follow-up workshops the month before and the same month—the city delayed its response and ignored nearly all the recommendations. The threat was as obvious as could be. The response plan was there. Yet it was almost as if the storm and the thoughts that went into preparation for it did not exist. The small element of uncertainty—when a storm would strike and how big it would be—was just enough to put officials into denial.
We all know that the sooner you deal with a problem the easier and the less costly it is to fix: a stitch in time saves nine. This principle goes all the way back to Hippocrates: Morbum evitare quam curare facilius est. An ounce of prevention is worth a pound of cure—or, as the French say, Mieux vaut prévenir que guérir. In German, Vorsorge ist besser als Nachsorge. In Spanish, Mas vale prevenir que lamentar! Or, in Swedish, Bättre stämma i bäcken än i ån.” (Better to dam the brook than the river.)
Alas, these maxims remain nice in theory but aren’t put into action nearly often enough. Of all the tricks that human nature plays on us, inertia is one of the most powerful forces preventing us from getting out of the way of a known challenge. How many students wait until the last minute to do that term paper, or pull all-nighters just before the final exam when studying earlier would have given them a much better chance of getting a good grade? How long have you waited past the recommended oil-change date for your car (and how much more would an engine rebuild cost than that simple oil change)? How many warnings might we ignore when a printer is running out of ink, and how inconvenient is it when the printer runs out before we’ve ordered a refill? Think of the impact of such everyday procrastinations magnified by the billions of people in companies, governments, even leaders making important decisions that affect millions, even billions, of other people.
The Little Dutch Boy of the Hans Brinker story walked by a trickling leak in a dike that prevented canal water from inundating fields and villages. But if he hadn’t known that a trickle could become a flood he wouldn’t have had the presence of mind to save his village. Alas, this legend turns out not to be Dutch; it is the product of the imagination of an American novelist. Nor could it even have happened, since dikes are giant piles of earth that would not have cracked the way the story depicts; it would have been impossible to save a compromised dike with a mere thumb. But the lesson in the story rings true all the same, and echoes the message that goes back in time to Hippocrates: decisive action can make all the difference if it comes in time.
No matter how good our intentions, all too often the only time we can act in the face of a threat is when it’s on top of us and when the cost is highest. This creates a vicious circle: we expend so much energy and capital in dealing with crises that could have been better handled early on that we believe we don’t have the resources to invest in heading off other threats early enough. It’s like claiming that we can’t afford to change the oil in our car because all our money goes to replacing an engine that would not have blown up if we had had the simple foresight to change the oil in the first place. This is the central paradox of Gray Rhino threats: rise to the threat too soon, while the threat is on the horizon, and your hands are tied; rise to the threat when you can access the resources you need, and the cost is astronomical, whether it’s a matter of softening the blow or picking up the pieces.
Not If but When
In The Black Swan: The Impact of the Highly Improbable, Nassim Nicholas Taleb writes about catastrophes with outsized consequences that are so rare and unthinkable that people weren’t prepared to face them because they couldn’t even conceive of their existence. At one point, Europeans knew only about white swans and could not picture such a thing as a black swan, hence the title: something so far out of the range of preconceived notions that most of us cannot imagine its existence. Black Swans are rare, create extreme impacts, and are not predictable, even though, in retrospect, the factors leading up to them may become clear. Taleb is talking about the descent of Europe into the Great War; the 1987 stock-market crash; the invention of the Internet; the rise of Islamic fundamentalism, and other such outlier events. The book was published in 2007, just as the credit bubble and risky mortgage lending and the derivatives industries of the early 2000s were leading to the failure of Lehman Brothers and the subsequent financial turmoil and deep recession that would come to be known as the Second Great Contraction. Its timing thus turned out to be opportune for providing a powerful metaphor for understanding the crisis that unfolded.
In a section of the book attacking humans’ overestimation of our ability to predict the future, Taleb jokingly speculated that someone might write an attack on his work under the name “The White Swan.” The Gray Rhino is not a rebuttal but a complement to the Black Swan. Taleb himself would argue that his readers who obsess about predicting the next Black Swan completely missed his point. It’s enticing to believe that we can predict the improbable, but we can’t. We just have to realize that unpredictable events will throw many of our assumptions out of whack.
Black Swans lurk outside of our ability to predict. Gray Rhinos are threats that we ought to see but often don’t see, or that we see but willfully ignore. Most Gray Rhinos are not the case of signals that were too weak but of listeners determined to ignore them and systems that encourage and accept as normal our failure to respond. There will always be people who are stubborn enough to ignore even the most obvious threat. But, as a rule, if a threat is obvious enough that a reasonable person can see it coming, it is a Gray Rhino, not a Black Swan.
Despite Taleb’s railing against our perception of our ability to accurately see into the future, most of the crises in the world are very likely occurrences. The biggest threats facing leaders are not highly improbable Black Swans but highly probable Gray Rhinos. We may not be able to foresee the details or the timing, but the outlines of the biggest threats facing us are hard to ignore.
Why worry about an odd bird when you’re facing a two-ton beast that is snorting, pawing the ground, and looking straight at you as it prepares to run you down? Gray Rhino crises are obvious and easy to picture. You can’t argue that a rhino doesn’t exist because it’s the wrong color: white, black, Sumatran, Javan, and Indian rhinos are all gray. Their potential impact is massive, whether political, economic, environmental, military, or humanitarian. Often, you’ve seen a Gray Rhino before because it may have happened to you or to others: a market crash, a war, a heart attack, a hurricane. It generally warns you before charging. The question is not if but when a Gray Rhino will happen.
The financial crisis that spun out of control in 2007–08 was a Black Swan for some, but plenty of people weren’t surprised: the crisis in the making was a crash of Gray Rhinos converging. There were many warning signals that the financial bubble that grew between 2001 and 2007 was well on its way to bursting. Plenty of people saw them and acted on their instincts. To students of financial volatility and the work of Charles Kindleberger, it was obvious that big problems were on the way. The International Monetary Fund and the Bank for International Settlements issued repeated warnings in the years leading up to the crisis. In 2004, an FBI report warned of widespread mortgage fraud. By 2008, foreclosures were at record levels. Christine Lagarde, then the French finance minister, warned at the 2008 G7 summit that a financial tsunami was on the way. William Poole, the former president of the Federal Reserve Bank of St. Louis, and Richard Baker, Representative of Louisiana, predicted Fannie Mae and Freddie Mac’s problems. Plenty of investors, both individuals and institutions, saw the problems. Some of them acted early enough to get out of trouble unscathed; others made fortunes on the collapse. Goldman Sachs, as we now know, bet against mortgages through derivatives contracts it bought from AIG. It even took out insurance against the collapse of AIG, because it saw that coming, too. The lawsuits that followed the financial crisis showed in excruciating detail how many firms knew that a collapse was on the way and bet against the securities they were selling to their own clients.
The 2008 financial crisis was far from a case of a lack of evidence in advance of the problem. The early signs were there. Many people read them. Others may not have acted quickly enough but were moving in the right direction, as shown by the Gallup Investor Optimism Index, which peaked at 178 in January 2000 but fell steeply from 95 in mid-2007 to 15 in the summer of 2008, not long before Lehman Brothers’ collapse. The index would plunge to a low of negative 64 that winter.
Yet the people in government and in leadership positions in business and finance who could have done something to prevent the crisis didn’t take this evidence seriously enough. Some may have chosen not to listen because they didn’t want to hear it. Others listened, then did a cold, hard cost-benefit analysis and calculated that the risks of staying in the game were worth it. The system was gamed to encourage behavior that was complacent at best, and irresponsible at the extremes.
Some people still insist, “Nobody saw 2008 coming.” Even former U.S. Federal Reserve Chairman Alan Greenspan has continued to claim that he didn’t see it. In 2013, he wrote in Foreign Affairs magazine that “virtually every economist and policymaker of note” was blind to the coming calamity. That’s not the case at all, but the failure to respond to the warning signs, even in hindsight, is typical. With many Gray Rhinos, like the 2008 disaster, not everyone will own up to the signals having been there.
The very refusal to recognize what ought to be an obvious threat is part of the Gray Rhino phenomenon. For a Gray Rhino to exist, enough has to have gone wrong that a threat is looming and a crisis becomes highly probable. At least some credible experts will have sounded the alarm. People know that something bad is going to happen. Or, at least, they should.
When George Soros saw the writing on the wall for the pound sterling, he bet $10 billion and earned, along with $2 billion in profits, the nickname “the man who broke the Bank of England.” In 1992, he realized that the relationship among the countries of Europe’s Exchange Rate Mechanism was at the breaking point. He borrowed British pounds and invested in German marks, triggering a run on the pound, which drove the value down by 15 percent against the Deutschemark and 25 percent against the dollar. Britain soon left the Exchange Rate Mechanism and floated the pound. Soros saw a highly probable event coming and made it into an opportunity for himself. In fact, one of the key lessons of Gray Rhino thinking is to see opportunity in responding to an imminent crisis.
Gray Rhinos may seem to appear most often as threats, but frequently they are value neutral: a combination of good and bad, depending on your perspective and how good you are at identifying ways to benefit. To television networks, the Internet began as a threat. To Yahoo and Google, the Internet was an opportunity. It took television networks quite some time to explore how the Internet could be a boon to them as well. High gas prices were a threat to gas-guzzling vehicles but an opportunity for hybrids. At least, this was the case in theory early on; it took consumers and automakers longer than one might expect to respond to rising gas prices.
When United Airlines destroyed the musician Dave Carroll’s $3,500 Taylor guitar and then refused to accept responsibility and pay for a new guitar, Carroll didn’t just get mad; he made a YouTube video that went viral, reaching more than 1 million viewers at this writing. United had failed to recognize the power of consumers’ newfound ability—through social media—to call out companies for failings and reach a wide audience; this large-scale failure made the airline vulnerable to an everyday, predictable problem that became a much bigger threat because of the power that the Internet had given to consumers. That same threat was a godsend to customers and to companies that did a better job of avoiding unfortunate incidents and owning up quickly and making things right when a problem occurred. Consumers’ embrace of social media also became a major way of communicating and getting valuable feedback on products and services.
In health care, changes are both opportunities and threats, depending on how creatively we respond. Obesity has reached epidemic levels in the developed world, driving up health-care costs and threatening lives. For those who suffer from diabetes, heart attacks, or other obesity-related illnesses, and pay for treatment, this is a full-fledged crisis. For health-care companies, it is an area for business growth. For companies whose products contribute to the problem, growing awareness of obesity is a danger—or an opportunity.
If It Bleeds, It Leads
Much ink has been spilled and many trees felled to describe why crises happen and the sequences of events that precede them. Yet it is just as important to understand why they don’t happen, or why they happen but are nowhere near as bad as they could have been. We can learn important lessons from the times when leaders get out of the way of a Gray Rhino. Unfortunately, we’re not as likely to hear about them.
In the news, “if it bleeds, it leads.” We all know about times when doing nothing or doing the wrong thing has escalated crises into catastrophes. Dangers averted don’t make the headlines, yet those are exactly the ones we need to study in order to avoid future catastrophes.
A key lesson of a famous business school case study, based on the Challenger disaster, is that it can be calamitous to make a decision based only on known failures. In the case study, students have to evaluate whether or not to run a car race on an unusually cold morning, when they know that their engine gasket sometimes fails at low temperatures. They have data only on races in which the gasket failed. The stakes are high: if they race and win, they stand to gain significant amounts of sponsorship money on top of what they already have; if the gasket fails, however, they lose their current sponsor and destroy their reputation. When you look at the data points from the failed past races, it’s unclear whether to race or not. But when you add in data from the successful races you see immediately that all the past successful races occurred at temperatures higher than those recorded for the morning of this race. It becomes obvious that the right decision is not to go ahead.
The engineers debating whether to launch the Challenger knew that the O-ring seals used in the solid rocket booster had a design flaw that allowed dangerous gases to escape and potentially destroy the space shuttle if it was launched at temperatures that were too low. The manufacturer had known about the problem since 1977, and shortly before the Challenger disaster it had been testing an alternative design. On the morning of the launch, several engineers warned that they did not have enough evidence that the O-rings would seal properly at temperatures lower than those documented at the time of any other launch. The NASA team pushed back, saying they saw no evidence of a link between cold temperatures and O-ring failure. “But, like so many of us, the engineers and managers limited themselves to the data in the room and never asked themselves what data would be needed to test the temperature hypothesis,” the Harvard professor Max Bazerman wrote of the episode in his insightful book The Power of Noticing: What the Best Leaders See. If they had done so, they would have known that the odds of a successful launch were too low, postponed the launch until a warmer day, and those astronauts would still be alive.
The lessons from that case resonate, in particular, with me. On the morning of January 28, 1986, when the Challenger exploded, I was sitting in a student lounge at Rice University in Houston. Many of my classmates and their professors had experiments riding on the shuttle or had connections to NASA. The disaster hit the whole country hard, but for the Rice community it was personal.
Many years later, I studied the Challenger case, handily disguised in the cloak of an entirely different set of circumstances, in an exercise at the Harvard Kennedy School of Government with Professor Bazerman. Our group struggled with the conflicting emotions of a team wanting to win a contest in which the stakes were high, though hardly as high as the lives that were lost in the Challenger explosion. We focused too much on the chance that nothing would go wrong; on all the reasons that the low temperature outdoors was not the reason the equipment had failed in the past. If we’d requested a full set of data, we would have seen that every single one of the successful tests was above a certain temperature, and would have decided not to go ahead. We didn’t ask ourselves the right questions about the data, which would have given us pause about proceeding. We failed to ask ourselves what made the difference when things went right.
In the real-life Challenger disaster, part of the problem was that the people making decisions weren’t asking the kinds of questions that would have allowed them to see that the right answer was to abort the mission until the O-ring problem was fixed. There are many other reasons that we fail to respond in time to warning signals: the quirks and foibles of human nature, including the plain old impulse to procrastinate; cultural taboos against raising the alarm; our bias toward overweighting positive outcomes and discounting negative ones; groupthink, or the tendency of people to reinforce the prevailing wisdom and ignore information that counters the story they have come to recognize.
Much as we grasp intellectually that the sooner we recognize a red flag and deal with it, the better, all too often we come down against acting to head off disaster. We know that a stitch in time saves nine, but we also have internalized cautionary tales working in the opposite direction. Perverse incentives reinforce this inertia and make it unlikely that we will recognize and deal with the most obvious threats.
We have a name for those who predict bad things to come, and it’s not meant to be complimentary: Cassandras. The word has come to imply someone who’s perpetually gloomy about the future—generally, one not to be believed. In the original Greek myth, however, Cassandra’s predictions came true. The daughter of King Priam and Queen Hecuba of Troy, Cassandra had the misfortune of catching the eye of the god Apollo. He gave her the power of prophecy, but when she did not return his affections he threw in a curse that prevented anyone from believing her predictions. She saw a Gray Rhino coming: the Greek attack on Troy. If only the Trojans had believed her, history might have turned out differently. The major lesson of Cassandra’s tale, which has become a tenet of Western culture, is that naysayers are not welcome.
The Five Stages of a Gray Rhino
As we’ll see in later chapters, cultural expectations are not the only obstacle to those who sound warnings. Human nature as well as organizational and social systems are set up to reinforce the status quo and a rose-colored view of what is to come. As we’ve already seen, denial is a deep-seated element in the lead-up to and aftermath of many crises. Denial, dangerous enough in the mind of a single person, becomes deadly when group dynamics come into play. If it’s hard to persuade one person to pay attention to a warning, it becomes exponentially harder as you add group members to the equation. Behavioral economists warn of the phenomenon of groupthink, which leads groups to seek conformity, making them extremely vulnerable to ignoring information that contradicts conventional wisdom and, in turn, leading to bad decisions. People would rather be wrong together than be right alone.
Even if we get past groupthink and other barriers to sounding a clear warning, it’s not easy to turn knowledge of a threat into action. If the first of five stages of response to a Gray Rhino threat is denial, the second and third stages include various reasons not to act. Usually, denial is followed by muddling, otherwise known as “kicking the can”; that is, finding ways to push the problem into the future. As it becomes clearer that muddling isn’t enough, we try to gain control over the situation, very much along the lines of bargaining, the third of the five stages of grief famously laid out by Elisabeth Kübler-Ross, which also begin with denial. In this third stage, our responses to Gray Rhinos can be useful, if tardy, diagnostic exercises, yet they, too, often devolve into squabbles over what the right response is. In both of the muddling and the diagnosing stages, which involve much wasting of time and opportunity, an array of entrenched perverse incentives and challenges of collective action stand in the way of acting.
In 1429, Joan of Arc heard God’s voice telling her to fight to save France during the Hundred Years’ War. A mere teenager, she convinced Charles VII to let her lead the French army against England, turning the course of the war in France’s favor and leading to a brief truce. After the truce ended, the Duke of Burgundy captured her and held her prisoner of war, then sold her to the English, who burned her at the stake for heresy at the age of nineteen. It was so rare for someone to hear and heed a warning that even the king, who owed her his crown, feared accusations of heresy and sorcery, which may have been why he did not do more to try to save her. The moral of the story: Act in time to save your people and get burned at the stake. For your troubles, you might eventually be made a saint a few centuries after your death.
In other words, no good deed goes unpunished. This is part of the reason too few leaders step up in time, unless it is on the off chance that they’re hearing voices, have a teenager’s sense of invincibility, feel that they have absolutely nothing to lose, or are a saint. It should not be as hard as it is for leaders to get out of the way of a Gray Rhino. But the odds are stacked against them standing up in time to prevent disaster.
Our financial, political, and social structures often encourage risky behavior and willful ignorance of threats. Being aware of these perverse incentives and ingrained biases is a first step toward changing the ones that we can change. The biggest challenge is the set of financial incentives and psychological predilections that favor short-term thinking over the medium and long-term strategies that could keep the danger at a safe distance on the horizon. Our system of rewards and punishments makes it easy to shirk responsibility for acting. The way we’ve set things up helps us to rationalize not acting. When this reason-based system collides with the irrational underpinnings of the decisions we make, it’s a recipe for disaster.
The tricks our own minds play on us make it difficult to get out of the way of a Gray Rhino. As a growing number of investors and policy decision-makers are coming to understand, we are not always rational when we weigh risks versus rewards or in how we act based on what we know.
Even when the foibles of human nature aren’t getting in the way, there are the genuine conundrums that make it hard to decide what to do. The trouble with many Gray Rhinos is that while there may be little doubt about whether a threat will materialize, the timing is far from certain. As John Maynard Keynes reportedly said, “The market can stay irrational a lot longer than you and I can remain solvent.” It then becomes difficult to prepare and to prioritize, for there are costs to acting too soon in responding to a threat or an opportunity. Investors speak ruefully of the widowmaker trade: betting that Japan’s rising national debt will crush the value of its bonds, a wager that for the past two decades has lured many investors to a tragic ending.
Michael Burry of Scion Capital saw the subprime crisis coming and began betting on it in 2005. But sticking with his bet cost him the support (and dollars) of investors who cared about short-term gain and complained that he wasn’t making money fast enough. To stick with his conviction until the trade played out, he had to fire half of his staff and sell parts of other bets. By 2007, of course, subprime loans had begun to unravel and his wager paid off. When all was said and done, Scion’s investment had returned 726 percent, generating nearly a billion dollars in profit. His story, brilliantly described by Michael Lewis in The Big Short, shows how hard it can be to act in time when there is an obvious threat—but also how profitable, if your pockets are deep enough.
Acting too soon on opportunities presents a similar challenge. The annals of Internet history are littered with the stories of early-stage companies that fell by the wayside after a new, more powerful generation of companies riding the Web 2.0 came along. Look at AltaVista, an early search engine that Yahoo later bought and eventually shut down in the summer 2013; or early Internet leader AOL, which Time Warner bought in 2000 for $164 billion, much of which Time Warner had to write off just two years later as nimbler players overtook AOL.
Another obstacle to our ability to deal with a threat is juggling which one to address first when we face many Rhinos at once. Given the uncertainty of timing and the scarcity of resources, it can be difficult to prioritize among competing Gray Rhinos. Sometimes the only choice is to face down more than one, because otherwise you’ll be trampled from more than one direction. Sometimes, though less often than happens in reality, the right response is to let the trampling happen.
Regardless of the reason leaders fail to act quickly to head off a threat, that, unfortunately, is what tends to happen. Eventually, muddling, fretting, and squabbling over what to do fail to avert the inevitable. We move into the fourth stage of a Gray Rhino crisis: a state of panic. How we respond in the panic stage depends on how much preparation we’ve done in advance: how many other times we’ve seen and responded to similar situations, how well we’ve envisioned the possible options once we’re required to act, and how many choices remain open or have closed to us as we muddled along and dithered over what to do. Good decisions help avert or minimize the impact of crises. Bad decisions lead to catastrophe.
The fourth stage, panic, moves quickly to the fifth and final stage: action or a trampling, or sometimes both. Even when it is too late, there can be hope: when picking up the pieces, leaders can work to make it harder to repeat the same mistakes. In the Netherlands, for example, the terrible North Sea flood of 1953 killed nearly 2,000 people. The country took the lesson to heart, embarking on a massive flood-protection public-works program to fortify itself against the kind of storm that comes along only once every ten thousand years. Cities like New York and New Orleans have turned to the Netherlands for advice on how to protect themselves from future catastrophic weather events—storms made more likely by our collective failure to respond to the Gray Rhino of climate change, which has raised sea levels and surface temperatures, making storms more violent and coastal areas more vulnerable.
Seeing the Rhino
We need a better way of thinking about Gray Rhinos: a framework for recognizing, prioritizing, and handling these highly obvious threats before it’s too late.
First, we need to distinguish the Gray Rhino from other types of threats, particularly its companion, the Black Swan.
White Swans are highly probable but low impact, so not deserving the kind of attention we reserve for the Gray Rhino. Fat Tails or Black Swans are events that are improbable and high impact. Because they are so improbable, and indeed largely unforeseeable in the case of Black Swans, the only way to respond is to create structures and systems that are generally resilient: strong foundations, ample reserves, flexible structures.
Gray Rhinos, by contrast, are both highly probable and high impact. The sooner we deal with them, the lower the cost. Unfortunately, the farther away they are, the lower the likelihood that we step up before they become more costly and our options become limited. This book is meant to shift that dynamic, to make us more likely to confront Gray Rhinos sooner, when the odds of succeeding are higher.
At each of the five stages of an approaching Gray Rhino, we have opportunities to change the course of events. You would respond very differently to a herd of rhinos on the horizon than you would to a rhino bull that’s too close for comfort. Similarly, the options and strategies for each stage of a Gray Rhino threat are distinct.
We begin by denying or minimizing the existence of a Gray Rhino threat; muddle along, instead of acting decisively, once we’ve recognized the challenge at hand; play the blame game as we search for solutions; come to an alert, panicked state when the Gray Rhino is about to charge, but we do not always have the tools to act wisely; and, finally, we do something—occasionally before the trampling, but all too often after the fact.
Important lessons are to be found in the ways in which leaders, organizations, and countries have or have not responded successfully. The difference between being trampled or not is part character, part luck, part circumstances, part strategy, and part leadership. Those who can anticipate a major disruptive change stand to profit. They also can change the world.
If leaders hear a warning and decide to ignore it, or heed the warning and do the wrong thing, they will be flattened, and remembered as a Neville Chamberlain rather than a Winston Churchill or as a Herbert Hoover rather than an FDR. They must wait to act until a threat is real enough to create a sense of urgency and push people to action, but they must not wait until it is too late.
Leaders need to start by worrying more about Gray Rhinos than about Black Swans, and finding ways to shock themselves out of denial and change our incentive systems to make it easier to respond. They can draw from the examples of the systems set up to save people from recurring crises like tornadoes, tsunamis, hurricanes, and even the annual flu virus, which do a respectable job of saving lives. These include ways to recognize signs of an impending threat, sound a hard-to-ignore alarm to people in its path, educate people ahead of time on how to react, and provide shelters and clear instructions when the threat is on the way. They must create fail-safe measures ahead of time that can trigger automatic responses to short-circuit leaders who attempt to deny the existence of a threat. A prescient Gray Rhino strategy changes perverse incentives in order to encourage leaders to act sooner, and uses our understanding of the weaknesses of human nature to make us more likely to do the right thing.
Leaders intent on avoiding tramplings would inoculate societies against the dangers of groupthink and find ways to keep fresh ideas flowing into debates and decisions. They spend time looking ahead to Rhinos on the horizon, even if that means letting less important, short-term problems get worse. They listen to diverse voices to avoid being told only familiar thinking.
The leaders best equipped to outsmart a Gray Rhino have access to warning signals and pay attention when the alarm sounds. They know what to do to get out of the way, or, at least, they blunder through enough trials and errors to mitigate the rhino’s charge.
By learning from examples of leaders who have faced down Gray Rhinos, whether they fail or succeed, we can do a better job of managing our countries, our companies, and our homes and families. The first lesson is that we can avoid being trampled only if we decide to do so. We need to recognize that Gray Rhinos are out there—and very, very dangerous.
Copyright © 2016 by Michele Wucker