Abstract thought drives science, technology, and business, but it needs to be balanced by a clear view of reality. Is that such a tall order?

by David Holt

Top people in all fields tend to be phenomenally observant. I remember an artist showing me the pattern a trowel had made in drywall as we sat in a restaurant, a musician pointing out the frequency of the well-tuned engine of a racing car, and a mathematician discovering the equation behind the underlying pattern in the gas consumption of his vehicle while driving.

Chess master Bobby Fischer sized up complicated positions at a glance. Napoleon was cool as ice amid the chaos of the battlefield, confident in his ability to improvise more skillfully than his opponent. 

The ability to master a complex arena and yet be able to see clearly among all the abstractions—and distractions—is the hallmark of true mastery. In this time of unparalleled complexity in human affairs, this rare quality is more important than ever. It is a quality that fascinated Pierre Wack. He graduated at the top of his class at the prestigious École Polytechnique in France and went on to consult internationally in business and economics. Wack was a left-brained analytical type who somehow recognized that this way of knowing was limited.

An inveterate traveller, Wack met an Indian philosopher who tried to teach him to clear his mind of all presuppositions and abstractions. This ran counter to Wack’s own inclinations, education, and work experience, but he was intrigued by the direction. The breakthough came when he was being instructed by a Japanese gardener (we would call him a landscape artist). In the West, the goal of a garden is to present plants in some ordered way, and even to teach people the names of the plants and the relationships between them. In contrast, in Japan a garden is meant to create a vista that will sharpen the perceptions of the observer, no matter where he is. The purpose of the exercise, said the gardener, is to teach the observer to see.

Suddenly the intellectual Wack “got it.” For the rest of his life he spoke of “seeing” as an art of the highest order. He sought out the keenest observers in every field and tried to learn from the clarity and simplicity of their perceptions. In time he went on to found the discipline of scenario planning at Royal Dutch Shell. Inventing techniques based on analysis and intuition, his team imagined multiple futures for the oil sector. When the energy crisis came in the 1970s, Shell was better prepared than most to weather the storm. As Wack came to understand, insight is the key. In large part, it is perceptual. It is simply “seeing.”

When deep analysis is not balanced by clarity of perception, much damage can be done. A recent article in Wired magazine tells the story of “the secret formula that destroyed Wall Street.” In 2000 a Chinese-born mathematician invented a formula that correlated financial assets and came up with the ultimate simplification of a complex financial universe—a single number. The formula unleashed a torrent of creativity in the trading world, as risk-filled assets called credit default swaps (CDSs) and collateral debt obligations (CDOs) were bundled up and hawked in the marketplace.

The mechanics of the model were so attractive that sales of these assets took off. By 2006, sales of CDOs reached $4.7 trillion; by 2007, sales of CDSs had soared to $62 trillion. But the complex formula hid a simple weakness. The model was based on 10 years of historical data at a time when housing prices, one of its key inputs, had only been going up.

When the hyper-growth of the U.S. housing market peaked and went into an inevitable decline, the correlations that the model was based on blew apart—and so did the appeal of the financial instruments it supported. Value started to disappear at a record rate. As housing prices plummeted, the risk-laden mortgages became too much for ultra-leveraged homebuyers, and the assets that had been bundled around the mortgages imploded, triggering panic selling across global financial markets.

The Wired writer explained the mass delusion. Consciously or not, everyone had assumed that housing prices would continue to go up forever. Rating agencies had bought into the allure of the magic formula, analysts had stopped looking at the values of the underlying securities (such as mortgages dependent on the housing market), and the “investment banks were making too much money to stop.”

When the housing downturn began, the inadequacy of the formula that had been followed by nearly everyone in the financial world was revealed. A powerful yet abstract theory was replaced by the recognition that, in the real world, uncertainty is always part of markets.

Real assets lost real value, and real people who should never have been issued risky mortgages suffered. Now, so does the rest of the economy. The creator of the formula has returned to China. His employer says he is working in a different field and is not available for comment.

David Holt is a writer and consultant on strategy and communications. He can be reached at dholt@eastlink.ca.