Blog article
See all stories »

An article relating to this blog post on Finextra:

Gaia and the risk manager

Financial risk managers could learn a lot from the study of bio-engineering and natural sciences says Andy Haldane, the Bank of England's head of financial stability.


See article

At last! A coherent account of the financial crisis.

Andrew Haldane's paper "Rethinking the Financial Network" really is an excellent piece and the first convincing explanation of the current financial crisis that I've come across.  Highly recommended.

In a nutshell, Haldane's argument is simply that the complexity of the global financial industry has increased to such an extent that, like all such systems - eg the weather, oceans, rain forests - it is inherently subject to largely unpredictable and catastrophic collapses from time to time.  The familiar metaphor from chaos theory of a butterfly flapping its wings on one side of the world and causing a hurricane on the other is roughly the idea.  He goes on to draw valuable insights from fields such as epidemiology, ecology and the management of large networks.

This got me thinking about the role of the financial media in the crisis and I can't resist having a go, on several counts:

Firstly, they really didn't see it coming.

Secondly, most reporting is obsessed with who is to blame, when a corollary of Haldane's analysis is that it's a systemic problem - ie everybody and nobody is to blame.

Thirdly, despite the previous point, it's arguable that the media have played a very damaging role in exacerbating the problem (although this is a difficult one - Haldane makes a good point that the informed reporting of SARS actually nipped it in the bud; and maybe the same thing is now happening with swine flu)

Finally, and most importantly, why have we had to wait so long for a coherent explanation of the crisis?  Another of Haldane's points is that the financial system is fragile precisely because it lacks diversity - there is a dangerous herd mentality.  Maybe this extends to the financial media.  Maybe the FT should employ more ecologists or cyberneticians?  I don't know.

It will be interesting to see if Haldane's views get the publicity I think they deserve.  On the other hand, maybe he's wrong?  What do you think?

8079

Comments: (6)

Nick Collin
Nick Collin - Collin Consulting Ltd - London 02 May, 2009, 13:36Be the first to give this comment the thumbs up 0 likes

Postscript.  What should I find in this morning's FT but a good article by Gillian Tett on precisely this subject.  Very encouraging!

A Finextra member
A Finextra member 04 May, 2009, 04:09Be the first to give this comment the thumbs up 0 likes

Nicely summarised.  Haldane is a bright spot in the world of central banking, and his speeches are all worth analysing. I have been reading and re-reading this one.

You have hit on the core point of this one - that the problem with systems lies in the very lack of diversity.  This finding is worthy of note because it is intuitively the oppositive of what we might expect in a capitalist economy.  One would assume capitalism would survive based on diversity and opposing forces, yet this suggests the opposite. 

Fascinating stuff.

A Finextra member
A Finextra member 05 May, 2009, 09:40Be the first to give this comment the thumbs up 0 likes

I haven't read Haldane's paper, but based on your précis of it I'm afraid I don't find the thesis at all convincing.

The current financial crisis is not very different in character or depth to financial crises throughout modern history, from Dutch tulip mania and the Missisipi bubble in the 17th century, the South Sea bubble in the 18th, the Overend & Gurney and Barings collapses in the 19th century, and in the 20th century the panic of 1907, the crash of 1929, the S&L crisis of the 80s -- and in the 90s alone, the TLCM collapse, the Japanese asset bubble and Asian financial crisis. They seem to be getting more frequent.

Almost all of these crises were caused by the same thing: the invention of a new way of speculating and/or new new financial instruments that were (a) very profitable for their promoters, and (b) sufficiently complicated, novel or mysterious for people not to appreciate (or to be able to conceal) the risks involved.

The current crisis is no different. The 1929 crash was mainly caused by the widespread use of leverage, a new way of buying stocks that was very lucrative in a rising market but carried unrecognised risks. The 2008 crash was mainly caused by the widespread use of credit derivatives, a new way of packaging debt that was very lucrative in a rising market but carried unrecognised risks.

There is no need to invoke "unique complexity" as if this crisis is somehow something that has never happened before. It has happened many, many times before -- that's the depressing thing. The main difference this time is that it's global in scale, because of the increasing interdependence of the world's economies.

If you're looking for someone to blame, you could do a lot worse that focus on the regulators, whose job was precisely to prevent this from happening and who have so far managed to slide out of accepting any accountability at all.

 

A Finextra member
A Finextra member 06 May, 2009, 10:38Be the first to give this comment the thumbs up 0 likes

Paul - I thoroughly recommend reading the Haldane speech text. Especially before challenging it :)

The subtext is just as compelling, in my humble view, as the words at face value. Haldane implies that just like adverse weather conditions, epidemics, forest fires etc, systemic financial crises are not only inevitable but necessary in a system which requires evolution to survive (as capitalism does). That is exactly why blame is inappropriate. Kudos to Paul at finextra.com and Anthony Hilton of the Evening Standard for discovering/reading the speech and spotting its quality.

A Finextra member
A Finextra member 06 May, 2009, 16:23Be the first to give this comment the thumbs up 0 likes

Fair enough. Where can I find it?

A Finextra member
A Finextra member 06 May, 2009, 16:44Be the first to give this comment the thumbs up 0 likes

There is a copy of it available by clicking the link at the end of this article:

https://www.finextra.com/fullfeature.asp?id=1150

 

Now hiring