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Too complex to exist

June 18, 2009 | RSS | EMAIL | PRINT | 2 COMMENTS

All around smart dude Duncan Watts has some interesting stuff to say about networks, complexity and the current banking crisis. I found his explanation of systemic risk especially interesting. He explains that although there were people working to figure out just what was going on and how risky it was, ultimately they couldn't judge the risk associated to the kind of failure cascade that happened after Lehman went down.

Traditionally, banks and other financial institutions have succeeded by managing risk, not avoiding it. But as the world has become increasingly connected, their task has become exponentially more difficult. To see why, it's helpful to think about power grids again: engineers can reliably assess the risk that any single power line or generator will fail under some given set of conditions; but once a cascade starts, it's difficult to know what those conditions will be - because they can change suddenly and dramatically depending on what else happens in the system. Correspondingly, in financial systems, risk managers are able to assess their own institutions' exposure, but only on the assumption that the rest of the world obeys certain conditions. In a crisis it is precisely these conditions that change in unpredictable ways.

Tags: banking, economics, networks


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COMMENTS

1Matt

I have read so many stories - in last month's Atlantic especially - that attempt to explain the complexities of systemic risk and the impossibility of forecasting the future. But every one of them comes off as a big fat excuse for missing blindingly obvious realities.

Too many people were buying huge houses and living off credit, and too many corporations were cheering them on. It was a house of cards that we all knew existed.

And now we're going to let everyone off the hook by claiming the financial crisis was unforeseeable and unfathomable and oh-so-complex? Whatever.

June 18, 2009

2Noah Brier

@Matt - Ha. A very fair response. I think you're right, there are a whole bunch of really obvious people at fault. I think ultimately the problem is that at some level pretty much all of us played a part. I don't think the answer is let everyone off the hook. Frankly, I don't think "the hook" is really the issue at this point. For better or worse we're all in this thing now and it's all our best interest to get out, whether some people make it off easy or not ...

June 18, 2009