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.